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50 comments on The Senate on price gouging

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Halfin on September 7, 2005 - 9:48am Permalink | Subthread | Comments top
As I pointed out in the earlier thread, the idea that high gas prices are a result of profiteering by individual station owners is absurd. There is far too much competition at the retail level. Each station is required by law to post its prices in large, easily visible signs. We have all seen that gas prices will vary by ten cents a gallon or more across a mile or two, or sometimes within just a few blocks. It is easy for motorists to find the least expensive gas in an area. Generally those stations are far more busy and crowded than ones with expensive gas. A retailer who wants to profit at the expense of his customers faces losing business to his competitors. Retailers simply do not have the choice to jack up prices as much as they would want.

If all the stations in an area have high gas prices, it is a sign that the costs to the individual retailers are uniformly high. If we do want to look for "profiteering" it would be at higher levels in the distribution chain.

The truth is that at the moment, with gasoline supplies reduced, supply and demand will automatically drive up the price of gasoline. Distributors, refiners and retailers have to raise their prices enough to reduce demand, otherwise they will run out of gas.

As far as the windfall profits of the oil companies, there are two reasons to let the companies keep them. The first is that in general we want to reward companies for being right and for investing in resources that are going to be more valuable in the future. This way we encourage companies to look forward and to try to anticipate future conditions, and to make their investments accordingly. We all benefit from a living in a world where institutions correctly and successfully anticipate the future and make useful preparations. Peak Oilers should understand this better than most.

The other good reason is because oil companies need to be spending those windfall profits in order to increase productivity in the future. It was noted on the earlier thread that those high profits are not turning into high dividends. The companies are retaining those profits, which makes them available for new investments. Clearly, oil is getting harder to find and produce. Using these windfall profits to invest in future oil production is one of the most socially optimal uses we could imagine.

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Yankee on September 7, 2005 - 10:11am Permalink | Subthread | Parent | Comments top
OK, I'm willing to believe that individual retailers aren't jacking up the price that much. (I only put it in here again because that's what our source said--I don't really want to restart that discussion.)

So if individual retailers aren't jacking up the prices, and Big Oil itself isn't responsible for the price of crude, where is the large increase in gasoline prices coming from? Is it legitimate, as you suggest ("with gasoline supplies reduced, supply and demand will automatically drive up the price of gasoline. Distributors, refiners and retailers have to raise their prices enough to reduce demand, otherwise they will run out of gas") or is there any actual gouging going on at any level?

For the record, I'm not asking this because I'm outraged at high gas prices. I couldn't really care less, especially because I don't ever drive. I'm asking because the government, the media, and the guy who writes in to MSNBC's "Pain at the Pump" is making such a huge stink about gouging that I want to be absolutely sure when I tell someone that the government, the media, and Average Joe are just plain wrong about gas prices.

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Halfin on September 7, 2005 - 10:32am Permalink | Subthread | Parent | Comments top
Well, I'm not an "insider" but let me give you a guess at what is happening.

In most places, there is plenty of competition at the retail level. In all but the smallest of towns, you won't have all the gas stations owned by the same person or company. (They may all have the same distributor, but that's another matter.)

This tends to keep retail markups down, but as we all know there are still considerable variations in price. Because margins are so low, a five or ten cents increase in price can mean two or three times the profits. Such a station can do half or third the business and be just as profitable. (This ignores the fact that for many stations, the snack shop is the biggest profit center, hence they can tolerate low profits at the pump if they get people to come in.) So there are various strategies gas stations can use, either low margin/high volume or high margin/low volume.

This breaks down if there is an actual gas shortage in the area. If stations aren't getting enough gas to meet demand, the high volume/low price retailers will simply run out sooner than the low volume/high price ones. In this circumstance, a higher price does make economic sense because they will do just as much volume of business as the low price stations. The most profitable strategy is to increase price until you would just run out of gas as the tanker truck pulls up. So in areas that are having actual gas shortages, where some stations are out of gas, then we would expect to see higher margins at the retail level despite the existence of competition. Stations can't undercut their competitors and steal business because it just means they will run out of gas sooner and their profits will be less.

