The editors of the Wall Street Journal are unhappy about President Biden’s expressed view on oil prices:
Business leaders have chalked up President Biden’s attacks on oil companies to political cynicism, but maybe they’re too generous. His tweet over the weekend ordering gas stations to lower prices betrayed a willful ignorance about the private economy.
“My message to the companies running gas stations and setting prices at the pump is simple: this is a time of war and global peril,†Mr. Biden tweeted Saturday. “Bring down the price you are charging at the pump to reflect the cost you’re paying for the product. And do it now.†Had Donald Trump issued such a command as President, the left would have cried “authoritarian.â€
It’s embarrassing for the leader of the free world to sound like he’s channeling Hugo Chávez. A Chinese state media flack praised Mr. Biden’s tweet: “Now US President finally realized that capitalism is all about exploitation. He didn’t believe this before.†Or maybe he did, and nobody wanted to believe it.
You’d think that the President’s Ivy League-educated economic advisers would have informed him that large refiners own fewer than 5% of all gas stations in America. More than 60% are operated by an individual or family that owns a single store, and the rest are independently owned chains or grocery stores that sell fuel. Many license brands from refiners.
Refiners largely exited the retail business in the 2000s because of thin profit margins. The Energy Information Administration says distribution and marketing made up about 5% of the price of gasoline in May, or about 22 cents a gallon. This covers the cost of freight, labor, utilities, real estate and credit-card fees (which can average more than 10 cents a gallon).
Most gas stations make a few cents a gallon in profit and stay in business mainly by selling food and cigarettes. The National Association of Convenience Stores says its members are struggling amid high gas prices because customers are making fewer stops and buying less.
More than a quarter of gas stations have closed since the 1990s because they couldn’t make the economics work. If retailers were to sell fuel at cost, most would go out of business. Perhaps those owned by large refiners would survive, but they’d be accused of predatory pricing by Mr. Biden’s antitrust cops.
The President’s economic ignorance isn’t a one-off. In recent months he has accused oil and gas companies of price gouging and demanded that they increase production even while his Administration threatens to put them out of business. Mr. Biden doesn’t understand that businesses make long-term decisions based on demand expectations and policy signals. Jeff Bezos called the President’s weekend tweet “either straight ahead misdirection or a deep misunderstanding of basic market dynamics.†They aren’t mutually exclusive.
I post on this because it connects so neatly with a conversation going on in comments.
For a briefing on convenience service stations, read this at the National Association of Convenience Stores, the trade association of convenience and retail fueling stores. Tight margins are very typical of retailers at all levels these days. 2 cents a gallon is pretty tight. That’s about 30 cents per vend.
The margin for refiners is better—it’s a bit less than $1 per gallon (“margin” defined as the price of gasoline less the price of the oil used to make it). That’s got to cover labor costs, maintenance of facilities, amortization of facilities, financing, etc.
The Federal Reserve Bank of Dallas broke down gas prices like this:
They comment:
Given that crude oil accounts for 59 percent of the cost of gasoline, a 34 percent increase in the price of oil should imply a 20 percent increase in the retail gas price. Likewise, a 22 percent decline in the price of oil should translate to a 13 percent decline in the pump price. However, that did not happen at the national level.
As Chart 2 shows, the spot price of gasoline (the price of gasoline at the refinery gate), as proxied by the prompt contract for New York Mercantile Exchange RBOB gasoline, generally rose and fell with the price of West Texas Intermediate crude oil. However, the response of U.S. pump prices has been highly asymmetric. While the price of retail gasoline cumulatively rose about as much as expected following Russia’s invasion of Ukraine, recent national retail gasoline prices dropped only 6 percent from the March peak, far less than the expected 13 percent.
This indicates that retail gasoline prices remaining persistently high was not the result of an oil shortage or high oil prices. Rather, the elevated retail gasoline prices must be attributed to events in the U.S. retail gasoline market beyond the control of oil producers.
Moreover, the asymmetry of the response of retail gasoline prices need not be evidence of price gouging. One potential explanation is that station operators are recapturing margins lost during the upswing, when gas stations were initially slow to increase pump prices. The reluctance to lower retail prices also likely reflects concerns that oil prices—and, hence, wholesale gasoline prices—may quickly rebound, eating into station profit margins.
