Misperceptions about gas prices and price fixing

[lostinacause]

Misperceptions About Gas Prices
August 19th, 2005

There are a number of myths and misperceptions around the nature of pricing and the oil industry that have lead a number of people to believe that price fixing was happening. People look to the level of profits oil companies are making and wonder how competitive forces are allowing the price to remain so high. There is still about price fixing and collusion. The level of prices and profits can easily be explained by economics without incorporating collusion as a factor for the prices.

The main reason that the prices of oil are going up is likely demand. With the speed of growth that countries like China and India are having, they are continuously increasing the demand for oil. Because of the demand increasing and the supply staying relatively fixed the price will have to go up to account for the increased demand. In the short term things that were not profitable such as advanced oil recovery and wells that would produce small losses become profitable slightly increasing production. Even with this additional production the price is going to be above its original value.

In the long run more wells will be drilled to accommodate the increased demand but as time goes on the costs associated with drilling wells is also higher as the low cost wells have already been depleted. Many of the projects going on now are getting more complex and are not economically feasible when prices are low. Because of this many analysts expect the price of oil to remain high.

People point to the fact that oil company’s profits are very high. There are a few reasons for this. The first is that the price of oil has greatly exceeded expectations. Because of the long lead times before production starts oil companies have to gamble on what the price of oil is. They evaluate each project given the oil price they expect and account for the risk in there evaluation. Because of this when prices are lower then expected their profits are lower. When the prices are high the profits are high. Prices have greatly exceeded the expected price therefore companies are making a great deal of money right now.

The final misperception that I am going to mention is shortages. Some don’t believe that the demand has increased because there are no shortages. Shortages are not caused by demand increasing. They are caused by the price not being able to change quick enough to create equilibrium. Thus the quantity supplied is lower then the quantity demanded at the particular price that it is selling for. This can be done by a mistake in the market or because of an imposed price through legislation. Because there are no price controls there is no shortage.

As a result none of the indicators indicate that the increases in price are due to any forces outside of the market. While this does guarantee that there is no collusion, it suggests that there is no reason why it exists now anymore then it did before.

Source: Possiblylogical.com/blog
Author: Me

[nothingshocksmeanymore]

1. So let me get this straight..in a nutshell you are saying oil companies

are not gouging us. Correct?

[lostinacause]

6. What do you consider gouging? I doubt the price increases are a result of

collusion. Also even if I am wrong and there collusion is causing a bit of the increases it is not a significant amount.

I should also add that the last statistics I saw showed that even with the price increase the total amount of oil consumed world wide is up. (Collusion generally involves restricting the amount of a good that is sold.)

[nothingshocksmeanymore]

8. And didn't I read elsewhere that you feel the war was not for oil even

though they secured the oil fields but not the Tawaitha nuclear facility?

[lostinacause]

10. Yes and no. The level of wealth in Iraq clearly played a role in the

decision and the Bush administration did not want to pay for the cost of the war. There are some legitimate reasons for attacking Iraq. I don't believe that I have mentioned any of them here. I tested the water on it once and saw that it was not a topic that I wanted to discuss. As with most issues that have the high levels of complexity, I have a belief on what should be done that is mostly my own. While I do believe that Iraq is a necessary target based on the approach I believe in regarding terror, there were some very critical mistakes that bush made. Most of them involve choices that gave him short term boosts in the polls and compromised the situation America is in right now. There is also no place for the "If you're not with us, you are against us" in a democratic nation. Within the next two days I will have my opinion on the war in Iraq and how it should relate to the war on terror both on my blog and on DU. I will create a link to it here as well if you would like.

[nothingshocksmeanymore]

13. I'm real interested in your legitimate reasons for attacking a contained

threat

[lostinacause]

27. Thoughts on terrorism has been added to my blog. Although

it does not say anything about Iraq you can start to see where my path would be similar and where it would be different from the one that Bush has chosen

http://possiblylogical.com/blog/

I will have two more entries on terrorism. One on what I see as the ideal approach another on the strengths and weaknesses of Bush's plan (including the events leading up to it and his choice of language). Both should be done by Monday or Tuesday of next week.

