Tuesday, October 30, 2007

The Oil Industry is Responsible for its Political Predicament

As the oil industry gets pilloried about high gasoline prices, it is interesting to examine how the higher prices come about.

Oil prices jump up and down, (actually, they don’t ’jump’ down so much as trickle down when they do drop), generally in response to events in the middle east, and elsewhere, or which affect the middle east or domestic oil suppliers. This is reasonable because such events cause buyers to panic and cause producers to take advantage of the panic by raising prices. Obviously, if the raw material price goes up, the price of the products made from these raw materials will have to be increased to cover the higher costs. However, the timing of the increased ‘prices’ to consumers is the problem.

After hurricane ‘Katrina’ hit the south eastern coast of the United States, gasoline prices increased immediately, not after a week or two, immediately! It is likely that such a devastating storm would cause a great deal of damage to commercial structures as well as private homes, and it did. A good number of oil processing plants and refineries are located in the hurricane-affected area and gasoline output could be expected to be adversely affected. But why would oil prices increase immediately; surely gasoline in the system at the time did not cost as much.

In the mid east, Iran, an oil supplier, is constantly pounding its chest (her chest?) threatening everyone, especially the United States and Israel. Iraq oil, which should be significant on the world market, is also constantly disrupted by terrorists who, from time-to-time, take their attention away from murdering innocents to blowing up oil pipe lines. Russia once a reasonably dependable supplier of oil to western markets, is taking advantage of their superior position with gas and oil deposits by incorporating political objectives into their marketing practices. Similarly, Venezuela, once our friendly oil 'pumper', has waived its red banners in our face and adopts an Anti-American oil policy under its screwball President Chavez in order to damage America by reducing oil sales to the United States (to the great delight of their new customer, communist China). Each such incident, and others, causes a vacillation, usually upward, of oil prices.

Critics of oil companies for raising gasoline prices are only partially wrong. It is not likely there is any overt, concerted effort by oil companies to increase gasoline prices in unison (the FTC has indeed concluded there was no ‘price fixing’); however they all use a similar but independent approach to gasoline pricing that results in premature immediate elevation of the cost of gasoline at the pump for consumers. Oil industry spokesman have admitted that the pump price of gasoline is related to increasing costs of oil at the source. In other words, as the price of oil is increased, the companies calculate the replacement cost of gasoline produced from the higher priced oil. The gasoline at the pump is then changed to reflect the higher replacement cost. Now this may make sense from an accounting standpoint, but it makes no sense to the consumer in the driver's seat. This pricing practice revalues gasoline already in the gas station reservoir at a higher price than originally purchased by the gasoline station even though no higher cost of production was experienced by virtue of higher oil prices. Thus, the gas station automatically posts higher prices for the same gasoline at the station that was sold at a lower price the day before.

When you buy gasoline, you may encounter a price higher than you saw earlier that day, or yesterday, at the same gas station. This is infuriating; particularly when the price increase is great. The upward revaluation of the price of gasoline ‘already in the pipeline’, which was produced from the previous lower-priced oil, contributes significantly to the increased profits reported by the oil companies. To many of us, this pricing practice is unreasonable, and unfair. Sure, a seller has the right to set any price deemed business-appropriate, but by using the same pricing practice of revaluing the gasoline in inventory, and charging essentially the same price as calculated for ‘replacement’ gasoline, the oil industry, de facto, act in concert to offer uniformly higher gasoline prices to the public, and at the same time table.

The higher gasoline prices do not justify public panic or pandering by politicians, including the congress, but the oil industry would be better served to take into account the public’s reaction to unnecessarily high, and premature, gasoline price increases. To do otherwise will cause the industry to be continually scrutinized and will encourage punitive governmental measures.

1 comment:

Vincent G. Gioia said...

I am testing 'comments'.