Monday, November 07, 2005

The Free Market strikes again!

Remember how everyone was freaking out about how gas prices were going to go up to at least $3.00/gallon? I remember the hysteria from one of the executives where I work - he was predicting that gas would jump to at least $4.00 or maybe even $5.00 a gallon. I don't know where he was coming from. Maybe he had watched The O'Reilly Factor and listened to O'Reilly's insane populist "the oil companies are evil" schtick. Maybe he was just making a bad inferrence, or maybe he just didn't have a clue about what a free market is. I know that a lot of people threw the basic economic laws of supply and demand out the window after Katrina and Rita ravaged the Gulf Coast, but in the end it looks like economics trumped hysteria. Sure, gas prices shot up 50 cents a gallon in my town overnight and stayed there for nearly a month. O'Reilly was proposing that oil companies all lower their profits by 25% (which, technically, would violate the Sherman Antitrust Act of 1898, but never mind that), free market conservatives were hunkering down, and pro-regulation activists and environmentalists were frothing at the mouth that perhaps this time they could take on Big Oil and win. Fast forward one month. People had curtailed consumption - surveys from AAA showed that miles driven had decreased, Detroit was having a firesale on their truck-based SUVs, and there was a waiting list a mile long for a Toyota Prius. Meanwhile, ExxonMobil announced in as quiet a way as possible that they had just made $10 billion in profit in the 3rd quarter. Forsooth! They must be gouging the consumer!

The thing that most consumers didn't realize is that while Exxon was minting money, they were merely charging what the market would bear. If they had priced gas at 25 cents cheaper, they would have lost money on most of the gasoline they would have sold. Sure, they would have still made money on the gasoline that was refined at Exxon refineries, but, as the lines at my local Costco attested, they would have run out of Exxon gasoline quickly, forcing them to either close down or buy gas on the spot market. That would have raised prices elsewhere, and long explanation short, lower prices at gas stations would have led to increased demand, which would have led to shortages. I value my time at more than the increased price of gasoline, so I certainly didn't want to go back to the 70s and Jimmy Carter's gas lines. While everyone was fuming about Exxon's profits, a funny thing happened. Gas prices started going down, and not by a little bit. They started plummeting. I was in Seattle when it started, and gas in Utah went from $2.70/gallon when I left to $2.50 when I got back. Now I've even seen it as low as $2.30 a gallon - another 20 cents in less than a week. So what's going on here?

It's simple. The refineries that were damaged in Katrina and Rita are coming back on line. There were some refineries that produced upwards of 450,000 gallons of gas a day that were offline. Now that they're getting back online, more gas is going into the market, and that additional supply is lowering prices because demand is relatively static. Oil demand has gone down, which has led to lowering oil prices, which has been passed through the refineries and soforth. My prediction? Gasoline will be below $2.00/gallon by New Year's Day. Whether it stays there is a matter of opinion. If people keep their habits changed, you bet. If not, we're looking at that as the new floor for a bit of time until exploration and drilling catches up - not to mention refining. We're operating flat-out right now, and until some more refineries are built, I don't think that will change.

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