There is no rational reason why retail gas prices at the local pump should skyrocket before a hurricane or immediately after a natural disaster, since the retail gasoline at the pump was purchased in a previous period and at a lower wholesale cost. That retail gas prices do rise during such events is merely more evidence of price gouging and exploitation. Fiction.
Here is another common misconception about gasoline prices that desperately needs dispelling. As before, our good friends supply and demand may be able to help, along with an understanding of how expectations influence markets.
First, the supply-side component. As mentioned above, cost does not justify prices, and the retail price of gasoline is not determined by the price of wholesale gasoline at the time it was purchased and pumped into the tanks at the local gas station. Instead, the retail price of gasoline at the pump is based upon expected replacement costs relative to current demand. In technical terms, the cost of the wholesale gasoline already in the reservoir at the local pump is a "sunk cost" (literally and figuratively), while parting with it by selling it to retail gasoline consumers is an "opportunity cost." In economics and in business, opportunity costs matter more than sunk costs.
Gasoline companies, knowing that Gulf Coast hurricanes can destroy oil rigs, damage underwater pipelines, and disrupt oil refining capacity, will expect that a hurricane-induced oil and gasoline shortage will push up the wholesale cost of gasoline. Expecting an increase in the future price of gasoline, local gas stations will logically pass some of that anticipated increase on to current retail petrol consumers. And, the opportunity cost of selling that gasoline will be reflected in the demand and willingness to pay for it among competing buyers, along with the anticipated cost of replacing it with higher-priced wholesale supplies.
Think about it this way: If you are a homeowner looking to relocate, would you sell your current home for the exact amount of money you paid for it, plus repair and improvement expenses incurred during the time of ownership? If the cost of something in one market determines the price at which it is sold in another market, then yes, you would. But, that is not the case, as the example should make clear.
The price you paid for your home does not typically even enter into the resale price decision because it is a sunk cost; it is historical, in the past, based upon market conditions that were different at the time of purchase. The price you ask for it when you want to sell it is based upon new market conditions, new developments, changes in supply and demand in the housing market that have occurred since you purchased the home, meaning that you might sell the home for much more or for much less than you paid at the time you bought it.
The same goes for the petrol in the tanks at gas stations, and the analogy to home sales is appropriate even when we recognize that the time duration between the purchase and resale of a home is usually much longer than between the purchase and resale of gasoline. Market price is based upon the (opportunity) cost of replacing that wholesale gasoline, plus the changes in the demand conditions that have occurred since the wholesale gasoline was pumped into the retailer's tanks. If that opportunity cost is expected to rise, the retail price will rise immediately to reflect that expectation.
Additionally, there is a demand-side component that is even more important. It, too, is related to expectations. Consumers, knowing that Gulf Coast hurricanes can retard oil and gas production and restrict supplies by knocking out refining capacity, will also expect prices to rise. On the basis of these expectations, and even before a hurricane makes landfall, consumers will increase their demand for gasoline immediately, hoping to buy some gasoline and top off their tanks before prices rise.
However, when all consumers act in tandem based upon similar expectations of rising prices, overall market demand will increase. And, because the supply of gasoline at the retail pump is fixed, at least momentarily, the increase in market demand based upon expectations of a future price hike leads to a self-fulfilling prophecy: prices rise immediately, even before the hurricane has had a chance to damage the supply chain, simply because demanders are more intensely bidding for the scarce supply of petrol at the local gas pump. This rise in price is an unmitigated good from the perspective of the market as a whole. It is precisely this rise in price that forestalls or prevents a shortage of gasoline and forces consumers to economize on its consumption, ensuring that there is enough gasoline to go around.
So, there certainly are rational reasons why the price at the pump jumps immediately when some change occurs in the global oil and gas markets, and the laws of supply and demand do a good job of explaining this connection. Now, admittedly, we may not like this fact, and we may complain loudly about the higher gasoline prices that result. But, we should at least take some comfort in understanding why.
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