Gas price collapse, just in time
In a saving grace of productivity downturns, gas prices are falling dramatically, as much as $1 lower than a month ago. Fabulous news! This eases the tremendous pressure on airlines faced with declining ticketing, car dealerships with tight credit standards, and consumers who confront a recessionary environment. Everyone these days is cheering the lower prices, and especially gas station owners.
Why would station owners be happy? I was speaking with a gas-station owner this morning, a man who was greatly relieved at the declining price. Contrary to what people think, he pointed out that they make very little money when prices are rising. Consumers are more reluctant to pay and become intensely focused on small price differentials. They are quick flee to others. Rather than face a loss of a loyal base, stations absorb the cost of gas rather than trying to jack up the price at higher margins.
So much for the complaints about gouging! The gas retailers are greatly relieved at lower costs so that they can lower the price, usually at a slower rate and higher profit margins than they raised them. This is because consumers become less price conscious and the retailers are anxious to make up the difference in the profits lost during the upward price period.
What people often forget is that profits are not necessarily related to price trends or even the size of the enterprise but to the margins between income and revenue. A lemonade stand can have higher profit margins than a large and established car manufacturer. Margins, not total revenue, are what matter.
Interestingly, those people who imagine that gas stations could "gouge" people last month don't seem to notice that these same stations aren't gouging people now. Why not? After all, if it is simply a matter of taking advantage of hysteria and raising prices as much as possible, why wouldn't they do this year round? As Art Carden asks, did they get less greedy over the last few days?
Why ever lower the price at all?
Well, it turns out that some people still aren't happy. Chuck Schumer has denounced gas sellers for failing to lower prices to the exact same extent that the price of oil has fallen! So let's imagine that they do, and they keep pushing them lower. Perhaps they could be accused to charging a low price, a wicked tactic to drive others out of business.
In general, however, most people are happy about low prices for gasoline. This is a model we should use for understanding price trends in the economy at large. Gloriously, the prices of oil reflect commodity prices in general, which continue on a downward trend that began in July. Yes, the price declines probably reflect a slowing economy. No, there is nothing wrong with this, contrary to Bernanke. Falling prices are a boon for consumers, a port in a storm. The worst mistake the government could make today would be to attempt to reverse this.
Bookmark/Share
|
Comments (16)
Comments (16)
Mikael
Well, not exactly true....
Anybody who has studied a commodity wholesaler knows that he makes money in an upward trending market since by default he is buing low and selling high because of the inventory days. This is also referred to as stock profits. The exact opposite is true in a downward trending market.
Published: October 20, 2008 5:47 PM
Matthew Bowler
Prices are falling. Their sollution? Reduce supply. Thanks OPEC. Thanks a whole lot.
Published: October 20, 2008 6:09 PM
Bruce
Jeffrey,
Let's not forget too that merchant fees for MasterCard and Visa are at 2% for most, which takes a bigger bite out of the merchant's bottom line as fuel prices rise.
Published: October 20, 2008 9:00 PM
Bill
Bad Ben and his benefactors in the congress and administration are attempting to do exactly what you recommend them not doing. They are trying every trick at their disposal to keep overall prices (especially asset prices) higher than they would otherwise be.
Published: October 20, 2008 9:15 PM
Bruce Koerber
And let's not forget the political cycle.
Published: October 20, 2008 10:08 PM
SailDog
The financial crisis was precipitated in large part by the price of oil and all its knock on effects. It knocked the base out from under the giant Ponzi scheme that is what our economies have become today. Lay in bad practice, greed and dishonesty and the collapse is every bit as spectacular as we have seen.
What this article fails to mention is supply. It alludes to demand, but does not mention supply. Supply was constrained by a myriad of forces (all traceable back to geologic limits) leading up to the current crisis.
Any economic recovery will require more energy, especially oil. Unless supply increases the increasing oil price (on an inelastic supply curve) will simply choke the recovery off so that it is still born. When supply actually begins to decline, we will experience an enforced contraction (no pun intended).
Neoclassical economics, especially Austrian economics falls woefully short in helping us understand the situation, much less plan our way clear.
We need a different strategy. One that is not based on growth in resource usage. I have no objection if we can run our economies and have growing populations if simultaneously we are using less and less non renewable resources. However, we must learn to do this and Austrian economics and the market are certainly not going to lead the way.
Published: October 21, 2008 1:24 AM
markm
Very good article. And I do like the point about price gouging.
Can I ask though: given all the monetary pumping that is going on at the moment plus the fact that the recent commodity price rises were being attributed to monetary factors: Why would these gas prices be falling all of a sudden? Ben Bernanke (and my own country's central bank (BoE)) have gone pumping mad as far as I can see. Shouldn't this be resulting in continued price inflation?
