The Senate on price gouging
Posted by Yankee on September 7, 2005 - 8:33am
(Original post) Yesterday, Super G opened up a discussion about what level is the biggest cause of the rising price of gasoline. Our source, who helped explain how the industry works, suspects that price gouging is most likely to be found at the retail level—the people who own gas stations. He also explained that oil companies are doing well right now, but it's because the oil futures market has bid the price up to $70/barrel for oil that was originally priced at $15-20/barrel.
If only the government understood how the market works. This morning, NPR had a story about yesterday's Senate Energy and Natural Resources Committee meeting. This meeting had been scheduled even before Katrina hit, and the Senators were already intent on sticking it to Big Oil.
Other senators, like Lisa Murkowski (R-AK) noted a concern for farmers and ranchers, while Byron Dorgan (D-ND) wants to introduce a bill that imposes a windfall profits rebate on big oil. He asked, "Will you do nothing when you have an industry that will reap a windfall of $80b?"
The direction that Feinstein, Murkowski, and Dorgan are going in troubles me. If I understand our previous post, it's merely coincidental that Big Oil is reaping windfall profits right now. The fact that oil is $70/barrel, which is the biggest contributor to high gasoline prices, has to do with the world futures market, not because Big Oil is free to set the price of crude at whatever they want. This seems crucial, and it seems dangerous for the Senate not to understand it. Taxing Big Oil is not going to bring down the price of gas.
The New York Times also had an article on the meeting. In light of prices, it's been suggested that environmental controls on different types of gas and additives be relaxed, and drilling in Alaska comes up again:
Several others argued for expanding domestic oil drilling in Alaska and offshore. Pointing the finger at environmental regulations he blamed for constricting domestic oil supplies, Senator Larry Craig, Republican of Idaho, questioned his colleagues stern words for the oil companies and other energy producers.
But there were also some positives (though perhaps only symbolic):
Senator Domenici and Senator Jeff Bingaman, who is also from New Mexico and the ranking Democrat on the committee, agreed to send a letter to President Bush asking him to require government agencies to begin conserving gas in their vehicles, saying that would set an example for consumers.
Up until now I've been optimistic, but maybe I should rethink my belief that the government will have to be involved in helping us find solutions to the US's ever-increasing demand for oil.
Update [2005-9-7 14:13:15 by ianqui]: Our industry insider emailed me to say that refiners are not the ones causing a quick rise of prices at the pump:
Refiners are NOT the guys raising prices instantaneously—they cannot due to contract agrements. Refiners could not engineer a price increase across all brands in a matter of days—their deliveries are contracted. Gasoline isn't pooled up in tanks and then auctioned off—gasoline deliveries are planned by dates and CONTRACTED....Technorati Tags: peak oil, oil, gas pricesOil and gas and everything else in the petroleum stream are based on contracted delivery. Failure to deliver and failure to accept delivery each have financial consequences.
This leaves distributors (who are notoriously greedy and secretive) and retailers (who have a lot of profit at stake even at pennies a gallon due to high corporate volumes) as the guys possibly gouging.
But as I said yesterday, the point is—NOT oil companies.
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The problem is that the public is ignorant, and doesn't punish such destructive political behavior with "throw the bums out" campaigns.
Not a trend but concern will rise some on this...
http://www.mms.gov/ooc/press/2005/press0907.htm
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.
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.
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.
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.
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.
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".
So she may be a bit interested in oil issues.
Regards
Unless there is collusion between all the retailers, I don't see how it is price gouging. If collusion is the cause then I would say we have an anti-trust situation.
Also, no one is putting a gun to your head to buy at any price. If you are not satisfied with $3.50, then forego consumption!
I'd challenge you to think about what fraction of the whole oil-transportation equation is actually free, when you consider federal-state-local investment and regulation. The most recent Highway and Energy bills being obvious cases in point.
Are we really 50% free market? 30%? Can anyone even know at this point?
I was not refering to the larger issue of the transportation network and all the various subsidies and incentives in place...
Take lettuce or baked beans as an example. A semi-load of either might be 60,000 pounds; driven from San Diego CA to Chicago IL (2145 miles) in a semi getting 7 MPG, the load would require 306 gallons of fuel. Increasing the price of fuel from $2/gallon to $5/gallon costs an additional $918, or an extra 1.53¢/lb.
These fuel costs plummet if the freight can move by rail. If the railroads aren't looking at ways to run express freights with power for refrigerated containers, they're going to leave a lot of money on the table.
I started by thinking about the (well documented) simian/human response to "fair" and "unfair" economic exchange. We have the capacity at least, for innate anger at a raw deal.
I then thought about The Ultimatum Game played by experimental economists. People will refuse a profit, out of principle, if it is not perceived as fair.
