Quote of the Day

From the WSJ's Morning Brief:

"My constituents and, I believe, most Americans think that somebody rigs these prices; that in the process, somebody is getting ripped off; and they think it's them, the constituents who ask me and the constituents of America who ask this question. So I want to ask you -- and please, in the few minutes you have, somebody describe in detail how the price of oil is set, because I close by saying if that is not rational, then are you rigging the price of oil or is somebody rigging the price?" Republican Sen. Pete Domenici asked of top executives of BP, Shell, ExxonMobil, Chevron and ConocoPhillips yesterday in a hearing on oil prices.

Insert your preferred exclamation (no profanity please) here (e.g., "Jeez-o-pete!"). My guess is that Senator Domenici has a staffer that could tell him that supply and demand forces set oil and gas prices. My other guess is that Senator Domenici was trying to score some political points. But, that's just me being my cynical (sleep-deprived) self.

I heard that the next question went something like this:

So I want to ask you -- and please, in the few minutes you have, somebody describe in detail how you make a peanut butter and jelly sandwich ... with the crusts removed. My constituents, and I, demand to know."

The Reinforcements (from Econbrowser): Senate Finds the Facts about Big Oil

Comments

[odograph]

Certainly market forces are at play, but it might be useful to remember that every successful "price fixing" prosectuion took place in a market economy.

Market forces do not disprove collusive ones.

(They really lost me at the swearing-in argument.)

[John Whitehead]

Odo,

But when obvious changes in supply (Katrina) and demand (China) lead to predicted impacts on prices it would be reasonable to not blame those who happen to gain from it.

And, recently there are some instances of true price fixing. But, at least around here, it seems like it is the work of just a bunch of clumsy bozos, not a Big Oil conspiracy.

John

[odograph]

Maybe I've just got a sneakier devil on my shoulder ;-).

This would seem to me the BEST time to juice prices a little bit.

("juicing" prices, is a little different than price fixing. It is more like a poker game where the suppliers are all players, raising ... keeping an eye on each other, consumer demand, and of course government oversight.)

[odograph]

BTW, I'm not sure if we discussed it here, but I think that the public sentiment about gas prices is centered in a percieved social contract.

And government spending on roads, etc., certainly implies a social contract.

[odograph]

P.P.S. - isn't it interesting that news about grilling of oil execs, and further cuts to AMTRAK come out of Washington on the same day?

[Dano]

You know, John, that some Senators didn't want the oil execs to swear in, right?

You can pooh-pooh and use your words all you want, but not one word you wrote does anything to show that collusion doesn't occur. Yes, yes, you repeated the mantra that supply etc. but that doesn't mean that the oil companies can't tack on a penny here, a penny there.

Again, nothing you said refutes collusion. Not even the Jeez-o-pete.

Best,

D

[ralph]

John, I'm with them on this. I expect that these executives can well lay out a supply/demand explanation on a dime. But normal humans don't understand much the long chain of events that has to occur from ground to gas tank. So, let the man explain: I mean, all Domenici's doing is giving the dude time to explain to the American people why any irritation they have is unfounded. I realize that people who teach live and breathe economics might find this odd, but do recall that you **did** actually go to school for YEARS to learn what you know now.... :-)

[Tim Haab]

Look, a student is actually paying attention in class--sort of. I got this unsolicited e-mail from a student today in response to our local paper's front page coverage of the Oil Exec's testimony:

"The oil execs managed to dodge many of the pertinent questions, trying to pass the blame and focus the attention on other things. However, wasn’t there an economist in the room when the Exxon-Mobil exec stated that they did jump up gas prices almost a quarter to try to decrease demand and prevent shortages? I’ve taken 7 weeks of your class and I’m pretty sure I could put forth a strong enough argument about the inelasticity of demand for gasoline, especially in the short run to discredit anything the executive said and basically prove that they were in fact price gouging."

I'm with him, except for that 'gouging' part. But hey, at least one of my stuents is applying what he learned in class.

[odograph]

Interesting, if they did say "they did jump up gas prices almost a quarter to try to decrease demand and prevent shortages" that would imply that they had some kind of social contract in mind.

If this was just markets, why would they care about shortages?

And if this was a "socail good" why do they get to raise the quarter, rather than the gas tax folks?

[ianqui]

I'm too lazy to look this up right now, but does anyone have a link to the execs' response to Domenici's question? Is there a transcript of the hearing somewhere?

[odograph]

P.S. - anybody have an idea on how I can make $10B in the next quarter, while selflessly enacting a social good?

[Tim Haab]

If "they did jump up gas prices almost a quarter to try to decrease demand and prevent shortages?"

i don't think they did that at all. Sounds good though doesn't it?

A rise in price decreases the amount consumed and has nothing to do with shifting demand.

They raised prices because they could. Demand increased in response to expectations of future higher prices (and possibly due to a short term supply decrease). Both of these things will raise market prices. The windfall profit comes from highly inelastic short-run demand (as my student pointed out--I'm so proud).

That Exec statement is the equivalent of a local politician saying they are going to raise the gas tax by $.05 to reduce consumption. Nope--ain't gonna happen. The $.05 increase will raise revenues.

[odograph]

Tim, I understood the inelasticity, which made me curious about your "except for that 'gouging' part." You seem to share the same sentiment as I expressed in my following questions, and you end this comment with "ain't gonna happen. The $.05 increase will raise revenues."

The "raise revenues" versus "gouging" call would seem to me related to the level of "emergency" and the associated social contract.

