I chuckle quite often when I listen to all of the conspiracy theories and speculation about gas prices. The more interesting ones are the ones which revolve around the President and the Vice President. It's an unfortunate thing, as it shows the lack of education on the part of many individuals, especially liberals, about economics. So I want to share with you a little bit about the truth of gas prices.
First of all, don't complain too much about your oil prices. In Europe, the average price per gallon, as of May 2007 is about $6.50US. This past week I saw it for $2.84US in Raleigh, N.C. OF course it varies throughout the country. For example, it is about $3.60 in San Francisco and $3.46 in Seattle.
So what causes these variations? Well a number of things can be the cause. State and federal taxes, distance between refineries and filling stations, environmental laws, and international events.
So what actually goes into the cost of gas? Well, about 52% of the cost is in the crude oil, 13% in refining costs, 9% in profits, 9% in distribution and marketing, and 15% in federal and state taxes. Refining costs vary depending on state regulations. State taxes vary depending on the state.
Now, it is very funny how people lose their sense when they hear that oil companies are having record profits. Suddenly the oil companies are evil, and the government should do something to stop them from making profits, and lower the gas prices. Well folks, sorry to tell you, but it isn’t the oil companies driving up the price. The oil companies have about a 9% profit margin on oil. To put that in perspective, Intel has double those profit margins, but no one is yelling at Intel for having so much profit. And, no one is yelling at Yahoo, who not long ago, posted nearly 45% profit margins during the time the oil companies were having record profits, and they don’t provide any necessary services. Yes, the world would get along just fine without Yahoo. Google, at the end of the fiscal year, had posted a 29% profit margin.
Somehow, the oil companies are the bad boys, and they provide something everyone needs, including Google and Yahoo. But, you are probably wondering, still, why gas is so expensive. Well, the main reason is world demand, in particular, India and especially China. China is growing at an incredible rate, possible faster than it can sustain in the long run. And, it is consuming a tremendous amount of resources, which is getting bigger every day. However, the supply of oil is getting smaller. Now, economics 101 comes into play. Quantity supplied is lower and Quantity demanded is higher. That means price has to go up. Yea, I know you don’t want to believe it, but it is the reality of the situations. I know many of you would like it to be the evil oil companies taking advantage of everyone, and the evil Bush administration. Well it just simply isn’t the case. No conspiracies here. It is good ole fashioned free market economics.
Here is a bit of an explanation from Herman Sampson, a Distinguished Undergraduate Professor of Agricultural and Resource Economics, at North Carolina State University, who discussed the issue in summer of 2006.
“Why can we not do anything about the gas prices?
Well, you can. You can change your lifestyle, driving habits, the vehicle that you drive, ride a bike, use foot power, purchase a hybrid vehicle, demand less goods and services that use fossil fuel and its derivatives in the production process; and I could go on and on.
I think what you are really asking is "how can we lower gas prices and not change our lives or anything else?" If I had an answer for that one, I would be a very popular fellar and pretty rich as well. I hear folks "popin' off" all over town every time the gas price inches upward.
First, most folks don't realize that the inflation adjusted price for gasoline (called "real price" in economic terms) is still not as high as back in the 70's. You keep hearing that oil prices are at record highs. True in "nominal terms" but not true in "real terms". Oil would have to be $90.00 plus dollars a barrel today to be equivalent to the price of oil in the 70's. We are a little more than 2/3rds of the way there right now.
Over the course of the next 6 months or so, I suspect that we are going to have to learn to live with $2.00 plus gasoline prices. Now, why? Many reasons that are all coming together at the same time.
First, CHINA. Yep, CHINA. The world demand for oil has grown significantly and CHINA is the primary reason. The Chinese economy has grown by leaps and bounds and they are consuming more oil than ever before. The Chinese people are starting to earn enough money to trade in their bicycles and purchase an automobile. And, there are over a billion of those Chinese folks. That puts a lot of pressure on the gas pump let me assure you. We did the same thing many years ago. We traded in our horses and wagons for automobiles. Other folks want the same commodities that you and I enjoy. When more and more people want the same things out of life, that creates what is called "competition". So, the Chinese are "competing" with us for the available oil supplies around the world. As the competition heats up, so do the prices. It is called "bidding". Plain and simple.