And finally I considered all the investment our society (and government) makes on the expectation of fair gasoline prices.
We have built ourselves into a place where it is not easy to refuse gasoline, but we think we made a bargain in the process.
I believe "windfall profit taxes" are a natural outgrowth of that. People perceive that the social contract (for fair prices in an oil-based society) was broken, and so seek to adjust things with this fudge-factor.
(please note that this is my analysis of public sentiment, and not my design of a perfect society or infrastructure.)
Who are you to think you might be smarter than Adam Smith? The Great Invisble Hand takes care of everything. Look at what it did in New Orleans. It waved bye bye to they who had not been independent agents of their own destiny. I think Barbara Bush (senior) said it best. It's all working very well for "them".
http://www.editorandpublisher.com/eandp/news/article_display.jsp?vnu_content_id=1001054719
It will all work out very well for the rest of us too. Be happy.
The three internal memos from Mobil, Chevron and Texaco illustrate how the oil juggernauts reduced refining capacity and drove independent refiners out of business in an effort to increase prices. The highly confidential memos reveal a nationwide effort by American Petroleum Institute, the lobbying and research arm of the oil industry, to encourage major refiners to close their refineries in the mid-1990s.
Saw this story prior to coming to the blog to see if anyone else had, http://www.commondreams.org/news2005/0907-04.htm; and there are additional docs here, http://www.consumerwatchdog.org/energy/fs/ You sure did, but no one is addressing their content.
These docs would seem to put a big hole in the appologists' spin, as it's clear several majors attempted and in some cases succeded in destroying refinery capacity to boost their refinery margins. I would also say they present excellent evidence for nationalizing the whole fossil fuel industry, as it is very clear they do NOT work in the interest of anyone, not even their own shareholders as I showed.
Now, who's going to defend the refinery destruction called for in these memos?
What it strongly suggests to me is the reason we don't have enough refining capacity now is that we used to have too much, so margins sucked, so some of them went out of business, and now we don't have enough (ie a classic business-cycle kind of problem).
price spikes comes into sharp focus when one considers the increase in refiner margins during the first half of 2005."
Now, if the companies were colluding to schedule shutdowns of refineries to reduce supply and pump up prices, then there might be something to talk about.
It takes a single bump for them to immediately cram it back down oil company throats.
So, as J loves to say, follow the money.
Who wins under the windfall profits tax? Who earns?
I cannot savvy the big retailers as NOT gouging when I see them raising prices 2-3 times a day while only taking deliveries twice a week... My neighbor filled up at $2.89 and bought groceries, and it was $2.95 when he went home with groceries an hour later. His son filled up at the same store for $3.05 the same evening on his way to their house!!
I'm not saying that old Ernie at the Stop-n-Drop is gouging, but quite possibly a company like Valero Energy (just for example) has the computer links store to store and the ability to raise prices within minutes by sending faxes or emails to their retail outlets. When you look at the daily volume a company of this size sells, a single penny extra in gas prices is not a small amount...
The hurricane knocked out a large fraction of US refining capacity and shut down delivery pipelines to a major part of the country. All of a sudden, that fuel was just not there any more. It means that people cannot use as much fuel as they're used to; if they fail to make changes, they'll run out.
Now, what are the retailers supposed to do about this? They can:
- Sell at the same old price, despite what it's likely to cost them to refill their tanks in a week or so (they need money in the bank to pay the distributor). And when they need that refill, it may not be there.
- Raise prices so that they'll be able to buy the next shipment, and so that drivers will conserve and stretch the limited supply until refineries are humming and pipelines pumping again.
You only have those two choices. Absent the instantaneous implementation of ration coupons (yeah, right) the only way to match supply and demand is to hike prices. Not hiking prices means empty tanks, shutdowns and paralysis of whole regions. Oh, and scalping by people who've hoarded the cheap fuel and sold it dear after the price-controlled suppliers run out.We have no price controls on gas or bread. The vast majority of the country has neither gas lines nor bread lines. You see both of those in places where prices are controlled, and IMNSHO you'd have to be positively evil to want to bring either of them to the United States.
3. Raise prices so that they'll buy the next shipment, and a little
extra, because people will accept it.
This isn't the first cycle on this. Retailers might have already gotten bured by taking choice "1" or found they could break even with "2" ... or found they could score a little extra with "3."
I'm afraid ignoring the obvious factor of human greed is as "astounding" as assuming it is the only factor.
I'm not saying it is all greed here, but there is sufficient evidence for a little suspiciion.
http://tinyurl.com/97q5h
I know this is just a side effect of a shocked market (it takes a while for prices to sort themselves out, and all that), but it's the highest price differential I've ever seen for gas stations that close.
