Explore Harvard's Nieman network Nieman Fellowships Nieman Lab Nieman Reports Nieman Storyboard

What, if anything, can bring down gas prices?

COMMENTARY | May 06, 2006

More domestic production seen as not making any difference; competition among refiners could make a difference—but not a big one.

By Henry Banta

Few recent events have produced as much bad journalism as the recent run-up in gasoline prices. Few writers seem able to get beyond, "You're gouging," "No we're not." Some basic points need to be understood before getting past the accusations and rhetoric. Some are simple; some aren’t. Most involve nothing controversial.

1. Oil is fungible. Within bounds one barrel is pretty much like another. It is traded on commodity exchanges like any other commodity, wheat, pork bellies, metals, etc. Differences in grade, i.e. gravity and sulfur content are just matters of price, reflecting the relative value of the products that can made from the crude oil.

2. There is a world market for oil. This means that the price of a barrel produced in the U.S. Gulf is affected by the cumulative prices of oil in the North Sea, Nigeria, Saudi Arabia, Indonesia, etc. A refiner buying a barrel of oil does not care about where it comes from, only the price delivered to its refinery.

3. No amount of domestic production can protect the US from the world market price. As long as the "marginal" barrel is imported, its price will set the domestic price. Drilling in Alaska or offshore California will not save us from high world oil prices. Complete independence is too expensive to contemplate.

4. Making the US "less dependent on foreign oil" sounds nice, but it will do nothing to make domestic oil cheaper. There may be other benefits, but it will not lower our energy costs. 

5. It is useful to think of all the oil produced in the world as flowing into one big pot. U,S. oil, Saudi oil, Nigerian, Mexican, etc., all goes into this pot. Likewise, all the oil purchased comes out of this pot. Price differences reflect only differences in quality and transportation costs. Thought of this way, most of what politicians say about oil policy is plainly wrong.

6. Increasing domestic production can't do much good; there is simply no way we can produce enough to change the world market price. Conservation can do a lot of good. First of all, our ability to reduce demand is far greater than our ability to increase supply. Second, if we do not stop burning so much of it, our grandchildren will be building levees around New York City.

7. Most of the world's oil is in places where it is not needed, and where the money it can bring is. The major oil producing countries, or at least some of them, are capable of restricting their output in order to get higher prices. A few countries have enough production that they can affect the world market price. But there is a limit. If they run it up too far, they will get real conservation, bring on stream all kinds of otherwise marginal production, and lose money. There is a point beyond which even a monopolist cannot raise prices without losing money.

8. There is not much we can do about the world price. Notions about suing OPEC are silly. Proponents should acquaint themselves with the concept of sovereign immunity and the act of state doctrine – long established fundamental principles of US law. It is after all, their oil and they can try to sell it on whatever terms they think they can get.

9. Crude oil itself is worse than useless; it is volatile, toxic and it stinks. It must be refined into products we can use such as gasoline and heating oil. Refining, therefore, is a very important industry, and in general, it is something we do here at home.

10. Competition among refiners is important. Refining costs make up just under 20% of the cost of gasoline (compared with a little under 50% for crude oil). Put another way, the refining margin is a bit under 20% of the total price of gasoline.

11. Moving this margin a few cents one way or another may not seem like a big deal, but it can quickly translate into few billion dollars.

12. Competition would hold the refining margin down. The more competition, the lower the price. For example, California: California has the fewest number of competing refiners of any market in the country. It has the lowest crude oil costs and the highest gasoline prices – i.e., the highest refining margins. In other words, competition at the refinery level matters. It may not save us from high crude oil prices on the world market; it still matters. 

Of course, to all of these there are exceptions, qualifications, and reservations. As to the first point, for example, there are refiners that cannot use heavy or high sulfur crude oil. (Heavy and high sulfur crude can be exchanged for more suitable crudes, with a price adjustment.) Point 9 should be qualified with a note that crude oil can be burned on some ships as bunker fuel. But without some understanding of the general principles one can get lost in a sea of particulars. The exceptions are, after all, exceptions. Anything inconsistent with these general points deserves a very close second look and a very good explanation.

Posted by Les Self
06/26/2008, 12:45 PM

I agree with Mr. Stephens.

"By David Ellis, CNNMoney.com staff writer
February 1 2008: 2:26 PM EST
Oil giant makes corporate history by booking $11.7 billion in quarterly profit; earns $1,300 a second in 2007."

Mr. Tate is right,
“A business exists to maximize profits and minimizes losses. It is not a CHARITY!”
But, Mr. Tate, price gouging is unethical !

Now, two years after Mr. Stephens and Mr. Tate’s posts, we are now at $140 per barrel, $4 at the pump and the oil companies are reporting absurd record profits. The pump price has almost tripled in four years. Pump prices should be up maybe 25% from four years ago, not 300%.

Is it time to take a stand with the power of the consumer?

I worked as a petroleum delivery driver many years ago for two different businesses, so I understand the local mom & pop gas station as well as the small distributor buy the least priced product which meets their specifications. Also, the name brand stations don't sell solely their brand of fuels with few exceptions. These stations are required to sell a small percentage of the store brand except for some of the premium fuels. Most consumers don't realize that the name brand gas they buy is probably the cheapest brand that meets the name brand specs that week. So they pay 2 to 5 cents more for the same gas that John Doe's Quickie Mart sells.

But, if we, as consumers, stopped buying from the "NAME BRAND" fuel stations these big corporations will find a way to bring down the pump price. Put the problem in the Corporations lap.

The NiemanWatchdog.org website is no longer being updated. Watchdog stories have a new home in Nieman Reports.