In a comment on one of my gasoline posts below, Barry Posner made some great observations about refinery capacity that are so good that I’m going to pull them out and post them here. I have been abstracting from refinery capacity in recent discussions of gas price fluctuations, because it has been a constraint for the past decade and will only become more of one. Here is Barry’s analysis:

Lynne:

Unless I missed it while reading this article, I think you overlook another important factor: capacity constraints in domestic refining capacity. We all know that the last new refinery in the US was built in 1976, and that many small refiners are forced to shutdown because capital improvements are not economic given RFG requirements.

This is partly due to NIMBY in the US, and is exacerbated by the patchwork RFG requirements and boutique gasolines: if there was a standard blend, we could simply buy more gas from refineries in places like the Virgin Islands, Dominican Republic, Jamaica and (in the near future) Cuba. We wouldn’t necessarily need new refineries on mainland US soil – but the boutique fuels make such projects more risky than they otherwise would be.

Reducing the number of blends required would ease short-term local spikes caused by localized refinery and pipeline outages (which will happen, random as they might be), and would encourage more refinery construction in the Caribbean, which would add some excess capacity (which is currently zero in the summer), thus dampening non-localized (natiowide) summer supply crunches.

New vehicle technology has made the 1990 revisions to the Clean Air Act very close to redundant. Now, if only we can get those revisions reversed without a giant handout to the ethanol producers…

My favorite movie of all time is being re-released! Monty Python’s Life of Brian will be re-released at the end of April.

The producers say they are doing this as a “Passion of the Christ” antidote. I don’t care why they’re doing it just that they are! I’ve only ever seen it on the big screen at midnight movies, which means poor quality video and audio. I wanted to go see it when it was released, but my parents wouldn’t let me; apparently they thought it might not be appropriate for a 12-year-old, no matter how warped a sense of humor she already had …

I can’t wait!!!

Of course, the best line in the whole thing?

“Yes, we are all individuals!”

“I’m not.”

“Ssssh!”

An article from the Minneapolis Star-Tribune on how the inflation-adjusted price of gasoline is not at a record high. Note his last quote from a source: “The market is going to take care of this.”

BTW, I agree with Kevin Brancato’s comment here last week, laying some of the responsibility for the economic illiteracy of the populace and of journalists at the feet of so-called “experts” like AAA. I think they should do a much better job of framing and contextualizing gas price changes than they do.

Jerry Taylor of Cato wrote a commentary decrying OPEC, laying out OPEC’s role in keeping oil prices high. He’s completely right. One interesting point that he makes is that cartel prices can be more volatile than normal market prices, which is going to mess with the heads of folks who are scared of markets because “they are volatile”:

Cartel prices fluctuate more because they are less certain than normal market prices, inviting speculation. In short, market agents are forced not only to consider global supply and demand but also to factor in OPEC’s behavior and its members’ fidelity to their promises. Hence, the market is less predictable and prices are accordingly more volatile.

Good point. I would only add that he should take into account contestability, and that potential competition from non-OPEC sources like Russia, Norway, Mexico and Canada are going to become increasing substitute supplies for OPEC oil.

OPEC’s meeting to decide on its strategy for next quarter takes place on Wednesday.

C’mon, people, doesn’t anyone know how to use a GDP deflator? Certainly the journalists writing articles like this at the Washington Post and the various and sundry wire services that have been feeding hyperbole to their readers have demonstrated their complete and utter inability to process the difference between real and nominal prices. Why don’t they get into such a tizzy and print articles on how our incomes have reached record levels?

Grr.

Meanwhile, here’s an interesting New York Times article on investment in drilling for oil and natural gas in the Gulf of Mexico, considered to be pretty dry. In this case the author makes the correct observation that as prices rise, investment in exploration goes up. He also highlights the role that technological change has played in enabling oil explorers to get product out of places that were impossible before.

I’m glad to see that not all journalists writing about this industry are economic thickies.

I had two students last quarter who are econ/journalism double majors, and I think they were mystified by why I kept encouraging them so vigorously, saying things like “we really need people with your combination of skills!”. This current gas price situation provides yet another data point supporting that argument.

UPDATE: Clearly Steve Verdon and I are both bugged about this, as indicated by his almost contemporaneous post on the same topic.

This Technology Review article on hybrid and hydrogen vehicles explains why hybrid vehicles will have commercial dominance over hydrogen for the forseeable future. It’s a good read, one that I wanted to comment on anyway and an intrepid reader alerted me to as well.

The argument in this story also makes a lot of the same points as I did in “Let the Hydrogen Economy Evolve”, a five-part series of articles on hydrogen at Reason Public Policy Institute.