[johnaries]

40. I read your blog, and what struck me was the last paragraph of the

"price misconceptions" section. You stated that there was no more reason to believe there is collusion now than there was before. However, there WAS collusion before! And the current situation is very similar to the previous occurences of collusion.

Therefore, there is no reason to believe that collusion is NOT happeneing again!

[I concur]

52. I could really give a...

flip whether gas prices go through the roof ($10/gallon)....in fact, I hope they do! Perhaps then this country will get on more ecologically-friendly modes of transportation to get around, maybe even bicycles (so that there's less obesity in America). Also the highways will be less crowded, when one does need to use them (HOV lanes will become a necessity of the past), and the skies more easy to breathe. Oh, and one more benefit with higher prices, as prices rise, GWB's legacy sinks!

[Mayberry Machiavelli]

33. It sounds like you're pretty much okay with the basic outline of what

Bush has accomplished during his presidency, aside from some errors in execution.

I guess my question is, why are you on a Democratic board?

I can't imagine you would have voted for Kerry or anyone other than Bush given the ideas you are espousing here.

If there were an election in 2008 with a Republican candidate espousing "stay the course in Iraq" and other candidates saying we need to leave, and I really hope there IS an election with that kind of choice, would you vote to "stay the course"?

I'd also hope there'd be a possibility that we'd already be out of Iraq, or that all major candidates promoted "U.S. out of Iraq".

[lostinacause]

58. Bush has not accomplished what America needs during his presidency.

Trade policy and terrorism, the two issues that I believe are the most important issues facing Americans; have not been adequately dealt with by the Republicans. The problem is that the Democrats don't seem to have good solutions either.

I also go on boards to disagree so it seems I am more extreme then I am. There are more then enough people criticizing bush here, I gain nothing from doing the same. I instead tend to discuss issues where my belief differs from that of the mainstream. This way I can find the shortcomings in my ideas and change them as necessary. With that being said I post on a variety of board and have found nobody who shares my beliefs. I am Canadian so I have never had the chance to vote for either Republicans or Democrats. I have voted for the (Canadian) Liberals both in both federal elections and have voted once for Liberals and once for the conservatives in provincial elections.

[lostinacause]

59. To answer your "stay the course" question:

I don't believe that leaving Iraq is a desirable choice. In the long run it will be costly as it sends the message "if you want us to go home all you have to do is kill as many of us is possible". This combined with the moral obligation that we have to improve the wellbeing of the Iraqis is enough that I think we have to wait until it is stable to pull out. I also believe that if we pull out now we will be back.

[lostinacause]

14. Any chance you could respond to the previous post?

[nothingshocksmeanymore]

15. I'm still trying to figure out what you are saying.

You seem to be defending oil companies and claiming there is no collusion, no price fixing and yet we see record profits for the past several years

[lostinacause]

18. If you need something clairified or expanded just ask.

I use some terms that have very specific meaning. I already know that I need to clarify the distinction between demand and quantity demanded in regards to another post.

[nothingshocksmeanymore]

20. I am interested in the legitimate reasons for attacking a contained threat

[lostinacause]

21. I was talking about in regards to this topic.

[nothingshocksmeanymore]

23. I think it all relates

[lostinacause]

25. How?

If the oil from Iraq makes it to the market it puts a downward pressure on price. Collusion would also become more difficult because of another producer. Thus even if I were to support going into Iraq solely for the purpose of getting oil, which clearly I do not, it would still not change the state of the world, nor would it change if my plan work as designed.

[Toots]

31. Gas in Iraq cost a nickle a gallon.

I suppose there was no collusion on Enron's part in the gouging of California in 2000 "Energy crisis" which immediately miraculously went away the day after the Senate switched hands. I heard a few days ago there would be refinery shutdowns for maintenance and such in near future.

[nothingshocksmeanymore]

2. So let me get this straight..in a nutshell you are saying oil companies

are not gouging us. Correct?

