There is something exciting about watching a Space Shuttle launch. The acceleration is incredible, especially when you consider the gross weight of the space craft to be about 4.5 million pounds. Within seconds of launch the shuttle is going 100 mph, 1,000 mph after one minute, and in a little over seven minutes, the craft is pushing 18,000 mph! But, have you noticed when it is landing, the Space Shuttle is going barely more than 200 mph. Going up is fast, but coming down is always slow.
Of course, the physics of putting large bodies into orbit around the earth requires nothing less than spectacular acceleration. The aerodynamics and physics of returning to earth safely demand that the vehicle slowly decelerate over a longer time to avoid burning up or breaking up upon touch down.
Even though economics is not a physical science per se, I have observed over the years that the same physical laws of space travel seem to apply to certain economic trends. Have you ever noticed how quickly interest rates rise during uncertain times only to slowly come back down long after the crisis is over? The stock market can “crash” in a day, but may take years to recover from that single event. In recent years, the price of gasoline has shot up like a rocket on news of a hurricane in the Gulf of Mexico, or political upheaval in the Middle East. However, even though the hurricane may pass by with little or no impact on the supplies, or the interruption of oil deliveries in the Middle East may not be significant, the price of gasoline can take months to come back down to pre-event levels. It is as though the prices ride a rocket up and take a parachute back down.
The explanations for this phenomenon are plentiful and I am sure your email inbox has been inundated with plenty of speculation, castigation, and a few suggested remedies during the recent jump in gasoline prices. I believe some explanations and remedies have more merit than others.
There is one very important thing that makes gasoline at the pump unique among the thousands of products Americans buy on a daily basis. Retail gasoline is the only product that posts its price in one-foot-tall letters that can be read from one-half mile away or more. As a result everyone knows what a gallon of gas costs even though most people could not tell you what they last paid for a gallon of milk or a loaf of bread.
I suppose posting gasoline prices in big numbers keeps the stations competitive. After all, how many of us have driven until our tanks were nearly empty until we found that station that was two cents a gallon cheaper. Yep, we showed them; nearly running out of gas to save ourselves 30 to 40 cents on a single $45 to $60 tank full!
If displaying gasoline prices for all to see encourages competition, it could also be said that it makes collusion easier as well. Under anti-trust laws in the United States, collusion among suppliers or retailers to set prices for their products is expressly forbidden. But, if the gas-station operator doesn’t even have to leave his store to see what the competition is charging across the street, then it is difficult for any prosecutor to make the case that the station owners met in secret to set their prices.
Imagine for a moment you are a gasoline retailer. Your average gross profit on gasoline is about seven cents a gallon. If you put yourself in their position, you would probably understand that it is less likely to be a conspiracy and more often just a case of business survival. When one station sees another raise their price a couple of cents a gallon, they all quickly follow suit. And it is certainly not in any operator’s best interest to be the first to drop the price when supply costs go down. Consider this: if your local gas station operator is making so much money selling gasoline, why do gasoline retailers spend so much time trying to get you into their store to buy things you can get at a hundred other locations? Cheap gasoline is a pricing theory called a “loss leader” that is intended to get you in the store to buy other more profitable products. Many a gasoline retailer has gone bankrupt trying to use gasoline as a loss leader.
At the other end of the supply-line spectrum is the price of a barrel of crude oil. You get the price of crude oil reported in the media every evening along with the daily stock market results. However, what makes the news is not the cost of the oil being delivered to refineries today, but rather it is the price expected to be paid for oil at some point in the future. When events cause speculation to drive the future price of oil up, it inevitably results in journalists prognosticating that the price of gasoline at the pump will be going up soon. With the consumers psychologically prepared for the increase, it is now logical for suppliers and retailers to go ahead and raise the price of a gallon of gas.
The last and perhaps the most significant factor that affects the price of gasoline here in the United States is that we are grossly under capacity for refining oil into gasoline and other products. Many small refineries have shut down over the years as their processing capacity made it uneconomical to bring them up to current environmental standards. At the same time, stringent environmental standards and the not-in-my-back-yard (NIMBY) syndrome has resulted is fewer new refineries coming online. Meanwhile, gasoline consumption has increased, and during the summer, many states and even some municipalities require specially blended fuels to reduce emissions. As refineries annually transition from making heating oil to ramping up to meet summer gasoline demand, they must stop production to retool their facilities. This leads to constrained supplies and the annual price increase that usually peaks around Memorial Day. The rest of the summer pricing remains relatively high because of increased driving and a constant cycle of shutting down refineries to adjust for the unique summer blends required by different cities and states. Add to that one or two hurricanes that may temporarily shut down gulf coast oil production and refineries and we can see a drop in supply with a corresponding increase in the price at the pump.
The reality is the supply and demand for energy, especially gasoline, is very volatile. There are many reasons why the price of gasoline at the pump may change—some are better explained than others. Nonetheless, the cost of gasoline does fluctuate often and can rise quickly. If you are frustrated about recent increases, and many of us are, don’t punish your neighbor who happens to be in the gasoline business. Don’t bother trying to boycott the big oil companies; they make just as much money selling cheaper products as they do selling expensive stuff. If you want to bring about real and positive change that will help the price situation at the pump, call your Representative and Senators. Tell them we need streamlined permitting for new refineries. We need more of every kind of energy. We should stop the ban on deepwater drilling and we should open more offshore areas to exploration. We should not let the EPA regulate green-house gases and implement a de facto energy tax. And, we need more oil, coal, natural gas, oil shale, tar sands, etc., developed in Alaska and the Mainland USA. Tell them we need to drill here, drill now, and pay less!