Not only that. They are probably anticipating continuation of the increased price of oil. That’s undoubtedly going on at all levels.
Oil economist James Hamilton who posts at Econbrowser has documented how responsive the global price of oil is to supply and demand factors.
A final factor that should not be ruled out in evaluating the forces responsible for the increasing price of oil is the role of the low cost producer. Presently, the Kingdom of Saudi Arabia is the low cost producer of high quality crude. Their production and reserves effectively allow them to set floors or ceilings for prices.
So, let’s recap. President Biden was empirically wrong in pointing at retailers as the culprits in high oil prices. The effect of retail price controls will be to drive some retailers out of business but probably won’t reduce the price of gas at the pump since that’s already decided before it reaches the retailers. Oil producers are unlikely to be the culprits. However, there is some evidence that refiners, trying to hedge against past and future changes, may be raising their prices more than strictly justified. I’m not sure how we’d go about determining that.
Where I disagree with the editors is in their use of the phrase “willful ignorance”. I prefer just plain “mistaken” since it doesn’t attribute motives. Why would President Biden make such a mistake?
The editors present one reason: there is a strong temptation among progressives to believe in the immiseration thesis. If things are bad there must be an exploiter somewhere. It’s a form of magical thinking. I don’t believe the empirical evidence is as strong as they do. In addition I suspect that President Biden suffers from a malady common in those who’ve spent too much time in Washington: he believes in the competence, power, and reach of big companies. I think that competence in big companies is quite rare and, as noted above, “Big Oil”, i.e. Exxon, Shell, etc. isn’t a likely culprit in the high price of gas at the pump.
“A final factor that should not be ruled out in evaluating the forces responsible for the increasing price of oil is the role of the low cost producer.”
Nitpick. I believe it is the marginal cost producer (i.e. the actor who has the highest cost of production of product in the market and can produce more) that is responsible for where oil / gasoline prices are.
My understanding is the marginal producer is not the Saudis (they are a low cost producer and they may not have much spare capacity). That it is likely either US shale, Russia, or Iran.
The problem for the administration is they don’t have a positive or productive relationship with US shale, Saudi Arabia, Russia, Venezuela and Iran.
Meh. The oil producers were making profits at $80/barrel. They make more at $120. Also, as even you acknowledge, prices are still higher than we can account for so you have to guess and make up reasons to account for that. Prices actually could be a bit lower. The fact is that we use prices to ration resources and we accept that for a lot of stuff but not for others.
Steve
Again, oil and gasoline markets do not work like most people think they do.
The gasoline supply is a function of refining capacity, and when the government is trying to eliminate fossil fuel usage, investors are reluctant to increase that capacity.
Gasoline is mostly refined from low sulphur oil, and WTI is low sulphur. Hence, WTI prices track with gasoline. The US has mostly low sulphur reserves, and decreasing US domestic drilling decreases the supply of cheap oil.
Oil and gasoline are mostly bought and sold in the futures market. This is good and bad. It allows accurate budgeting for costs, but when there is a large price differential, somebody gets screwed,
Gasoline delivered today was priced in the past, and it was based upon the anticipated cost to refine. (Anticipated supply/refining capacity is an additional factor.) Money lost from selling cheap gasoline refined from expensive oil must be made up somewhere, and that somewhere is the spot market or the future.
If gasoline demand unexpectedly increases, the additional supply must be purchased at the spot price, and as noted, the spot price must include the cost of gasoline contracts that are losing money. Additionally, present & future supply (refining capacity) & demand must be taken into account.
If this were as easy as googling a few links and running statistical regressions, ER Doctors would run the oil and gas industry.
When you use government to eliminate fossil fuels, this is what happens. Increasing the cost of oil and reducing the refining capacity MUST result in higher gasoline prices.
Thank you Captain Obvious. This is all well known. These factors have all been followed for years. What has been noted is that gasoline prices are disproportionately high even taking in all of these factors. That is why you have the WSJ (pro-business, pro-oil) writing the following.
“Moreover, the asymmetry of the response of retail gasoline prices need not be evidence of price gouging. One potential explanation is that station operators are recapturing margins lost during the upswing, when gas stations were initially slow to increase pump prices. The reluctance to lower retail prices also likely reflects concerns that oil prices—and, hence, wholesale gasoline prices—may quickly rebound, eating into station profit margins.”