[lastknowngood]

3. Oil/gas is a monopoly who get together and decide exactly how

much the saps i.e. customers can pay and then they set the price daily. To believe otherwise is foolish, they are not in competition but collaboration to screw us and they own our house/senate and the white house.

[tx_dem41]

32. Don't they meet the first Monday after the Bilderbergers meet?

Or is it the second Tuesday after the CFR meets? I always get confused between the two.

[louis-t]

4. In other words.....

Nyah nyah, nye nyah nyah. Oil companies had record profits before the energy bill was passed, chimpy gave them a big fat tax break with very little incentive to look for alternate energy sources, and then the prices really took off. Neocons are manipulating an already tight oil market to their own benefit.

[lostinacause]

7. There is little economic justification for the tax break that Bush gave.

It is irresponsible given the way profits are.

[louis-t]

9. And they will not 'invest' their tax break

the way that little fuck is telling everyone they will.

[lostinacause]

12. As with any tax break some of it will be invested, however

the oil industry already has a good incentive to invest given what the oil prices are and are expected to be. The tax breaks would be far more effective if either put in to subsidizing high tech recovery research or other industries that would add more value to society. Personally the debt and corresponding deficit would be my pick.

[louis-t]

19. They will not invest in refineries

which are sorely needed and the only thing that can make increased production and drilling work.

[durablend]

22. Oh, they'll invest the profits...

Yachts, limos, private jets, mcmansions, etc. etc. etc.

[Greyhound]

5. Wow! It's getting pretty deep in here...

Record profits, in each of the 4 years * has been in office.

[Skittles]

17. I do not have boots high enough

:puke:

[johnaries]

11. Yes, demand has gone up, but supplies are exceeding demand.

Therefore, demand obviously is NOT the source of the price increase.
Edit to add a link:
http://money.cnn.com/2005/08/17/news/international/opec.reut/index.htm
The Organization of the Petroleum Exporting Countries is already pumping 1 million bpd above its anticipated requirement for 2006.

[rman]

16. you equate production to supply

As of yet it does seem that production is able to keep up with demand. But in order to do that oil companies have to resort to less attractive sources of oil, because the production of "sweet crude" has peaked.
Global production capacity is definately being squeezed by the demand.

[johnaries]

24. While it is true that refineries have been taken off line which has slowed

production, refineries have been taken off line before for no reason EXCEPT to drive up the price.

That is what I believe has been done again. That is why I believe it is "price fixing".

THAT is why I am calling for an investigation.

[rman]

26. uhm no;

Sweet crude has peaked, so now there is insufficient refinery capacity to deal with heavier crude.

=====

Refinery expansions efforts needed to match evolving crude supply - Report
Vienna, 17/8/05
http://www.opec.org/home/Special%20Features/2005/Fea082005.htm

Refinery capacity expansion plans are needed in the major consuming regions to reflect the evolving quality of global crudes if efforts to moderate crude prices and reduce oil market volatility are to be effective, according to the OPEC Monthly Oil Market Report for August. The report highlights the fact that recent production trends have resulted in a global crude slate that is heavier and sourer. At the same time, the refining sector has been slow to not only expand to meet the increasing demand but also to adapt to the changes in crude quality. The resulting constraints in the downstream sector have become a major source of upward pressure on prices.

“The recent rise in crude oil prices to new record highs — triggered by a series of refinery outages that have aggravated downstream constraints along with increased geopolitical tensions — only highlights the pressing need to enact concrete measures that would encourage rapid and sizeable investments in the refining sector,” the report said. The report noted that it will take several years to deliver the projects needed to ease current bottlenecks and prepare the appropriate refining capacity to meet expected demand. “Any delays will only continue the current mismatch between the installed refinery capacity and crude type, and undermine OPEC efforts, and those of other producers, on the upstream side to reduce volatility in the oil market,” it added.


OPEC Monthly Oil Market Report Aug.05
http://www.opec.org/home/Monthly%20Oil%20Market%20Reports/2005/MR082005.htm

also mentioned in the report:
"Brazilian oil supply is now expected to average 1.99 mb/d, a growth of 190,000 b/d versus 2004.
The performance in the second quarter of 2005 was better than expected, with the two new
deepwater fields (Barracuda and Caratinga) now reported to have reached peak production."

