Tuesday, March 23, 2004

New Year, Same Old Story

Every Spring, the media starts to fill up with horror stories about the rising price of gas. Dark hints and accusations of oil company profiteering soon follow. "It's price gouging," someone will always accuse.


There are perfectly normal explanations that are rooted in government interference in the marketplace. It really is your government's fault! But that doesn't make for good news stories, as the "greedy oil companies" template has been well-established by now.

From the Knowledge Problem website comes this perfectly rational explanation:
The existing EPA fuel oxygenate requirements that arise from the Clean Air Act Amendments of 1990 require that all refiners deplete their inventories of winter fuel before restocking the tanks with the summer fuel (something to do with reducing the probabiilty of mixing). This requirement exacerbates the seasonality that is inherent in gasoline prices because of (1) changes in the demand for gasoline and (2) the price inelastic nature of the demand for gasoline. So now in addition to inelastic seasonal demand for gasoline, we have inelastic seasonal supply of gasoline. And politicians and "uninformed newscasters" wonder why we have seasonal price spikes ...

In theory these price spikes should provide an arbitrage opportunity for some clever entrepreneurs. But the opportunity cost of inventory storage is very large; petroleum refining is a very aggressive oligopoly, so the profit margins are just not there to support carrying such a capital cost. Furthermore, constructing more tank farms is almost as much of a no-no from the aesthetic/NIMBY perspective as building more refineries (the last refinery built in the US was constructed in 1976, in Louisiana). So expanding storage is expensive and difficult to achieve.
Make sure to read the comments as well.

Do I think people will pay attention to such simple market economics? Of course not. The conspiracy theory is so much sexier. Ah well....

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