However, in most of the country this is not happening. Here in California I haven't seen any stations run out. But in areas impacted by the hurricane, or the temporary pipeline outages, where gas is actually running out, this effect probably played a role.

In the rest of the country, though, I would expect that the increases in prices are happening at higher levels, at the distributors and refineries. With fewer refiners in operation the distributors have to bid up the price of gas to get their supply, and the distributors then pass along their costs to retailers. Since the bottleneck is refinery operation, I would expect that that is where the high prices are originating, and that is where the excess profits would be collecting.

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Stuart Staniford on September 7, 2005 - 1:58pm Permalink | Subthread | Parent | Comments top
I'm not even clear what "gouging" really means. Do we mean simply 1) "making a larger profit than is typical for a business", or do we mean 2) "having excess market power and/or acting anti-competitively in order to make a larger profit than is typical for a business". Obviously the oil companies are starting to do 1), but that seems like an inevitable by-product of the situation in the market, not something unreasonable they are doing deliberately. I don't know about 2), but if there is any of that going on, the appropriate remedy is anti-trust law. And if we are going to stick it to the oil companies, how come we still haven't managed to do anything about Microsoft's outrageous margins (which are clearly due to 2).

It seems to me that the usage in the MSM of "gouging" is mainly 1), and it just reflects a lack of even the slightest economic knowlege.

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Yankee on September 7, 2005 - 2:23pm Permalink | Subthread | Parent | Comments top
Halfin and Stuart, make sure you see the update.
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Halfin on September 7, 2005 - 8:15pm Permalink | Subthread | Parent | Comments top
I'm not quite sure how to react to this display of corporate loyalty (in the "update"). So the distributors are "notoriously greedy and secretive" and struggling gas station owners are "gouging" but the oil companies, his employers, are nothing but noble paragons of virtue! Of course, why didn't I realize it before?

I've got some friends who work for Microsoft and they're the same way. They'll talk your ear off about how the company is unfairly maligned on the net. I guess there's something to be said for allegiance to the team.

As far as his claim that refineries can't raise prices because they are bound by contracts, I believe that's only part of the story. After all, we all know that many refineries are shut down, hence they aren't fulfilling their delivery contracts. Of course there are probably clauses in the contracts for "acts of God" and such, but that still leaves the distributors up the creek. What do they do, if their contracted-for gasoline is not being made available? Do they just go out of business for a while?

No, I believe they have an alternative. They buy it on the spot market. The truth is, although as the insider says much gasoline is sold via contracts such as those traded on the Nymex exchange, a certain fraction is held back and is sold on the spot. This allows for handling variations in demand and unforeseen circumstances. I don't have informed knowledge of the details but that is how these markets generally work.

Prices float in a spot market and are no doubt very high right now, as all the distributors who have been cut off because their refinery partners are not delivering on their contracts fight over the limited pool of available spot market gasoline. This drives up the price, produces a windfall for those refiners which are lucky enough to have some excess capacity, and raises costs for the "notoriously greedy and secretive" distributors.

It may well be true that the distributor market is not all that competitive and many localities have only one or two main distributors. This means that if a distributor is facing high costs, his competitors may be able to take advantage of this and raise prices on their own. So there probably are some cases where distributors are profiting from shortages even when their costs aren't excessive. But ultimately the high prices must be stemming from where the shortages are happening, which is at the refineries.

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RayJ on September 7, 2005 - 4:11pm Permalink | Subthread | Parent | Comments top
Stuart,
In general, I think gouging laws tend to assume 2) is always the reason for 1).  Also, note that the gouging laws tend to apply only during declared emergencies.  As such, price rises before Katrina and Microsoft's pricing cannot be addressed under gouging laws.

On the issue of profiteering, which is what Microsoft and the oil companies may be accused of, it is very difficult to prove and obtain a guilty decision, given the power and political connections of these companies. As a side note, the breakup of Standard Oil was a close run thing and, according to Yergin's account in his book, The Prize, most people were surprised when the Supreme Court found in favor of the government and ordered the breakup.  It probably would have ended differently had Roosevelt himself not taken a personal interest and "fanned the flames of public outrage".
 

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50 comments on The Senate on price gouging

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