Thursday, May 11, 2006

The Price of Gas

The price of gas has gone up 100% in the last year. Whose fault is it?

You know, it's the question which is the problem, and the symptom of the state of affairs in the United States today. Our country has become so huge and so complex that it is all but impossible to manage. Even at the township level, where I am most directly involved, the rhetoric is not about what is good for our community, but rather what is good for particular individuals.

Maybe things have always been this way in politics, and I'm just finally getting old enough to recognize the reality. That reality is that we have a shadow government which is "owned" by a small set of greedy and ambitious individuals, and the elected officials are pretty much their hand-picked pawns. As I commented in another blog entry, the difference between Democrats and Repblicans is negligible, and the struggle over who is in control of the White House and Congress isn't about ideology, but rather which set of puppetmasters get the keys to the kingdom for the next term. Of course, many of the puppetmasters play both sides.

So gas prices might be where they are because the puppetmasters have decided that this is the price the economy can withstand, in the same way drug pushers have to figure out how much their addict-customers can afford to pay. The pushers don't care whether the addicts thrive, only that they survive to buy drugs another day. Maybe that's exactly what the puppetmasters are thinking, and they'll keep pushing up the gas prices a little at a time, forever.

But it could be that gas prices are what they because of purely market-driven supply-and-demand microeconomic forces. Why is it not okay for the oil companies to push up gas prices until they see demand soften?

We have to be assured that the oil companies aren't engaging in price fixing -- where they get together and conspire to raise prices. But let's for a moment believe that they aren't. Why isn't it okay for them to keep raising prices until they see a decrease in demand? It's not like there is some law that says gas has to be cheap. Gasoline is not the easiest stuff in the world to make and distribute after all. First you have to find the crude oil (expensive), then you have to get it out of the ground (expensive), then you have to transport it (expensive), then you need to refine it into gasoline (expensive), then you have to transport it to market (expensive), and then you have to sell it at carefully engineered and operated gas stations (expensive). And we get to buy it for less than $3.00 gallon.

Compare that to the cost of soft drinks. Those are made from water (available pretty much everywhere), corn syrup (the grain elevators are stuffed and there's another crop on the way), and a few chemicals for color and taste. The manufacturing step is pretty straightforward compared to gasoline, and the logistics chain is much simpler. Nonetheless, we consider $4.50 for eight 20oz bottles of Gatorade to be a good price (per the current Kroger ad). That works out to $3.60 per gallon by the way.

Many folks note that the oil companies are making record profits with the gas prices so high, and think it is immoral. But don't we, the buyers, make the choice whether or not to pay that price? Our memories are so short. Back in the 1970s, we were all driving those big gas-guzzling Detroit battleships when gas was 50cents/gallon. Then the oil crisis hit, and Americans flocked to little American cars like the Ford Pinto and the Chevy Vega -- and to Hondas, Datsuns and Toyotas.

But then the oil prices stuck around $1 per gallon for the 90s, and we bought SUVs by the millions and continued moving further and further into the suburbs. It only took us a decade to forget the pain of high gas prices and go right back to gas gluttony. So now we start another changeover, with the early adopters buying up all the hybrid vehicles while SUVs are sitting unsold at the dealerships.

From a pure economic standpoint, it's entirely understandable that the oil companies should test the price elasticity of their product. Elasticity is the relationship between changes in price and changes in demand. The price/demand relationship is said to be elastic if raising prices lowers demand (and lowering prices increases demand), and inelastic if changes in the price don't have much effect on demand. The price/demand relationship for gasoline seems to be completely inelastic right now: regardless of the change in price, our demand stays the same. If I were the oil companies, I would keep pushing up the price until some weakness in demand is created, and then would try to figure out which combination of price and demand yield the maximum profit. That's what every other enterprise tries to do -- why is it inappropriate for the oil companies to do the same?

But you really have to be sure the oil companies are actually competing with each other. Many industries will have a 'price leader' who is big enough to set a price point for their product. Everyone else can be expected to cluster around whatever price that leader set. But some will sell for less and try to snag a little bit of the market on price alone. Others might try to charge more than the price leader by adding features or services to the product. Sometimes the little corner vendor grows up to be Wal-Mart, taking the market away from the leaders (when is the last time you shopped at Montgomery Ward?).

I guess I believe the big oil companies are still competing with each other, in the same way Coca-Cola competes with Pepsi. Coke and Pepsi spend millions on advertising to convince us that there is a really difference in between two products which are about 99% the same (water, sugar, food coloring), and they do so because taking away one point of market share from the other is worth a great deal of money. The gas companies also spend a vast amount of money on advertising? If they aren't competing with each other, why advertise at all?

I also think it's appropriate for the oil companies to make decent profits because it will give them capital to find more oil, and maybe even develop new energy sources. I heard it once said that if the railroads understood themselves to be in the transportation business, we would now be flying New York Central Airlines. But they viewed the airplane as a fad and not the future of transportation (Western Union made the same mistake with the telephone). I hope the railroads are figuring out that passenger rail travel may come back in vogue, and are investing in appropriate equipment, personnel and facilities to catch an increase in demand.

In the same way, I hope the oil companies are viewing themselves as energy companies, and are using a lot of that profit to develop better ways of making and distributing ethanol and hydrogen. They should also be the largest researchers in areas such as batteries and fuel cells. Otherwise, they should pay out some huge dividends to release capital to investors who can put it back into companies who are investing for the future. Either way, they should not be ashamed about making a profit. It's those profits which fund growth and innovation. Even if you tend to left-wing politics, you need profitable businesses to pay corporate taxes to fund your programs. Robin Hood is unemployed if there aren't any rich folks...

Bottom line, if you don't like the gas prices, get a cheaper car, use public transportation, ride your bike to work, or find some other solution. The oil companies don't owe you a cheaper price. Isn't our economy healthier in the long run if we let these high prices be the impetus to lessen our addiction to oil?

No comments: