Breaking Down Gas Prices for Whoopi Goldberg
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One story in the news was brought to my attention yesterday by my wife, and it gives me the opportunity to clarify some misconceptions. On the ABC show The View, Whoopi Goldberg went on a rant about gas prices:
In a nutshell, Whoopi is angry that gas prices are so high, and essentially feels like this is simply the oil companies ripping off the public. She points to the latest quarter of oil company profits — expected to be very high — as evidence. She asked ABC News Correspondent Jim Avila to explain the situation to her, and while he did provide some useful information, he also muddied the waters somewhat. He pointed out that fear is largely driving the market, asserting that there is no good reason prices should be where they are. I would be interested to hear someone explain where they should be, and the basis for their answer. Yes, the oil market is being driven higher by fear, but the market isn’t totally disconnected from supply and demand. We are not, in fact, swimming in oil. There are real supply issues, and Russia just issued their own warning that the easy oil is about gone. But the whole issue of tight supplies was completely denied in the Goldberg segment. Further, Avila made mention of “the people who control the prices” which perpetuates the myth that oil companies are sitting back and pulling the strings (more on that below).
Understanding The Hows & Whys of Refinery Operations
But where Avila really muddied the waters was in asserting that refineries are not producing as much as they can. I covered this quite extensively in the post on gasoline myths. Refineries have to be maintained, just as you have to maintain your car. The most popular times to take refineries offline are prior to the summer driving season, and following the summer driving season. So each spring and fall we see refinery utilization fall. (The reason most maintenance isn’t done during the lowest demand period — winter — is because the weather isn’t conducive to maintenance at that time). According to the Energy Information Administration, current refinery utilization in the U.S. stands at 82.7%. Avila commented the refineries aren’t being completely utilized; that there is still 20% capacity left.
That’s wrong on two counts. First, if you look at refinery utilization historically, overall utilization only rises above 90% once maintenance season is over and high summer demand starts to kick in. But utilization is never 100%, because the 150 refineries in the U.S. are never going to be running at 100% capacity at the same time. There will always be issues with refineries that cause production to be curtailed here and there, which is why the practical limit of utilization is around 95%. So there isn’t 20% capacity left. Further, the practical limit during maintenance season is even lower, so it is a fallacy to imply that refiners are deliberately withholding capacity.
Avila rightly pointed out that gas prices always seem to fall much slower than they rise. In fact, this phenomenon has been documented. The reason for that is that consumers are less choosy when prices fall, and retailers don’t have to be as aggressive with their pricing. When prices rise, consumers will drive across town to save a nickel, but when they fall, consumers are just happy that they are going down. Refiners and retailers alike will have more difficulty maintaining profit margins when prices are rising due to consumers being more selective, and they will try to make up for that when prices are falling. When I explained this to my wife, she said “So they are gouging us!”
Correlation Does NOT Imply Causation
That gets into the whole discussion of what gouging actually is. Whoopi captures the anger of many Americans when they notice that they are paying record prices for gasoline, while the oil companies are reaping record profits. When I try to explain to people that oil companies (particularly U.S. oil companies) can’t really do much to influence oil prices, they will invariably ask “Then how do you explain the record profits?” That confuses two issues. To say that they don’t control prices is not the same as saying they don’t benefit from higher prices. Oil companies make a lot of money when oil prices rise. (Pure refiners can actually lose money under those circumstances, because they have to buy oil and may not be able to pass the higher costs along). But they are along for the ride, as opposed to operating the ride. Oil prices are set on the world market by how much people are willing to pay for the oil. ExxonMobil doesn’t raise prices so their profits will go up, their profits go up because world oil prices went up.
To get a better understanding of the difference, presume you bought a house for $100,000 in an area where demand for homes is rising. Three years later, you sell your home for $400,000. Question: Are you a scumbag who made a windfall profit by gouging the purchaser of your home? No, you would say that you sold your house for what the market was paying, and you were fortunate to be in the right place at the right time. You didn’t make money because you priced a $100,000 home for $400,000, you made money because the market had bid up the price of homes. You were a price taker as opposed to a price maker.
U.S. oil companies are the same: They are price takers, and right now oil prices are providing them with big profits. (OPEC is a different story; as a group they wield significant power as price makers). Of course ExxonMobil could decide to sell all of their oil for $20 under market prices, just like you could decide to sell your home for half its market value. What would happen in that case? People would snap up the oil (or the house) and then turn around and sell it for market value. So Exxon would simply forgo profits and someone else would take them.
Conclusion: Whoopi is Clueless
So when Whoopi asks “How can they do this to us? Don’t they know they are hurting the American people?” — I don’t think she understands what “they” are actually doing. They aren’t scheming to see how badly they can rip off the American public. They are producing oil and refining it into fuel and other products, and as a result of much higher prices they are making a lot of money. I know that it feels like we are being ripped off when we see our dollars show up as record oil company profits, but that is far more a function of supply and demand (with some portion due to speculation) than it is a conscious effort by oil companies to extract more money from the public. It is also important to keep in mind that oil companies are in the business to make money, but if they really could control prices then we wouldn’t see the kind of volatility in the market that we have seen the past few years.