Doesn't it take longer than a day for oil to become gas?

Oil jumped to $78 per barrel yesterday.  My wife paid $3.30 for gas this morning.  I'm pretty sure it takes more than 48 hours for Middle East oil to become Columbus, OH gas.  So what's going on?  In short, expectations matter.  Prices are expected to go up in the future, so prices jump today.  Is this greedy suppliers taking advantage?  No just rationality at work. 

Comments

[Chris Ball]

I wonder though, what about other products that depend heavily on oil, but where that dependence isn't in the public consciousness as much? Did the price of plastics jump overnight too? How about chemical fertilizers? Asphalt? How does the increased price of oil cascade down the supply chain?

[John Whitehead]

Chris,

I think you might have answered your own question. The price jump is quick in the gas market because these prices are right in front of us.

Or, the price takes longer for other products since oil is a smaller fraction of the inputs into production.

Or, we don't notice the price increase since it is small relative to the prices of the other products.

John

[Don Lloyd]

Tim,

A gasoline retailer may have spent $2.50 for a gallon of gasoline sitting in his underground tank, but this is a (literal) sunk cost.

Why would he sell a gallon today for $3 if he expects the replacement cost to be $3.50 next week? Just holding the gallon will leave him $0.50 better off at the moment next week when his supplier finishes topping off his underground tank.

Regards, Don

[Brian]

If the reatailer didn't up the price of gas, you'd alway buy in the time between oil price up and gas price up. And wait on the way down:

http://www.econbrowser.com/archives/2006/05/congressionally.html

[PaulS]

Obviously you've answered your own rhetorical question. The "interesting" part, though, is that while Joe Bloggs thinks the gas station guy should sell gas for what he paid for it, Joe would never dream of selling his own house for what he paid for it.

The only principle discernible from all this is the one that says Joe Bloggs ought to have a free ride paid for by somebody else. And in a democracy, for example Nova Scotia or New Brunswick, he can of course help himself to a free ride whenever he feels like it - at least until something breaks.

[joshua corning]

so wait do we even need a 50 cent gas tax now??

I sure hope you guys are getting good stats on all this.

[joshua corning]

The only principle discernible from all this is the one that says Joe Bloggs ought to have a free ride paid for by somebody else. And in a democracy, for example Nova Scotia or New Brunswick, he can of course help himself to a free ride whenever he feels like it - at least until something breaks.

and that is yet one more reason why democracy just does not work.

In other news I welcome our new oil company overlords.

[John Whitehead]

Joshua,

Think of the current price spike as a "geopolitical risk" tax.

John

[joshua corning]

Think of the current price spike as a "geopolitical risk" tax.

I like to think of it as the ending of the complicity to tryranny subsidy.

Note: This of course has huge logical holes in it.

[jerry]

And your explanation for why, in a competitive market with rational expectations, the prices take so long to go down is ...?

Why would he sell a gallon today for $3 if he expects the replacement cost to be $3.50 next week? Just holding the gallon will leave him $0.50 better off at the moment next week when his supplier finishes topping off his underground tank.

When the shortage is averted, why shouldn't pump prices reflect that morning's decline in per barrel costs? If the owner holds on to the oil in the ground, his competition's prices may be even cheaper next week!

I don't know how to reconcile "competitive market" with "system with instant price increases and lag for price decreases"

It seems to be explained only in that there is not a competitive market, and if not, then it seems reasonable for market regulation to step in.

The first thing I would do is the following, require all gas stations to put on a public and government website their oil purchase information in a standardized format.

Grade of Gasoline, Quantity Purchased, Time and Date, Distributor, Cost.

If that did not create forces to bring the leads and lags of prices into account then the second thing I would do is make those gas stations publish on the same website daily sales figures:

Grade of Gasoline, Quantity Sold, Time and Date, Price.

This information would provide the consumer more detail in what any one gas station's particular value add is. That is, who is ripping them off or not.

The end result would be a system in which non-competitive speculative leads in price increases are damped and risk-avoiding, price-gouging lags are damped as well.

When will economics take a systems approach and not just blame everything on an invisible cloud monster?

[valerie]

i worked in the oil industry for 10 years. they charge more because they can. today it takes about sixty eight cents to make a gallon of gas. the rest is middle men and profit. that costs include the labor and total processing for the oil to become gas, jet fuel,.... we used to have a saying at exxon: exxon, we do it because we can, we are the problem! we used to wear the t shirts at work just to piss off our bosses. if everybody boycotted for a week the prices would drop like a hot rock. if anyone tells you different they are not working in the industry or are making too much money to fess up.

[kebko]

Jerry:

I suspect that if you did that, you might find that you save a few pennies a gallon on gas, but I think you would also find over time that the reduced profit margins in the industry would reduce investment, and you'd have to drive an extra couple of miles to find gas for sale.
As a side note, as I think about it, the irony here is that the very basis for all the conspiratorial hand-wringing - the volatility of the price - is actually the best evidence of a free market. Margins are so thin that retailers have to immediately react to every change in costs. If it were a less free market (like almost every other market for goods out there) the suppliers would have meatier margins and they would tend to allow margins to be squeezed in the short term in order to keep stable prices (& content customers). I suspect that this is a large reason why we don't see such constant price volatility in plastics & other petroleum based industries. The logy market, derived from fewer niche players with fatter margins, helps ease the swings.

Valerie:
The fact of the matter is that some of the most powerful interests in the world are shareholders of these oil companies. And, the net profits that these companies are reporting to shareholders (which is public information) are generally less than 10%. So, all these profits you claim they are making are disappearing at some point before they get to the shareholders. Are you telling us that these very powerful interests are being defrauded by some secret trolls inside the companies that are taking all this money & hiding it away somewhere?

By the way, my very sweet late grandmother-in-law had most of her meager wealth tied up in Occidental Petroleum stock. I always like to picture her when people go on about the evil oil companies. I imagine most of us have grandparents who derive some retirement income, directly or indirectly, from oil company profits (at least the profits that aren't secretly stolen by the trolls before they are reported to the SEC). Our grandparents are even more evil than you thought!

[jerry]

I wouldn't do much of anything kebko except prove there was either a free market or not a free market and encourage competition.

What I propose would show the station owners who is getting screwed by their distributor.

It would also let the station owners benchmark the profit margins of their competitors and use that information to inform their own business decisions.

It would let someone with a website and a bot determine which stations gouge the most, and which stations create the most value for their customers.

It would let customers and researchers generate curves showing the price leads and lags and study those curves.

All in all, my proposal would flatten price disparities to the owners, allow owners to better understand their and their customers businesses and allow the consumer to determine if the price they pay is worth the value and service they are getting.

All of that should serve to promote competition.

Look I believe in competition and the invisible hand, I believe in evolution, and I believe in systems engineering.

I believe that random walks and competition in evolution led to a bird in several hundred million years, and I know that from Orville and Wilbur Wright to the 747 took about 55 years.

I don't understand making the random walks and competition pressures of the invisible hand our one and only forceful god.