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The Price of Gas

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Three bucks for a gallon of gasoline is perfectly sensible. Incessant blather about gas prices, on the other hand, is intolerable. As John McCarthy advises, he who refuses to do arithmetic is doomed to speak nonsense.

Gasoline prices are known for being highly volatile. Unlike things like, say, a particular fast food restaurant's cheeseburger that can go for years without a hike in price. Of course, when the commodity being traded is called “single,” “double,” or “triple,” relatively minor adjustments can be made in the quantity of the packaged good: if costs of raw materials or labor go up, you can keep your ninety-nine-cent pricetag by reducing the serving size or making another adjustment in the process that reduces labor cost.

With commodities bought by a raw measurement like weight or volume, or where supplies are more volatile, flexibility in packaging to keep a consistent price in front of the customer isn't so easy. (Fresh seafood, for example, will often appear on restaurants' menus as priced at “market rate.”) One obvious solution is for the vendor to normalize the price by setting a price based on some average, knowing that when cost prices are high, they'll lose money, but that they can make up for it when cost prices are low. The issue here is that as soon as the costs are low, someone will sell the commodity for less than the other guy, who will respond with a lower price, and so on. Thus, in an open market where everyone sells essentially the same commodity, prices are driven downward by competitive pressure, ever closer to raw cost.

Pricing has a lot to do with packaging: how much you're getting for whatever unit you're buying, the experience of the transaction, and what you get to do with the results. That's why a hamburger at a pub can cost seven dollars and a hamburger at a fast food place can cost a dollar. It's also why there can be more flexibility in pricing on the higher end: if you want to go to a place with some atmosphere, some people you like to hang around, and where they'll pour you a proper pint of your favorite brew, you don't care so much about a twenty or fifty cent difference in the cost of your hamburger. Nor do you much care if it's sixteen or fifteen ounces.

Contrast this with price sensitivity at the bottom-end: places with no dining room are cheap to maintain because it's just kitchen and drive-through. There's no dining room or public restrooms to keep clean, no counter presentation for the customer and no need to decorate the interior. Labor costs are focused entirely on making the hamburger, taking your money, and throwing it into your car as you drive by the window. It doesn't really matter to you if it's Rally's, Daddy O's, or anything else. But you'll notice if that's seven ounces instead of eight and might even count how many french fries you get. (And you certainly wouldn't do anything silly like call them frites français.) In the middle, you've got a bit more flexibility. McDonald's is a place you can sit down and eat in a clean place without having pay too much, and you can be sure you're going to get exactly what you got every other time you went to any other McDonald's anywhere. Wendy's is basically the same deal except that they encourage you to customize what you're asking for, because, as they remind you, they don't make it until you're finished ordering it. It takes a few extra seconds and costs a few extra cents but it's exactly what you wanted.

So what does food have to do with gas? Or, what does food have to do with gasoline? Plenty, since we're really talking about the pricing of a commodity in a marketplace. What prompted me to compose these thoughts into a single form is a priceless bit of email that a friend of mine forwarded to me (along with upwards of thirty other people). Resisting the intense urge to hit “Reply to All” was no easy task; I'm afraid that letting nonsense stand unanswered is not in my nature. (Very well, I admit it: I did hit the button but I stopped myself before writing even a word.)

The message in question follows, exactly as I received it. It is quite breathtaking in more ways than I shall enumerate. I'll resist the urge to point out errors in grammar, spelling, punctuation, and logic except to the degree that they affect the material issue. Ready? Neither am I, but here you go, anyway.


I hear we are going to hit close to $4.00 a gallon by the end of the year. Want gasoline prices to come down? We need to take some intelligent, united action.

Phillip Hollsworth, offered this good idea:

This makes MUCH MORE SENSE than the "don't buy gas on a certain day" campaign that was going around last April or May!

The oil companies just laughed at that because they knew we wouldn't continue to "hurt" ourselves by refusing to buy gas. It was more of an inconvenience to us than it was a problem for them. BUT, whoever thought of this idea, has come up with a plan that can really work.

Please read it and join with us!

By now you're probably thinking gasoline priced at about $1.50 is super cheap. Me too! It is currently $2.95 for regular unleaded in my town.

Now that the oil companies and the OPEC nations have conditioned us to think that the cost of a gallon of gas is CHEAP at $1.50-$1.75, we need to take aggressive action to teach them that BUYERS control the marketplace.... not sellers.

With the price of gasoline going up more each day, we consumers need to take action. The only way we are going to see the price of gas come down is if we hit someone in the pocketbook by not purchasing their gas!

And we can do that WITHOUT hurting ourselves.

How? Since we all rely on our cars, we can't just stop buying gas. But we CAN have an impact on gas prices if we all act together to force a price war.

Here's the idea:

For the rest of this year, DON"T purchase ANY gasoline from the two biggest companies (which now are one), EXXON and MOBIL. If they are not selling any gas, they will be inclined to reduce their prices. If they reduce their prices, the other companies will have to follow suit.