Check out this oil price primer from Frederick Leuffer in the National Review. Lots of good information there. I particularly like that his answer to “are we running out of oil?” is a curt “No”.

According to lots of news over the past couple of weeks, that’s what a lot of folks are doing. Forbes, for example, had this feature on “pump-busters”, where they showcase fuel efficient vehicles of all types and sizes. They also break down the component costs of a gallon of fuel:

But what exactly are you paying for? According to the U.S. Department of Energy’s Energy Information Administration (EIA), every time you slip a nozzle into your gas tank, 43% of your outlay is for crude oil. Taxes are the next biggest chunk (26%), followed by refining costs (23%). The remaining 8% is to pay for distribution and marketing.

And in St. Petersburg, Florida, gas prices are leading consumers to shop for hybrid vehicles.

Knox Wimberly, sales manager for Palm Harbor Honda, said interest in the gas-stingy cars has surged along with gas prices, which hit another record high Friday in the Tampa Bay area: $1.717 for a gallon of unleaded fuel, according to the Automobile Association of America.

“We’ve given away every single brochure we have on the vehicle,” Trachtenberg said. “And every single Prius built for the next eight or nine months nationwide has already been sold.”

The American International Automobile Dealers Association confirms this experience.

One of the refreshing and creativity-inducing things for me about the Internet is reading well-written essays by people who think about the same kind of issues as I do, but with their own perspective and je ne sais quoi.

I reveled in such a find yesterday, upon reading The Idea Shop. There Andrew David Chamberlain has already discussed such important and interesting issues as water policy, the fable of the bees, why we don’t run out of oil, and the transaction costs facing startup businesses in developing countries. And he does so with a a voice of simultaneous clarity and wonder — clarity from simple, elegant explanation of economic dynamics, wonder at the fantastic complex system of mutually beneficial exchange.

Thanks to Newmark’s Door for the pointer.

In spring, our thoughts typically turn to … the seasonal increase in gasoline prices (what did you think I was going to say?). It all started with this New York Times article on 6 March, which noted that consumers are complaining about high and rising gas prices. They concisely summarized the most apparent causes of the price increase:

Reasons for the increases include prices for crude oil, which sold for a high of $37.45 a barrel on Friday on the New York Mercantile Exchange. Worldwide supply of crude appears to be tight, partly because O.P.E.C., the world’s largest oil cartel, plans to cut production next month and because of political and industrial turbulence in Venezuela, a major provider of oil for the United States.

In addition, many refineries in the United States are changing over to production of so-called summer fuels, an expensive process in itself, and refinery operators say they are also having to pass on some of the increased costs of producing gasoline with newly mandated levels of oxygenates, primarily ethanol.

Tyler Cowen picked up on this article in his discussion of whether or not to boycott gas stations. Tyler related an important fact from his reading of a recent Gregg Easterbrook column: in real terms, the current gas price is well below the all-time high, which occurred in 1981. Then Steve Verdon picked up on Tyler’s thread with a couple of posts, including a reference to this SF Chronicle article that discusses the increase in gas prices in California, and Senator Boxer’s request for an FTC investigation:

Various investigations of the oil industry have failed to find any illegal market manipulation during earlier spikes. The most recent state inquiry, concluded last year by the state Energy Commission, found nothing amiss.

“Our industry had a profit margin of about 6.3 percent and all industries are at 6.7 percent” for the fourth quarter of 2003, Sparano said. “That’s not excessive.”

That profitability fact is important, because it is consistent with the hypothesis that the root cause of higher gas prices is fuels regulation. The seasonal pattern of price changes is also consistent with that hypothesis. The profits in the petroleum refining industry being not too high on average also suggests that Bill Lockyer is misguided when he worries about a “lack of competition”, particularly given these data:

One of Lockyer’s chief complaints about California’s gas market is what he calls a lack of competition. He said that seven oil companies control 98 percent of the state’s refining capacity and then market 90 percent of the gasoline they refine through their own service stations.

Seven is a pretty big number, especially when you are discussing an industry as complicated, capital intensive, and regulated as petroleum refining and marketing. Put another way, oligopolies can be very aggressive and competitive, and just going by the number of firms in an industry is a naïve and unsophisticated approach that is certain to lead to bad “competition” policy. My opinion, YMMV, so to speak.

Last week Northwestern Newsfeed interviewed me about gas prices. You can find the transcript and the audio feed at the Northwestern Newsfeed website.

In a separate post I will analyze the causes of the current increase in gasoline prices.