Note the words “potential explanation” meaning no one has really explained it yet. Prices are 30 cents-50cents more per gallon that expected using historical norms. No one knows why. However, it is apparently beyond the pale to even suggest that someone might be taking extra profits, which is pretty bizarre in my estimation. Money is a great incentive. People make money when they can. Somehow people will accept that taxes are an incentive since it involves money but making profits would never incentivize people to do stuff we dont want them to do.
So maybe the WSJ is correct and it “need not”, but maybe it is. Wouldn’t be surprising. Instead of being patriotic and trying to hold down prices maybe they are making extra profit to make up for leaner times. Because they can.
As an aside, surely you realize this isn’t all that unique? Sure the oil and gas industry has its own peculiarities but everyone deals with supply shortages and varying costs with supplies and equipment. I have to make sure the facilities of all of our hospitals stocked and up to date. Drugs that cost $5 today are $200 next week (a real example BTW). We even go through shortages of IV fluids. I cant just snap my fingers and have extra ventilators or US machines. They only make so many and you have to plan ahead. Anyway, the prices help to ration. Those who want stuff the most are willing to pay. The suppliers then make much larger profits than normal. Its how things work.
Steve
@steve
As usual, you are trifling and clueless. Because I have little knowledge of the subject matter, I rarely comment on the healthcare industry. In fact, I do not have enough knowledge to determine who or what I should believe.
The WSJ is the mouthpiece for Big Business, corporations, and the Republican Party, in that order. As such, the WSJ spouts the conventional wisdom of their customers. If you recall, the WSJ missed the housing bubble until the financial collapse.
Again, most people (including the WSJ, progressives, most economists, and ER Doctors) do not understand how oil and gas is bought, sold, or produced. (If I recall correctly, @Steve Verdon? was an economist for an oil company.)
Unlike many products, the price of gasoline is very elastic, and there is no “shrinkflation”, (Actually, lowering octane and reducing additives is a form of shrinkage, but there is no way to shrink the size of a gallon.) So, today’s prices will drop, and somehow, the WSJ, progressives, most economists, and ER Doctors will not notice.
Like ER Doctors ordering supplies, the oil and gas industry makes assumptions about future demand and future supply, and when those assumptions are inaccurate, ER Doctors, refiners, drillers, and gas station owners must use the spot market.
Like medical suppliers, the refineries uses just-in-time (JIT) methods, and they have little reserve capacity. Unlike medical suppliers, the government is actively trying to eliminate fossil fuels, and investing in additional capacity only makes sense to progressives and ER Doctors.
There are no historical norms for today’s market. The COVID shutdown was unprecedented, and other than illegal drug dealers, the government has not tried to actively eliminate an industry. Claiming that gas prices are 30 to 50 cents higher is absolute nonsense.
I will do this slower this time. Most gasoline sold today was purchased months or years ago, and the price was based upon the anticipated price of today’s spot price. Today’s spot price is based upon today’s supply and demand. Today’s supply is the combination of additional refining capacity and excess storage.
The price of oil being refined today is subject to the same constraints. Most was purchased months or years ago. The cost to refine some gasoline was fixed in the past, but the cost to refine oil at the spot market price is higher.
The cost to produce every gallon of gasoline is not the same, but it gets stored in the same tank and pumped through the same hose. Unless you are proposing the gas stations price every gallon of gas individually, the price will be based upon the amalgamated cost.
Storage capacity is another factor. Unlike ER Doctors building a new wing, nobody wants gasoline stored in their backyard, and again, the government is actively trying to eliminate fossil fuels.
Storage capacity is more flexible, but more factors are involved. Using unused tankers as storage works until the tankers are needed to transport oil, and shutting down domestic oil production means more oil imported in tankers.
I suspect that your Excel spreadsheet is starting to smoke, but we have not gotten into oil itself. Petroleum products include more than just fossil fuels, and when the demand for those products increases, it affects the price of oil.
(Using plants to produce plastic requires the same amount of energy produced from millions of years of gravity, and a windmill ain’t gonna cut it.)
I realize that simple people want simple answers, but the world is not simple.