If we were discussing a non-critical item like candy bars or chicken wings ... well we wouldn't be discussing them here or in congress. If prices went up in response to a shortage (and maybe a little extra revenues), who would care? We'd buy less of those things or more of another.

This only might be "gouging" because we grant private oil companies a somewhat unique position in our society. We build infrastructure forward on the expectation of "fair" oil prices, and in the process make ourselves totally dependent on "fair" oil prices.

[John Whitehead]

James Hamilton feels the same way that I do about it: http://www.econbrowser.com/archives/2005/11/senate_finds_th.html.

Here is the oil exec's answer to the Senator's question (from WSJ Morning Brief):

"Now Senator, that's an extraordinarily complex question that you just asked. I think as I made -- in the comments I made, the U.S. companies that are represented here, in terms of the total amount of production that they have that they contribute to the world supply is relatively modest. Our own company is less than 3%, and we're the largest producer. The facts are that the world supply pool, many, many countries contribute to that and many companies operate in those countries. But obviously, the big actors in the equation are Russia and the Middle East countries and OPEC," ExxonMobil Chairman and Chief Executive Lee Raymond replied.

[odograph]

BTW, I don't have a hard and fast position of what the rules should be. My hot button is just the assumption that this is a free market.

There is a huge amount of government intervention all along the pipeline, from nationalized oil companies, right down through to county and city regulations on hydrocarbon use.

The government influences are both boon and bane to the private companies intermingled with them. On the one hand they are burdensome, and on the other they provide markets (and bordering on "guaranteeing them").

[odograph]

You typed your 2:38 while I typed my 2:42.

My answer to 2:38 (and Prof. Hamilton) is that no one disputes a market aspect.

[ianqui]

Lee Raymond's response is a non-response. What a missed opportunity. He should either have a canned answer that explains in 2-3 minutes how the world oil markets work. (Or, if he thinks like odograph does, then he should point out the government's role in affecting oil prices.) Apparently the public and congress both sorely need an understandable explanation of how the whole oil discovery-drilling-delivery system works, so that we can not waste time with this kind of grandstanding when this kind of thing happens again.

[odograph]

We might as well expand it to "governments' roles" rather than a single government's role.

After all, would our President be sweet-talking Kings in the proverbial free market?

[joshua corning]

"anybody have an idea on how I can make $10B in the next quarter, while selflessly enacting a social good?"

That is the great thing about capitalism...you can enact social good while at the same time being a greedy bastard.. :)

Or is it a pure bile to suggest that while John and Tim do the world a public service by teaching youths the ins and outs of economics that they also draw extravigant monthly pay checks.

[joshua corning]

oh crap i almost forgot...here is an article at reason.com on this very same subject.

http://www.reason.com/hod/sd110905.shtml

"Our aggregate profits are so large because we have huge sales. But our profit margins—the more relevant measure—are below the overall Standards and Poor industry average. Exxon Mobil, the most profitable company among us, posted $100 billion in sales last quarter —the first American company to hit that mark ever. But its profits were $10 billion—hardly a margin that suggests the "price gouging" that some of you have accused us of."

and this

"Besides, we already tried windfall profit taxes—along with leisure suits and polyester ties—with disastrous results.

During the period between 1980 and 1987, the last time when such a tax was in effect, 1.6 billion fewer barrels of oil were produced—because such taxes diminish the incentive to produce oil. "

[The Stalwart]

I don't think that Sen. Domenici was trying to score points at all. I think he thought he was serving Lee Raymond up with a softball question, allowing the CEO to explain how supply and demand works. But Raymond botched the question, and it only then appeard that Domenici was grilling him. That was just my take.

There were several other Senators guilty of trying to score points and grandstand for sure.

[odograph]

joshua, I'm actually a happy market element. The "selflessly enacting a social good" bit was specifically directed at the suggestion that they raised prices "a quarter" just to protect us from shortages.

(I'm sure I agree with Tim and John more tham my comments imply ... the interesting discussion is at the edges.)

[joshua corning]

"joshua, I'm actually a happy market element. The "selflessly enacting a social good" bit was specifically directed at the suggestion that they raised prices "a quarter" just to protect us from shortages."

yeah my comment came off more critical of you or even john and tim then i ment it to...i was just sort of throwing that out there at my own imagined strawmen.

[Chris]

I'm sympathetic to Reason's argument, but why use profit margin? Wouldn't it make more sense to use return on capital or return on investment?

[John Whitehead]

OK, I'm trying to catch up.

Dano: Roughly, due to market forces, the price of a barrell of oil has doubled and the price of a gallon of gas has doubled. I don't see where a penny here and a penny there is the big problem and worthy of distorting windfall profit taxes (that might/would reduce the supply of gas).

Ralph: The supply and demand analysis is learned by 19-20 year olds in the first month of their first semester of econ. My guess is that the public would be OK with the Senator and the Executive having an honest discussion about what is really going on.

The Stalwart: The Senator seemed to make it clear that he didn't want to understand how markets work. If this was a softball question the hoped-for answer would have made him look ignorant and silly(er).

Everybody: the next time that you participate in a labor market and the buyer is put in a position where the seller (you) can extract a higher price (wage), imagine turning that higher wage down so that someone else will be better off. Not quite, but this a bit what you're asking the oil companies to do -- turn down the sure thing for the greater good (your co-workers get health insurance). I don't like the oil companies either, but it doesn't do much good to beat them up in this situation (Exxon Valdez? Let's have at it!).

Thanks for the great discussion (on what I thought would be a throw away post, benefiting only my funny bone)!

John