[johnaries]

29. This is NOT sufficient to explain the sudden increaseses in gas prices.

There are a lot of "smoke screen" explanations for the recent increases, but they simply don't add up.

The most common explanation is that it's because of "increased demand from China" which has already been proven to be false and misleading.

Look at history. This is NOT the first time this has happened, and previously it was shown to be manipulation by the oil companies. There has not been sufficient evidence to show that it's any different this time. You have not presented any evidence to show that it's any different this time. It happened in the 70's, and it happened in 2000 in California.

Perhaps the price increases are legitimate. But we will not know until Congress holds an investigation.

And the question still remains, why won't Cheney allow the discussions and decisions of his Energy Task Force be made public? Are they relevent to the current situation?

What is he hiding?

The American Public deserves answers. And we will never know if the current gas prices are legitimate until these questions and more are answered.

[Misunderestimator]

28. possiblylogical.com/blog which resolves to greenfieldlawn.com/blog...

There are exactly three entries there. This is one of them. Another one is about terrorism... where you write such things as:

"While many factors are said to be the cause of terrorism, I believe that the people of the Middle East lack self-determination an opportunity. The lack of both of these lead to anger and resent, making it so radical behavior and scapegoating can occur. Recent policies and action taken in the cold war by both the Soviets and the Allies has only made the problem worse. Furthermore through the conflicts the rest of the world has given the Middle East the power to wage war amongst themselves and against the rest of the world."

I've read that entry a few times, and I truly can't tell where you stand on the issue of terrorism, or even what you meant by the quote above. Does the US have no blame in your mind?

Then this apologist thread defending big oil...

[lostinacause]

50. I rewrote it. It should be a little clearer.

As with any country supplying arms to the area, America does share some responsibility for what happened. I understand why each of the players did what they did and given that one side intervened in that area, the optimal decision for the other side was to follow. Even given that America and the rest of the west shares some of the responsibility for what happened, it is still necessary that some solution be found to solve the problems dealing with terrorism.

[salin]

30. back in 1998 prices at the pump skyrocketed

then they declined - nearly everywhere... except northern california (and perhaps elsewhere in the northwest.)

All sorts of reasons were given - refinery fires being the favorite.

There was an effort among independent gas companies to offer periodic lower cost gas days. And suddenly there was immense efforts to run those folks out of business.

When Sen. Barbara Boxer threatened a senate investigation into possible collusion and price fixing... suddenly the prices began to drop and mirror the rest of the country.

Interesting thing is - that while prices stayed high in SF Bay Area (around 2.00 a gallon) - there was a gas price war in LA (1.00 a gallon). Seems that the prices in the north were being used to subsidize a price war in the southern part of the state that was being waged to force.. you guessed it - independent owners out of business (because they couldn't subsidize their losses by inflated costs at other stations in the northern part of the state.)

Point being, the idea of some price-fixing really isn't an absurd concept - it has been done before.

[Pepperbelly]

36. Two factors drove the prices down ...

First, Clinton released a significant amount of the oil reserves.

Second, Clinton had the DOJ open an investigation into price gouging nationwide.

Then the prices tumbled.

[salin]

37. They tumbled everywhere.... but Northern California

and IIRC Clinton undertook that per Boxer's loud pushing for it (eg she was a major instigator.)

Notice the actions today - the Bush admin has accelerated its buying of oil for "reserves" for more than a year... keeping demand high and supply more scarce.

[Pepperbelly]

39. of course ...

He will continue to do so as long as it enriches himself, his family, and his monied friends.

He is a despicable, deplorable, greedy monster with messianic delusions, unbridled ego, and a certainty gained from solipsistic self-aggrandizement. If it benefits him, it is good for America. I hope it burns when he pees, a fiery rope of lava twisting from his bladder down his urethra and out his shriveled penis.

[salin]

41. now you did it!

now I have to learn a new word (I, who was once teased unendlessly by a SO per my rather robust vocabulary)... "solipsistic" ???

btw - always great to see you, Pb!

[Pepperbelly]

43. good to see you, friend salin ...

And doesn't 'solipsistic' work beautifully for Bonehead?

How is the weather in your fair college town? In mine, it is miserble hot, feels like a big dog breathing on you when you step outside. God bless air conditioning.

[salin]

45. same in this college town...

steamy. Just guessing, due to geography, that yours might be a tad steamier.

Indeed it fits that hedonistic, self-centered, megalomaniac to a tee.

Solipsistic: The theory or view that the self is the only reality.

[Pepperbelly]

47. pleased to see you...

Hail to the chief!

:smoke:

[Mayberry Machiavelli]

34. You need to edit or spellcheck your blog, esp. the first essay.

Only 12 hits on the hit counter so far, so you have plenty of time to make a good first impression.

[Tom Yossarian Joad]

49. A grammar checker would serve him better from what I've read...

:toast:

Pomposity & bad grammar don't mix.

[lostinacause]

51. It should be a little clearer now.

Regardless of how bad my grammar is, there is no purpose behind unnecessarily insulting me. Since going on this forum I have treated people far nicer then they have treated me. My English has always been weak. Up until recently I have not seen it as critical to my success. Surely there are things that you, or for that matter anyone, else is bad at. Would it be fair for me to rub those into your face?

As for my arrogance; it was inevitable. I was picked on when I was a child and since I about 16 I have been very successful. I have a natural understanding of philosophy and as you may know philosophers are generally among the most arrogant people. As of the last year I have started to come to terms with my arrogance and while it is still bad it is not what it used to be.

We are also talking about two issues that I have better knowledge of then most people so I am more likely to believe that my knowledge is absolute.

[Tom Yossarian Joad]

60. "so I am more likely to believe that my knowledge is absolute." LMAO!!!!

God, I hope you are being sarcastic.

Pomposity + Hubris + Arrogance = Easy Target.

[lostinacause]

61. There are certain truths that most people hold as absolute.

Basic Math would be one such truth. The more knowledge an individual has in one such area the more likely they are to feel that thing in that area are absolute truth. To hold nothing absolute would render a person useless. To hold everything absolute would do the same thing. I bother to go on because by now you either understand or you won't. Either way you have shown a personal weakness in the way you have addressed me. I hope you will learn as I have that compromising yourself by attacking people who disagree with you weakens both of you.

[lostinacause]

62. I should also add the question;

Why do you feel you must be predatory towards me? What are you trying to accomplish? You can't claim that you were trying to change any characteristic about me because a rational conversation is the best way to change people. So why were you deliberately trying to cause pain to someone?

[Pepperbelly]

35. why deny reality?

These bastards are gouging the shit out of us as evidenced by their skyrocketing NET profits. They are awash in cash right now. Merely passing along the increased cost of the crude would not cause profits to soar. They are price fixing.

And no, since we had this discussion before, your attribution of the increased profits to market vagaries is nonsense. It COULD POSSIBLY account for fluccuations in prices but not in NET profits.

What is your stake in acting as an oil company apologist here?

Would you support a massive investigation into price fixing?

On edit, I just re-read your explanation of high profits and under than scenario, the profits would have decreased, not increased. If the price exceeds plans, then it cuts profit.

[lostinacause]

53. "My stake"?

I live in Alberta (Canada) and my girlfriend works at an oil company. So my wellbeing is influenced by higher prices but not by enough to compromise my integrity.

Because of where I live I have a better understanding of how the industry works and more information about the trends and behaviors of the industry are available through the media and post secondary institutions.

My goals are the same as they are when other issues, to adapt and expand my beliefs and to spread the information that I believe is correct. You have to understand that I am getting around twenty people looking for shortcomings in my argument.


As far as the pricing argument goes here is a simple example of how the price of an output exceeding expectations leads to higher Net profit (and higher economic profits)

Let
P1 – situation where price is expected price
P2 – situation where price is greater then expected price
C – Costs of production (fixed and variable)
N – Number of items produced
P21 – price difference between 2 and 1 which is positive

Profit = revenue – costs
Profit =quantity produced * price – cost

Net change in profit = Profit2 – Profit1
= (N * P2 – C) – (N * P1 – C)
= N * P2 – N * P1
= N (P2 – P1)
= N (P21)
Therefore since N and P21 are both positive and net profits go up when commodity prices exceed expectations.

