Thursday, September 21, 2006

Rising Falling

Rising gas prices increase demand and reduce supply. Falling gas prices reduce demand and increase supply. At least over the short term. It is caused by market psychology and results in market mania if the supply/demand curve is steep enough.

Here is how it works. If consumers expect prices to rise (s)he will purchace as much as possible as soon as possible in order to lock in as low a price as possible. Correspondingly producers have an incentive to hold as much supply off the market as possible becaues it will be worth more later.

With falling prices consumers will put off purchaces as long as possible because prices will be lower in the future. Correspondingly sellers will want to sell all they can before prices go lower.

The supply/demand curve for oil is steep. Thus there is no true equilibrium price. Small fluctuations appear as noise, but large fluctuations are greatly amplified. Prices will (temporarily) stablize when demand again equals supply. Then prices will slowly increase as new demand brings forth little supply because new supplies are no longer worth the effort. The producers already producing will produce as much as possible to try to match income with fixed expenses. With enough demand prices will start spiking and the cycle will repeat.

All these oscillations could be damped if drilling wells didn't take so long. Or if refineries could be built in six months. Any system that has high amplification factors and long lags will oscillate. Its the law.


Duchess Of Austin said...

I drove by the gas station this morning and the price of gas is now $2.30. 6 weeks ago, it was $2.89 or thereabouts. How can anybody say that only market fluctuations cause this?? I mean, come on, the price has fallen over 50 cents in 6 weeks??

There has to be more to it than merely the changing of the seasons, and I should think that in urban areas the demand for gas would stay pretty much the same, regardless of the time of year.

I'm not a huge Bill O'Reilly fan, but I believe the man has a point when he says that big Oil is manipulating the price....

M. Simon said...

If big oil can manipulate the price why isn't it $6.00 a gallon?

Captain Ramen said...

I agree with your assessment.

Not so duchess.. a gas station owner has to buy his gasoline from a refinery, directly or indirectly. The price you see at the gas station is more or less based on his cost from the refinery. It isn't as if refineries only service urban areas or rural areas. It's one market.

Next time you observe fluctuations in gas prices, compare gas stations that do a lot of business with those that do very little. I noticed that an indie gas station near a freeway entrance that does almost no business was as much as $0.50 higher than one down the road, and further more he didn't change his price for a month, where the other stations chnage prices almost daily.

Why? Because he doesn't cycle his inventory as often as the others - that is, he runs out of supply at a much lower rate than his competitors. Meaning he doesn't get an updated cost as often, either. This is a classic problem in an inventory business... stuff you paid $10 per unit for last year is piled to the ceiling in your warehouse. But you can now buy that item for $5. Do you cut prices to stay competitive but lose money? Or do you sit on it and hope that eventually you will run out and be able to resupply at the lower price?

Think of consumers buying gas at the pump as if they were speculating in the stock market. Often a stock price is determined not buy the actual *value* of the stock, but rather on whether the day trader sitting next to you wants it.

In otherwords gas prices can be seen as a bubble, where every player buys it on the spot market.

Perhaps one way to introduce stability would be to allow consumers to purchase long term gas contracts like a futures market. I know that I get about 30 mpg in my honda civic. So I could offer to buy 1 month, 3 months, 6 months or a year's worth of gas up front based on that.

linearthinker said...

I have my own well. My water is heavy with iron and manganese. The iron I can live with. The manganese makes my coffee taste bad. So, I buy my water at the local market to brew my morning cup, having had marginal experience with low cost filters for manganese removal. Over the last several months, the cost of the cheapest bottled water in this rural area has spiralled up from 69 to 99 cents per gallon. I buy less water at 99 cents. The water bottler is also one of the big three in the local dairy business. Last time I checked, the price of two half gallons of 2% milk was over $5.00 per gallon. I know blue ribbon milk cows are expensive, and the milk has to be squeezed from the teat, filtered, pasteurized, homogenized, diluted, bottled, and delivered, but considering the logistics and infrastructure required for a jug of that dairy's water, or of their 2% milk, vs that required to deliver a fillup of gasoline to my tank, I marvel at the ability of big oil to deliver a consistently reliable, high tech commodity for the price we seem so quick to bitch about. Especially when a considerable fraction of their product stream is shipped as crude from half way around the world. I'm old enough to remember how smug I felt as a graduate student riding my bicycle past the half-mile long lineups of irate frustrated working stiffs who had to spend more time filling their gas tanks than playing with their kids in the evenings during the price controls slapped on by Nixon and Carter back in the day. I shudder when I hear talking heads like O'Reilly bloviating about big oil's manipulating prices, and I get physically sick at the prospect of Washington asshats holding hearings on the subject.

Duchess Of Austin said...

Yes, but I live in TEXAS. We refind the oil here, so if it is as you say, they don't have to ship it very far from Texas City to Austin, thus reducing the transportation costs, and the refineries have been paid for for years, so it's basically they pay for crude oil and personnel. I can understand why it's expensive in California and say, Chicago, because there is no source there, but Texas? Puleeze....somebody's pulling the wool over all of our eyes.

Captain Ramen: I could go for that buy it at spot point for a specific time....actually there is a "gas bank" somewhere up north where they do just that. You can make "deposits" and lock in a particular price until you are ready to pump it. I love that idea.

linearthinker said...

A folk tale for you. One day in late summer, a news announcement was made by a breathless feller on Channel 3. "Big oil reserves located in gulf." By a week later the gas prices at the pump had dropped 12 cents per gallon. Folks who'd watched the price shoot up 33% over the last four months were convinced big oil had been screwing them, and they'd just screw 'em right back. They trotted down to the local gas-bank, and laid out their whole gas budget for the next year, buying on lay-away, so they could lock in the 12 cent discount before the gas company realized they'd slipped up. Now, in October, they're smugly filling up their tanks at $3.05 per gallon from the stale old late summer gas from the big old tank up north, while their neighbors are tanking up down the street at Cal's Cut-Rate for $2.45 a gallon for regler with a born-on date of yesterday. Incidentally, I think I know where that big old tank is up north. It's somewheres near Amarillo. I filled up with Chevron there in about February of '04 for $1.29 a gallon. I was so happy I bought a fist full of pitcher postcards and sent them to all my friends and neighbors tellin' what I'd found. I was awantin' to rent a U-Haul and fill 'er up with jerry cans. I'd hit the mother lode! Later I figgered out that the postcards and stamps had run my gas bill up to about a $2.75 a gallon unit cost, but it was worth it...some of my friends had never got a pitcher of the Cadillac Ranch delivered in the mail before. I love Texas.