But to have an impact, we need to reach literally millions of Exxon and Mobil gas buyers. It's really simple to do!! Now, don't whimp (sic) out on me at this point... keep reading and I'll explain how simple it is to reach millions of people!!

I am sending this note to about thirty people. If each of you send it to at least ten more (30 x 10 = 300)... and those 300 send it to at least ten more (300 x 10 = 3,000) ... and so on, by the time the message reaches the sixth generation of people, we will have reached over THREE MILLION consumers!

If those three million get excited and pass this on to ten friends each, then 30 million people will have been contacted! If it goes one level further, you guessed it..... THREE HUNDRED MILLION PEOPLE!!! Again, all you have to do is send this to 10 people and DON"T purchase ANY gasoline from EXXON and MOBIL. That's all.

How long would all that take? If each of us sends this email out to ten more people within one day of receipt, all 300 MILLION people could conceivably be contacted within the next 8 days!!! I'll bet you didn't think you and I had that much potential, did you! Acting together we can make a difference.

If this makes sense to you, please pass this message on.


Where do we start? How about at the end? The conclusion is that gasoline “should” cost a buck and a half. The conclusion is completely without foundation. If we want to take a look at some issues regarding pricing of gasoline in particular, let's start with taking a look at the critical components of the cost of gasoline. The four major categories here are the cost of marketing and distributing the gasoline (the smallest of the four major influences), costs of refining and profits (tied for smallest, or perhaps just larger than that), taxes (the second largest, approaching double the amount wrapped up in refining and profits), and then the largest cost is crude oil.

The conclusion here is that gas “should” cost as much as it last did in December 2003, when the cost of crude oil was hovering in the range of about sixty cents per gallon. Note the chart nearby. Not only do we see that the retail cost of gasoline in September 2005 spiked up to about three dollars per gallon, but we can see the cost of crude oil is kissing a dollar and a half per gallon. So my question for the author of this harebrained scheme is this: just how is ExxonMobil to deliver gasoline at retail stations at a price that will just barely cover the cost of the unrefined oil? Should ExxonMobil stop paying taxes? Perhaps ExxonMobil should stop marketing and distributing the fuel: they'll just wait for everyone to come to them to get it. Or perhaps they shouldn't bother refining it at all and they'll take no profit whatsoever. Without the refining process, your car can't run on it and without the ability to operate at revenue levels that exceed costs, the company cannot stay in existence, which means they can't import the crude, can't refine it, and once again, you're back to walking.

So let's look a bit deeper into the reason behind the rise in crude oil costs. Contrary to what some airheads will claim, “market price” doesn't always work against the consumer. In late 2001, the Energy Information Administration issued a featured article on its Web site entitled, “Why are gasoline prices falling so rapidly?” Therein, prices were compared for the period from January 1999 until December 2001. Of note was the period from May 2001 when retail gasoline cost roughly $1.70 per gallon until November, when it cost just over $1.20 per gallon.

EIA noted that three major factors influence the cost of retail gasoline: changes in crude oil prices, seasonal shifts in the balance between supply and demand, and unusual events or trends affecting the balance between supply and demand.

Using these same factors, we can look at the price of gasoline in September 2005. First of all is the change in crude oil cost. As noted above, the cost of crude oil has shot up rapidly this year. In January 2005, it was going for less than ninety cents per gallon on average and climbed to nearly a dollar and a half.

Secondly, look at seasonal price fluctuations. Summer is peak demand period, dramatically higher than its low demand point during the year (January). With suppliers of crude and refineries running at so close to capacity, there is little that can affect the supply, meaning that increased demand means increased price.

Finally, unusual circumstances. We've got them aplenty right now, with the U.S. refineries at the Gulf coast suffering massive hurricane damage from Katrina.

The only way to make the price of gasoline go down in such an environment is to reduce overall demand. That means that you'd better start thinking about using public transportation, carpooling, walking, or using more fuel-efficient vehicles. Boycotting ExxonMobil or anyone else is just an exercise in ignorance.

Created by cmcurtin
Last modified 2005-10-03 01:02 PM

simpler still...

Posted by donetrawk at 2005-10-07 09:08 AM
This country has the cheapest gas in the world. (Been to Europe in the last few years?) People need to stop complaining.

(Oh, and public transportation and walking are not an option for most of us. In my case, I work 20 miles from home... no public transport connects the city I live in with the one I work in.)

Bravo, sir!

Posted by Rex at 2005-11-11 09:29 AM
Now we just need to wait for Doc Brown to build a machine that runs on beer, beer cans, and banana peels.

it's true

Posted by shaner93 at 2005-11-15 11:34 PM
OK so we can't get gas down to $1.50.

But did you hear Bill Gates is giving away $5 for every person you forward that email to?

Send it to 30 people and that's like $20,000!

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