[lostinacause]

57. I believe that the primary purpose of any investigation would be

to make people feel better. Given the desire here it might be a good strategy. There are usually indicators of price fixing beyond what has been seen with the increasing prices we have faced. When these indicators start to surface then would be a good time to start an investigation.

The problems that American consumers are facing are similar to what Canada is facing so it is likely not a result of collusion at the retail end. Factors such as the falling dollar have also made the prices increase.

[rustydad]

64. Price fixing?

The truth is that as prices rise the value of oil-on-the-way, that is oil already purchased and waiting delivery or in the pipeline jumps in value over what was paid. Oil is future purchased, sometimes a week or a month or months ahead. What should be happening is price driven demand destruction through higher taxes on gasoline. That way the demand is reduced and the extra money paid by the consumer goes into the public treasury rather than Exxons bottom line. We are at *Peak* folks. Here now and forever. Bob

[Dover]

38. And I suppose the auto companies are pushing gas guzzlers because

Americans so desperately want them? That's why when more efficient imports begin to win market shares, they put restrictions on Toyota and other foreign car imports and also lobby in Washington to remove gas efficiency standards.

The oil and auto companies seem to have similar strategies. Can anyone explain the relationship or what these confounding strategies are about that seem to hobble our economy and hurt all but those in these industries?

[WMliberal]

42. in case you missed the 1970's, collusion is the whole idea of OPEC.

They are a cartel. They meet to mutually decide how best to control supply to keep prices artificially higher.

[Pepperbelly]

44. but then we have collusion on top of OPEC ...

within the USA and that is actionable. It damned sure is.

[WMliberal]

46. plus $20+ per barrel added due to speculation of the war and fears of

an Iranian embargo.
Every penny of that speculation goes into the profits of the oil giants, as it is not at all related to an increase in production costs. It's a lot like the "fees" charged by credit card companies and banks.

[lostinacause]

56. When two companies are colluding the natural response

would be for one of them to increase production. IF OPEC is colluding effectively and they realize that American firms are reducing production OPEC's best response is to increase production. Knowing this, American companies are unlikely to decrease production since it will only result in less oil to sell at the very best at a marginally higher price.

[Mayberry Machiavelli]

48. If you read his blog, I think he DID miss the 70's, says he's a student at

a Canadian school of Economics.

[lostinacause]

55. Opec is now mentioned in passing.

I did not see it as relevant to add since OPEC is not bound to the same laws American companies are. There collusion is their goal and this is well known.

[lostinacause]

54. I was talking about American companies and supposed collusion.

Perhaps I should state that more explicitly in my blog.

[ProfessorGAC]

63. You're Essentially Right, But. . .

. . .you left out the biggest single factor. The oil industry, because they run in a high demand (basically a constant) commodity business, they are in the comfortable position of running a Fixed Margin marketing plan.

The operating margins are based upon a fixed percentage above raw material + variable operating costs + constant overhead abosorption. In this way, when oil prices are high, (raw material), the fixed percentage is a larger number. For instance, one gallon of crude at $1, plus 10 cents of total overhead and variable costs would be $1.10. At a fixed margin of 30%, the minimum market sales price would be $1.43. The company makes 33 cents. But, if oil goes up to $1.50, the sales price goes up to $2.08, since the market is actually fairly predictable and the brokers buy direct from the refiners. This means the refiners make 48 cents on a gallon.

These are all high end examples to make the point, but because of the unique situation in which gasoline is such an elastic commodity, there is no advantage for any company to sell on price. At the same time, nobody can charge too much more than anyone else, since there will be a lower price just around the corner.

So, there's no price fixing, merely an economic "coincidence" that drives the prices to the same level, in a highly elastic way. And, since no country can function without fuel, they get away with a very opportune pricing structure.
The Professor