Published: October 21, 2008 1:29 AM
Curt Howland
SailDog, what you are looking for is "coercion". The power to force people to do what you want them to.
Might I suggest you stop looking at Austrian economics for this coercion, and look to the institutions of coercion: government.
What Austrian economic analysis of your efforts will demonstrate is that your interventions reduce efficiency, no matter what your rhetoric may be. But don't worry, since you don't believe it, you can go ahead and push your agenda with a clear conscience just like the rest of the politicians.
Published: October 21, 2008 7:35 AM
Ed
Wow. So now not being able to drill for oil off of the U.S. coast is a "geologic limit", I suppose the fact that Mexico hasn't been able to increase it's oil production in decades ever since it nationalized the oil industry and OPEC manipulating supply to keep prices artifically high are also "geologic limits". Btw, when supply truly does contract what we will experience is forced inovation, and technologic advancement due to hundreds of millions of individuals worldwide spontaneously and simultaneously turning their attention to focus on the problem at hand, in a concerted effort no government could ever hope to match. Necessity is the mother of invention, government does everything it can to avoid necessity.
Published: October 21, 2008 8:11 AM
Terry
Another effect of the lower oil prices is a hiatus on exploration. With crude prices below the cost of extraction, the access to new deep-water resources will be delayed until the price will stably support that development. Also, the more marginal national oil companies (94% of global reserves) will postpone maintenance on their fields, and as we already see, production will be cut. The time lag that these actions will throw into the system may well result in a lower available supply at a time when inelastic demand will be rising.
Published: October 21, 2008 8:12 AM
Shawn Ritenour
Doesn't lower prices for anything signal deflation and that a depression is right around the corner. Shouldn't Shumer be calling for even more inflation. Think of all the purchasing power being lost by the gas station owners!! The horror!
Published: October 21, 2008 8:45 AM
Michael A. Clem
We need a different strategy. One that is not based on growth in resource usage. I have no objection if we can run our economies and have growing populations if simultaneously we are using less and less non renewable resources. However, we must learn to do this and Austrian economics and the market are certainly not going to lead the way.
Saildog, you're confusing the science of economics with the economic policies of politicians and bureaucrats. Austrian economics explains the situation quite well. We got into this mess because politicians thought they could "improve" on free market economics with their coercive policies, but clearly, their intervention in the economy is the cause of our economic crises, not the solution.
Austrian economics does not recommend any particular government policy except to stop interfering in the economy. Austrian economics does not encourage "economic growth", but explains how it is possible for it to occur, and how government intervention is preventing that growth.
And once again, it doesn't matter what resources we're talking about, renewable or non-renewable, supply and demand will price them accordingly, if governments will allow them to work, and stop mucking about with prices. Higher relative scarcity of a resource should mean higher prices, encouraging conservation, increased production (where possible) and the seeking out of alternative resources.
One last point: while governments can certainly interfere in the economy and increase our problems, they cannot violate the laws of economics. Increased productivity can only occur through capital formation and savings, regardless of what laws are passed, or how much they tamper with the money supply, or how many wars are fought.
Published: October 21, 2008 8:47 AM
Inquisitor
"We need a different strategy. One that is not based on growth in resource usage. I have no objection if we can run our economies and have growing populations if simultaneously we are using less and less non renewable resources. However, we must learn to do this and Austrian economics and the market are certainly not going to lead the way."
The same thing we hear from every crank/socialist. :)
Published: October 21, 2008 9:49 AM
greg
All of this would be true if the rise in oil was due to supply and demand. You must look to see how oil prices are set in the market. It is set by the supply and demand of future contracts. The demand for these contracts by people that can not take delivery of the commodity, push the price beyond the supply and demand threshold. Then the price started to fall with a few short covering rallies. So investors were faced with margin calls and the selling of these contracts continued causing the price to fall further than the supply and demand limits.
Now, OPEC is talking about cutting supply. Again, this will not work as countries that rely on oil money can't afford to cut because the price has dropped by 50%. What OPEC says is not what they do.
Published: October 21, 2008 2:55 PM
Abel
Jeffrey,
Don't we see this fall in gas prices just before every presidential election? I seem remember it happening in at least the last two presidential elections. If that's true, I predict that we'll see falling prices right up to the election and then prices will go back up, though probably not as high as they were, especially as demand for home heating oil ramps up.
Published: October 21, 2008 3:41 PM
Kathryn Muratore
Prices are always higher in the summer than winter. If you look at the 1 year trend, we have just about (finally) matched gas prices on the same day last year after months of inflated prices. However, we're still much higher than October 2006. If deflation is allowed, we can hopefully start to track closer to prices those of 2 years ago (or better yet, 10 years ago...remember 80 cent gas?).
(I got these numbers from http://www.gasbuddy.com/gb_retail_price_chart.aspx?time=24 )
Published: October 22, 2008 9:05 AM