I think the biggest issue is that a job at Walmart isn't likely to pay the bills. Biking two hours total for an 8 hour a day regular job is one thing. Biking two hours total for an irregular hourly job, where one won't be getting full time, and one probably has 2-3 other jobs, all about the same distance (but not located near each other) from home. Then, that could be the point where you hit the "fuck it." wall and the feds get happy because there's less unemployment as the person who quit the wally world job might have quit the other minimum wage jobs and no longer looks for "gainful" employment (and wally will find someone desperate enough for the modern day serf wages) and now starts to try to make money outside the box.
Thinking outside the box regarding money could be good and bad. It could be starting one's own business which can mostly be done remotely. Hey, maybe bicycle powered rickshaws will start up in the US to get the consumers to the bus stations when they don't want to bike themselves. Maybe it will be something as relatively victimless as drug dealing/manufacturing. But in a recession/depression, other than spending some time gardening if one has land, the desperate often don't see many other choices than taking what it is they think they need.
-Room to maneuver: Wide shoulders, little-used sidewalks or bike paths. On narrow streets, some drivers will cut you off, or suddenly turn right as if you aren't there.
-Clean riding surface: Around here there is a lot of broken glass, and I've had three slow leaks in one month. In PA, on the same bike, I had three leaks in ten years.
-Light: Right now, it is still dark when I leave, but it brightens up as I ride. There are some street lights, but not enough for when it stays dark until just before 8 AM.
-Safety: Beach Drive/Rock Creek Parkway in MD/DC is a great path, but women cyclists have been attacked in the wooded portions.
-Storage: You need someplace safe to store the bike while you work. Back in the 80s, I used to keep mine in the unlocked basement of a building, chained to a column. Someone saw me go in and spent all morning hammering off the lock.
-Shower facilities in or near the office, unless you do physical labor anyway.
-No outside meetings, or a company car to drive there.
Lack of any of these can make commuting by bike a bad experience, if not impossible.
I'm trying to remember the farthest I've ever bike-commuted. Navy Annex to Bethesda and Belle View to Rosslyn were each about ten miles.
Bleh, I have problems going much more than 0.1-0.2 km barefoot in snow to the park to walk the dogs. But then again, as my wife's not a barefooter she can't even imagine walking around in the snow without shoes, much less my idea of "fun" which is sliding down the driveway after an icestorm (talk about a jolt of sensation).
Climate is relative to cetain extents. I went to school in California (Pasadena), and there were natives who'd wear winter ski coats and shudder at the cold when it dipped beneath 65F, while those from Montana and Wisconsin thought 50 was still appropriate shorts and t-shirt weather.
They're needed for heating fuel elsewhere in the country, and it would be more efficient to burn the grain as heating fuel and use the LPG or CNG as motor fuel than to turn them into ethanol. My analyses are here:
The Ethanol Mirage
Ethanol Mirage II
gouge
Informal. To extort from.
Slang. To swindle.
So, I looked up extort:
ex·tort
To obtain from another by coercion or intimidation.
That doesn't sound quite right. No one is intimidating me into buying gas, and only my bosses are coercing me into driving every so often. Otherwise I can walk or bike as I choose.
swin·dle
To cheat or defraud of money or property.
To obtain by fraudulent means: swindled money from the company.
That might be true if the gas shortages were fraudulent, but I doubt that is the case right now.
I think the Word Detective says it best:
"... I was, of course, familiar with its colloquial use as a verb meaning "to cheat" or "to charge an exorbitant price." "
ex·or·bi·tant
Exceeding all bounds, as of custom or fairness: exorbitant prices.
IOW, it does not seem customary or fair to charge such exorbitant prices for gasoline, and (presumably) make so much profit off of the downtrodden automobile driver. Someone must be gouging us.
I think a better source is Wikipedia:
"Price gouging refers to a sharp, temporary increase in the price of items that are in high demand because of a civil emergency, without a generally recognized justification or in breach of contract. The term is distinguished from profiteering by being short-term and localized, and by a restriction to essentials such as food, clothing, shelter, medicine and equipment needed to preserve life, limb and property. In many jurisdictions, price gouging is a felony. Some support the ability to price-gouge, either asserting that government prohibition of the practice is a violation of moral individual rights or that price gouging has beneficial effects."
Wikipedia is such an awesome resource!
I take this to mean that the list is not exhaustive. I don't see that they exclude gasoline (or water, or plywood, etc.) as not being essential.
"Conversely, price hikes, regardless how big or obscene, don't qualify as "gouging" in non-emergency times.
Merchandise covered includes anything "which is consumed or used as a direct result of an emergency or which is used to preserve, protect, or sustain the life, health, safety or comfort of persons or their property."
That certainly leaves room for interpretation, as does the Florida statute that includes any "essential commodity." But it's easy to make a case for water, milk, batteries, plywood, and generators - products most often cited in price-gouging charges. "