Oil And Fuel Price Summary, And Musing On Comparative Advantage

Lynne Kiesling

One of the beautiful and often-overlooked things about human action and exchange is not just comparative advantage. It’s the dynamic changes in comparative advantage as the environment changes. What you do relatively well (and relatively less badly, to really trigger the comparative advantage concept) changes over time, as you change, adapting to the world around you as it changes. This website is, naturally, an example of that fact. You will note that I have backed off of the oil market content. Why? Because James Hamilton rocks, and he specializes more deeply in oil, while I’ve deepened into electricity and telecom, those delightful network industries.

That said, I’ve had a few folks in person and online ask me about oil prices and fuel prices (including Fox News, but I’ve been too busy to drag myself into the studio), so I’ll offer a few thoughts, focused on the Upper Midwest. The persistently high oil prices reflect a large risk premium (security, change of regime in Saudi Arabia, etc.) interacting with the stubbornly high Chinese demand for oil due to their growing economy. Don’t forget that in real terms, the price of a barrel of oil would have to be $90 today to be as high as it was at its highest in the 1970s; today oil is about $66/barrel.

The array of factors influencing gasoline prices is much more complex. First you’ve got constraints on refining capacity; the last refinery built in the US was in 1976, and refiners have been squeezing more blood out of the stone ever since, but it’s increasingly difficult and we’re operating very close to capacity. Then add in the demand for other petroleum products, like jet fuel and the build-up of home heating oil for the upcoming winter, and there are a lot of different things competing for the scarce refining capacity. Add to that the season: two weeks before Labor Day, and we’re taking driving vacations.

Then there’s the regional fuel market balkanization due to the wide range of fuel formulas to meet the federal fuel oxygenate requirement. While the recently-signed energy bill promises to streamline the formulae and reduce the fuel market balkanization, it hasn’t kicked in yet, and won’t until next spring.

In the Chicago area, gasoline prices have driven a recent increase in the local consumer price index, and if you take out gas prices the local CPI has actually fallen:

Retail prices in the Chicago area edged up 0.1 percent last month, the Bureau of Labor Statistics reported Tuesday. That brought the 12-month consumer price index 2.6 percent higher than a year earlier. If gasoline prices are removed from the index, the Chicago CPI would have declined 0.4 percent, reflecting lower prices for apparel, food, recreation and communication.

Nationally, prices rose 0.5 percent in July, the most in three months. Excluding energy and food costs, the national CPI inched up 0.1 percent, thanks largely to a big drop in new-vehicle prices.

Just look at those sectors in which prices have fallen: apparel, food, recreation, and communication. Not surprisingly, I think technological change has a lot to do with driving that dynamic. Also important in looking at gas prices in Chicago are the taxes, which are still there but a shrinking portion of the price as prices rise, and the effects of the federal fuel oxygenate requirement’s fuel market balkanization, which we get in Chicago in spades. Plus our fuel is ethanol-oxygenated. Hey, I wonder if the drought this summer is going to mean higher ethanol prices because of the bad corn harvest. There’s a hypothesis to keep an eye on …

Yet we continue driving. We may shift into more fuel-efficient vehicles, as recent data indicate. Yet we are still driving. Why? The two things that make sense to me are that at the margin, our demand is pretty inelastic for the driving that we do, and that the fuel, while expensive, is not as large a component of our household budgets as it once was. Cars that are more fuel efficient contribute to that, as well as allowing us to drive more miles for the same fuel cost if that’s what we want to do.

2 thoughts on “Oil And Fuel Price Summary, And Musing On Comparative Advantage

  1. The drought in IL has had little effect on the price of corn and therefore ethanol prices probably wont be up much either. Two reasons for this, huge stocks from last year and a crop of some size in the rest of the corn belt.

  2. More refineries will only help smooth shocks like refinery maint and accident shutdowns. More refineries don’t mean lower prices. I think the industry loves to run at high utilization rather than take the risk of sinking billions into new refineries. They can also build refineries closer to production a la Dupont who shut down some US chem plants and relocated to the Gulf.

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