Gasoline Prices and Localized Monopolies

The price of gasoline and diesel fuel amaze me,  regardless of when prices are high or low.   I often harass my friend who is the general manager at a major gas station about his prices, and he often jokingly responds that his bonus is based upon how high he can keep his gas prices for specific periods of time.  Needless to say, that upsets me even more and I usually trade a few insults with him about his business methodology.  My friend's business tends to be the price leader in town, signalling the price of gasoline and diesel simply by the price he displays on his billboard.  Other gas stations in town follow his price increase or decrease within a few hours,  except for those who claim to have specialty gasolines with proprietary additives.

Outside of two major national gas stations,  all of the gasoline in town and most of southern Utah comes from the same pipeline about 10 miles west of Cedar City. This brings up another interesting point in that prices for gasoline at the same gas stations (example: Maverick) are about $0.25 higher in Cedar City over that of St. George,  yet all of the gasoline comes from that same pipeline west of Cedar City!  When I ask those gas stations in Cedar City why they are about $0.25 higher than St. George, they claim extra "transportation" charges (but as mentioned, all of the gasoline comes from west of Cedar City), so I feel like I'm getting ripped off....and I hate getting ripped off by a bunch of profiteering clowns.

So what causes price changes in gasoline and other petroleum products?  The Economist does a pretty good high-level review:  http://www.economist.com/blogs/economist-explains/2014/12/economist-explains-4.

My reasons for caring about gasoline and diesel prices are very legitimate.   I work in the transportation industry,  where my yearly local  and regional diesel fuel consumption exceeds 4.5 million gallons a year, so  every penny counts. The Economist web link above, summarized, proposes that supply and demand are not the only determinants of price.   Weather and geographic location also play an important role. Some topics worth reading comments on:  1.)  Does everyone feel gasoline price differences between cities in Southern Utah are reasonable or unfair?  2.)  Does product differentiation (bulk gasoline vs. name brand gasoline) warrant local price differences?  3.) Why the sudden rapid gasoline price drop?  Is there a hidden agenda?


Dave Tufte said...

Bronson: 94/100 (marked down for plural/singular agreement, I did not mark down for not italicizing or underlining the title of The Economist ... but I thought about it)

For some reason, gas prices bring out the harshness in people. Personally, I don't get it, but you're not alone Bronson.

I knew some things about gas prices before last summer, and I've learned a lot since (since it's a macro-ish topic, I'm probably "the expert" that most of the reporters for the newspapers, local news sites, and TV broadcasts consulted).

The first big issue is why has there been a big price drop everywhere? This drop is global, and comes from a shift outward in the supply of crude oil. This is mostly from the huge amount of oil coming out of shale deposits in Texas and North Dakota. This is directly related to technological improvements: primarily horizontal drilling, and secondarily fracking (even though people worry more about the latter, it's actually a less important development). This is complemented by the very high quality of the oil coming out of the shale ... it's a very rough analogy, but it's sort of like they're refining it under the ground.

Second, why are there retail price differences between Cedar City and other locations (primarily St. George). This is a tougher question to answer, but appears to be related to the thinner market in Cedar City. What drives prices down in a market like this is one retailer choosing to drop prices first, and others following. This tends to occur more readily where there are more retailers, which is why our thin market is problematic. In addition, most retailers lost money on gasoline in Cedar City earlier in the year, and they're understandably "gun shy" about dropping their prices quickly.

Lastly, everyone wonders if this is sustainable. No one really knows. What we do know is that the difference between the price needed to justify a new well (with horizontal drilling and fracking), and the price required to keep it pumping once it's drilled, is quite a bit larger than for standard wells. This is making a lot of analysts think that the low prices for crude oil (as low as about $30/barrel, which is 35% below where the price is now) may be sustainable. This price drop is starting to look a lot like the one from the mid 1980's. We're all familiar with the saying that "past performance is no guarantee of future performance", but that's the one we have to go on ... and prices stayed down for about 15 years after that.

Dave Tufte said...

Oops. I forgot to include some references to the text.

Supply shifts are in the area you're doing now: Chapters 2 and 3.

The strategic behavior for price drops is in the Chapters on game theory is in Chapter 10.

The shutdown rule is discussed in Chapter 5.

Jerry said...

I stumbled across this and figured it would be a good fit here.


It provides some insight into why prices are falling so low, overall the supply of oil was greater than demand. The middle east has not slowed production, Europe's demand has tapered off as some economies all faltering and US substitute oil like Dr. Tufte mentioned (fracking, shale etc).

One theory I have heard tossed around is OPEC maintaining production not only to hold on to precious market share, but to disrupt alternative forms of oil production. Basically reducing the margins effectively halting alternative oil productions who cannot turn a profit selling oil at $45 dollars a barrel. However, I have heard some of the shale oil producers in the US have a break even around I want to say $35. Again no one knows how long this will last or what economies will be crumbled by it.

I think prices in Cedar City are higher than St. George because there is more competition in St. George. In Cedar City, less gas stations results in less price adjustments allowing them to maintain a higher price.

I find gas prices to be fair, I would love for them to be lower. Maybe this is because I am still used to paying $3.60 a gallon so every time I drive by a station I think its great. The longer this lasts, the more sensitive people will be about the 25 cent differences.

Dave Tufte said...

Jerry: 35/50 ("are" not "all", what does "... US substitute oil like ..." mean, "is that OPEC" not "is OPEC", "margins and effectively" not "margins effectively", "it's" not "its", and I thought about taking off for not capitalizing Middle East ... but since it's sort of a made up name, I didn't).

What a great link Jerry. Vox is always a good source (other students take note), but this article was particularly good: covered a lot of angles, and still pointed out at the end that what we may be experiencing is the unlikely possibility that all the potential surprises have just been breaking one way for a while.

It's not correct to say that supply is greater than demand. These are lines (or curves) ... and "greater" just doesn't make much sense for a line/curve. What they mean is that quantity supplied exceeds quantity demanded.

Joey said...

Oil prices are extremely important to the economy I live in. Due to the recent declines many businesses in my area are beginning or have completed an initial round of layoffs. The fear of losing one’s job has also affected many other industries in my area. The housing market in my area has all but stopped, and many people have left the area because they were hired on a contract basis and were the first to be laid off.

The hospital I work at is also slowing down. With the decrease in population our customer base is dwindling, and with the economic uncertainty many people are putting off medical procedures, and with the increase in unemployment there is an increase in the amount of uninsured patients we see which leads to an increase in bad debt.

While low prices at the pump are nice, it leads to some other undesirable side effects. Oil is a very large part of our economy. As it falls so to do many other industries.

Dave Tufte said...

Joey: 50/50 (on your writing)

But, frankly, what does this have to do with Managerial Economics?

This is a description of side effects. But it isn't an explanation of very much of anything.

1) Is this demand or supply shifting, and which way: "Due to the recent declines many businesses in my area are beginning or have completed an initial round of layoffs."?

2) Is this demand or supply shifting, and which way: "The housing market in my area has all but stopped ..."? And is that sales of new and existing homes or construction of new homes or both that's stopped?

3) Is this demand or supply shifting, and which way: "... with the economic uncertainty many people are putting off medical procedures ..."?

4) This nugget is huge: " With the decrease in population ... and with the increase in unemployment there is an increase in the amount of uninsured patients we see which leads to an increase in bad debt." As a reader I'm not even sure what to make of this. Are you saying that overall demand has both shifted left, and yet a segment of that demand has shifted right? Is so ... um ... why did I have to say that instead of you?