And Then There’s Those Pesky Oil Prices

Crude oil prices are the highest they’ve been in 12 years, and the Iraq situation is only one reason, as I’ve been saying for months and as this Business Week Online article points out.

High oil prices and their translation into high gasoline prices have produced their usual response from Midwest politicians — a request for a Federal Trade Commission probe. In normal times it’s almost like clockwork in April and May to have Midwest politicians squawking about how high gasoline prices must be the result of collusion, but because of Iraq, Venezuela, and the cold winter we’re seeing the price gouging claims come out of the closet well in advance of the spring season.

To counter this claim I refer the gentle reader to Russell Roberts’ commentary from NPR last week, as I did in this post. His conclusion:

There’s one other twist to the gouging theory. If market forces and competition rule the gasoline market, then how can suppliers charge more for the oil they bought months ago when prices were lower? Again, think of your house. When you sell your house, you can’t charge whatever you like. But you can charge what the market will bear. And that has nothing to do with what you paid for it If war comes, and if there’s no real disruption to oil supply, the price of gasoline will fall dramatically, just as it has in the past. And sellers who paid a premium for their supplies will take a loss. The fact that they paid a lot for their supplies will be irrelevant. Somehow, their alleged ability to exploit us will disappear overnight like the morning mist.

Claims of price gouging rely on assuming that the demand for gasoline is inelastic. Since we’ve experienced quite a few price increases over the past couple of months, we are at a point where the demand for gasoline is more elastic than it was before, although in absolute terms and for some people and some markets it may still be inelastic.

One of the challenges facing those who want to prove collusion is the problem we call observational equivalence — if gasoline prices at competing stations move in unison, is it because they are colluding, or because they are operating in such a competitive market that any cost change in the entire market gets passed on to consumers by all of them? Both explanations lead to prices moving in unison, and you have to look at external factors to infer the cause of the behavior.

I am skeptical about collusion, largely because almost every analysis ever done of retail gasoline markets indicates that they are among the most competitive markets in the country. Politicians in the Midwest also have to take into account the effect that reformulated gasoline and boutique fuel requirements have on the costs of refining, and on fragmenting retail markets and enabling companies to pass their refining costs on to consumers. March is the time that refiners switch over from winter gasoline and heating oil to summer gasoline, so expensive crude oil is likely to be reflected in gasoline prices throughout the summer.