Gas Prices – The Big Secret

In California, pump prices of gasoline have gone up over 20 cents per gallon in just the past week. Analysts say a price of $5 per gallon, once unimaginable, is in clear sight by Memorial Day, the start of the traditional summer vacation driving season.

There’s a lot of useless and baseless presidential campaign rhetoric about the link between the administration’s energy policies and gas prices. Many people also hold very naive assumptions about the key determinants of gas prices: distance between the pump and the refinery, accidents and natural disasters, global terrorism, military conflicts, environmental regulations.

Of course, all of those factors do matter in determining gas prices, because they affect the cost of production. But even in sum, they’re almost marginal when compared with the most significant determinant of price.

Here’s the “secret” about the prices energy companies charge: there’s a demand curve for gasoline and it is very inelastic. No matter the price, within certain boundaries, Americans will consume a lot of gas. Profit-maximizing enterprises, like energy companies, will price at a level determined by consumer demand and willingness to pay. Rising gas prices indicate that enough consumers will buy enough gasoline at higher prices to ensure historic company profits.

And if that bothers you, don’t waste time complaining or, worse, pretending the answer lies in drilling more or easing environmental regulation.

The answer – the only answer – is to just stop buying.

10 thoughts on “Gas Prices – The Big Secret

  1. Why does no one connect the rise in gasoline prices to the rise in oil company profits? It is almost a one-to-one relationship. When gas prices started rising during the Bushes, oil company windfall profits went up correspondingly. When gas prices peaked, so did oil company profits.

    One can say that prices rose for supply and demand reasons. But the fact remains that prices rose at the same rate as profits. Supply and demand had nothing to do with it. If it did, profits would not have risen at all, because the pump prices would have risen only to meet the rise in costs.

    Oil companies wanted to increase profits astronomically, so they raised consumer prices astronomically. It has nothing to do with supply and demand. It’s all about greed.

  2. Alan: Sorry, but I disagree. Supply and demand are everything in determining price. Economics doesn’t suggest that prices increase 1:1 to cover increases in cost but, rather, that they increase to create equilibrium with demand, at a price that more than covers long-run marginal cost. Profits have happened precisely because demand is so high it allows energy companies to price their product at prices well above long-run marginal cost. Greed is neither here not there. These are profit-maximizing enterprises.

  3. Agree about this being demand-driven and that the solution lies in reducing demand. It’s my understanding that the station owner (who is generally not a major) makes very little regardless of the price. He is at the mercy of the wholesale price charged by the refinery. Refineries aren’t cleaning up either, which is why the majors have been unloading refineries. The big money is being made on crude markets, where sellers are seeing huge margins. But the problem there is not that BP or Exxon is setting the price on those world markets for crude. The majors’ share of that world market just isn’t that big any more. On those markets world demand has just been outpacing supply — not because companies are holding back supply, but because there’s less cheap oil now and the world’s appetite keeps growing. So producers sit back and capture the benefits of that imbalance.

  4. Don’t see any demand of outraged citizens demanding to remove environmental safe guards. It’s difficult to have a say in energy prices, while we support and condone the oil cartel setting prices by their own protected enclave. Of course the exuberance and innovation of the US citizens with the Bakken shale oil boom is in spite of a total indifference by the executive branch on taking actions to help us. Of course, we don’t license or permit an oil refinery in the midwest. Just let another hurricane shut down the energy hub in the Gulf where the majority of refineries are incapable of processing the more oil we need. Oh yes, if we stopped buying gasoline is sort of like holding our breath for attention. India, China, etc. will continue to buy and buy more gasoline and oil. We are the tail of the dog. Realize the USA is not very important in the energy prices or decisions globally that do affect us.

  5. Thanks for your comment.
    It depends on which part of the market you’re referring to. The US certainly isn’t the tail in the downstream retail market. Consumer behavior in the US is a large determinant in setting those prices. And I wasn’t so much referring to a boycott as a re-thinking of how we use our energy, and from what sources we get it. Clinging to an outmoded paradigm of consumption is killing us.

    1. are you driving and “outmoded paradigm” or a VOLT for $43,000? Don’t talk about intelligentsai elite jargon, when scraping up change to get to the coffee house for the next session on this brave new paradigm. By the way, what is this plan? Solar panels and wind turbines are NOT even being reported as glowing examples of this new green power paradigm. Because they have failed miserably with no standards from our ineffective and inept executive branch that wants to regulate the oil industry, but fails to regulate the electric industry.

      1. What I’m talking about driving, mostly, is buses, light rail, the subway. Public transit would be a new paradigm (excuse the expression, again) for many of our fellow Americans.

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