The second factor is refinery capacity. Right now, there are adequate oil supplies around the world to satisfy world demand. The problem is, that we are not able to refine that oil fast enough to meet the demand for refined fuels around the world. Some of this problem is due to U.S. environmental regulations on oil refineries and distillate products (gasoline). First, environmental regulations became so onerous with respect to building new refinery capacity, that oil companies just did not do it. There was not enough incentive (profit) to do so. Our refinery capacity is old and not nearly as productive as new facilities would be. Environmentalism has costs and we are all paying those costs right here and now. The second environmental factor is all the different blends of gas that must be produced for the U.S. market. California gasoline is different from North Carolina gasoline for example. All these different states have developed different formulations for their respective states due to clean air requirements and environmental concerns of their respective political bodies. It is much cheaper to run large batches of a single fuel blend than it is to run many small slightly different batches of fuel blends. Also, we can buy gasoline pretty cheap from Brazil and Argentina and have it shipped right in to the Gulf Coast to help alleviate our capacity problems. But, no we can't do that because Argentina and Brazil gasoline is just run of the mill gasoline and is not "blended" for the U.S. market in terms of the environmental requirements.
In the past, Presidents have turned to the U.S. Strategic Oil Reserve to help ease oil and gasoline prices. By releasing oil from the reserve, the short run supply of oil increases and prices usually come down some and Americans become happy campers for a while again. The Clinton administration did this right before the election between Gore and Bush. Some believed it to be more of a political move to assist in the election of Gore than an economic necessity. Bush has decided to use the strategic oil reserve for what it was intended to be used for. Emergencies. We are not in an emergent situation yet. If Bush were to release oil from the strategic reserve at this point, many many would argue that it would be a political move. Gasoline prices would probably not come down much at all if any. Why? Because we are getting all the oil we need right now, we just can't refine it fast enough. If more oil becomes available, it is just going to sit there waiting for refinery capacity. More oil is not going to solve the refining capacity problem. Bush recently announced that the U.S. would no longer be adding oil to the strategic reserve to allow more oil to be available to the markets. In other words, instead of releasing oil from the strategic reserve, we have temporarily just stopped adding to those reserves.
There is also a lot of uncertainty left in the world around the Middle East in terms of terrorist activity and oil flow disruptions from the Middle East. As long as there are concerns about oil security in the Middle East, there will be a "risk premium" associated with oil. More recently there have been militant flair ups in Nigeria which have been causing a lot of angst in the oil markets as well. And then there is Venezuela that just recently nationalized its oil industry and is supporting Iran in terms of political rhetoric. Iran recently tested a high speed torpedo capable of sinking an oil supertanker right smack in the middle of the Straits of Hormuz and you are all aware of Iran playing with nuclear material and the worry that they are trying to develop a nuclear weapon. All of that makes markets very nervous. Uncertainty makes markets nervous and uneasy. Why? Because markets are simple people interacting with each other. Does the thought of Iran having a nuclear weapon make you nervous?
Oil and gasoline prices will eventually be a drag on the economy. Higher gas prices behave very much the same way that an increase in taxes behaves. We will probably see a reduction in folk’s discretionary incomes as they pay more at the pump. This will start to be felt by different industries. As I pay more for gas and diesel, I will be eating out a lot less I assure you. I won't have as much to spend at Wal-Mart, so my son Zack is going to get real tired of hearing, "No, No, No, No, No, and No". He is going to think that "No" is the only word that I know anymore. Folks may cut one or two trips to the beach out. All those folks down at the beach will make that much less money. Folks may not travel as much to see the fall colors in the mountains. Folks may purchase one less shirt or pair of pants. Folks may not throw that pair of underwear with a hole in them in the trash but wear them for a month or so longer.
Adjustments will be made and those adjustments have costs, and benefits. Already, the higher prices for fuel have resulted in flat growth in fuel consumption in the U.S. Most recently, prices have eased just a bit as the consumption of fuel has eased somewhat due to the higher prices. The latest worry is of course inflation. If you were wondering why the stock market tanked last week about 300 or so points, it was because the inflation report showed higher inflation that was expected by the markets. The stock market does not like inflation. The stock market now anticipates that the Federal Reserve will continue to increase interest rates. The stock market does not like high interest rates either. People tend to move their money out of the risky stock market for a sure fire return, interest in financial institutions covered by Federal Deposit Insurance as well as U.S. Government Treasury Securities. These have very very low risk compared to the stock market. Therefore, when interest rates are high, money tends to leave the stock market causing stock prices to slide. “
