Gas Prices May Spike

Hurricane Irene is bearing down on the East Coast, threatening nearly 10% of the nation's refining capacity that lies in Philadelphia, New Jersey and Delaware.

Gasoline futures traded in New York have already spiked, rising 10 cents a gallon this week, largely on fears there will be a disruption in output from the refineries, barge routes or pipelines serving the heavily populated eastern seaboard.

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Gas Prices

Gas prices fell another 2 cents, marking the fourth straight decline after rising more than 18 cents in 8 days following Hurricane Ike, according to a nationwide survey of credit card swipes at gasoline stations.

The average price of unleaded regular dropped 2 cents to $3.757 a gallon, from $3.777 a gallon, according to the survey released by motorist group AAA...

Current prices are about 34% higher from a year earlier at this time. Still, prices are 54 cents, or 13%, down from the record high price of $4.114 a gallon set on July 17...

More than 30 refineries, which convert crude oil into usable gasoline, had shut down or were operating with reduced capacity in the Gulf region after the storms hit. The number has since fallen by more than half, restoring gasoline supply to retailers and easing consumer prices.

Many crude pipelines in Texas and Louisiana had also shuttered ahead of the hurricanes. Those are slowly coming back on line.

Lower oil prices have also helped lower the cost of retail gas. Crude has been moving lower since mid-July amid weakening demand, losing more than a third of its value since it reached a record of near $150 just two months ago.

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Cartoon: Gas Prices

Economic Ignorance and Price Gouging

President Bush Saturday said officials will ensure gasoline stations don't gouge customers after Hurricane Ike, but with some prices near $5 a gallon, some consumers were not so sure.

Dozens of iReport.com users complained of rising gasoline prices Friday and Saturday. Sean Kennedy, of Knoxville, Tennessee, took a photo of a Knoxville station displaying a $4.99 per gallon price for regular gasoline on Saturday.

The previous day, he said, he had bought regular gas at the station for $3.59 a gallon.

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My thoughts: Pure economic ignorance. A complete lack of understanding of the concept of supply and demand.

Other Economists:

On Price Gouging by Donald Boudreaux
Prices are not set arbitrarily. They are what theyare for a variety of reasons. These reasons are summarizedby the two words “supply” and “demand.”...

Therefore, the fact that is unfortunate is not the higher price; it’s the underlying reality reflected by the higher price. That a natural disaster destroyed supplies and supply lines is indeed unfortunate. But this is the reality. Because, as Thomas Sowell reminds us, reality is not optional, we ought to deal with it as best as we can.

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Mitigating Disaster:Abolish FEMA and Let Gas Prices Rise by Dwight Lee

The higher prices we paid for gasoline reflected the fact that the hurricanes temporarily reduced gasoline supplies. After the hurricanes there was not as much gasoline available as consumers wanted at pre-hurricane prices.

Furthermore, more gas was suddenly needed along the Gulf Coast to bring in rescue personnel, evacuate the homeless, help clear the rubble, and get on with reconstruction efforts. The higher gas prices motivated tens of millions of drivers to conserve gasoline, allowing more to be available where it was badly needed. No matter how much sympathy we expressed for the hurricane victims, it is naïve to think we would have reduced our gas consumption much, if any, without a price increase.

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Anti-Gouging Hysteria by Jeff Tucker
In my own neck of the woods, I've never seen such hysteria about the supposed need to fill up tanks. There was a wild rush on gas stations, which of course produced shortages very quickly, and the prices responded as best they could. One wonders how much gas might have been left for those who really needed it if the anti-gouging police weren't on the patrol.

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Fill-in-the-Blank Article About Price-Gouging Laws by Art Carden
Natural disasters wreak unspeakable human tragedy, and we can decide between interventionist policies that make things worse or noninterventionist nonpolicies that allow rapid recovery...

The important point, as always, is that the restrictions on price gouging harm precisely the people they are supposed to help...

A price control by any other name is still a price control, and price controls have always served to compound the miseries wrought by natural disasters.

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A Price Gouging Reader

Wholesale Gas over $5

Wholesale gasoline prices in the U.S. Gulf topped $5 a gallon on Thursday as the region's oil refineries began closing down ahead of Hurricane Ike, adding to fears that U.S. drivers could see pump prices rise again.

Prompt spot gasoline prices in the U.S. Gulf traded at a record $2.50 a gallon over their gasoline futures benchmark, which itself traded as high as $2.83 a gallon in active trade on the NYMEX exchange, putting the price tag on a wholesale gallon of gasoline as high as $5.32 per gallon.

"The worst-case scenario for the hurricane season is what we're looking at with Ike," said Chris Jarvis, senior analyst with Caprock Risk Management.

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My thoughts: Supply and demand. Those who continue to scream price gouging are wrong.

25% of Fuel Production Shutdown

13 of the 26 Texas refineries, representing a production capacity of 3.6 million barrels of fuel a day, had been shut down, the Energy Department said.

Texas accounts for more than a quarter of the nation's total capacity to produce gasoline and other petroleum fuels. In normal operation, facilities there can produce up to 4.8 million barrels a day, according to the government...

"Close to 20% of the U.S. refining capability could be lost for a long period of time," wrote Jim Rouiller, Senior Energy Meteorologist at Planalytics in an email. "Major and long term damage likely at the major refining cities from Galveston and Texas City northward to Baytown," he wrote.

After Katrina, some refineries were shut down for 6 to 9 months, according to Tom Kloza, chief oil analyst for Oil Price Information Service.

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Hurricanes, Gas Prices, and Sunk Costs

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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Gustav or When the Levee Breaks Part II

Have the people of New Orleans learned?