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Wasting Energy Discussing Oil

By Brian | April 26, 2006 | Share on Facebook

I’m no expert here, but I smell political posturing here on both sides of the aisle.

Given: Gas prices are sky high
Given: People are pissed off that gas prices are sky high
Given: Gas comes from oil
Given: Oil companies are recording record profits lately

Conclusion: Oil companies should give back some of those profits and lower gas prices.

Here’s my problem: Correlation is not causation. Are the oil companies’ large profits the result of high gas prices? If you think about it for a second, it gets really murky.

First of all, we should distinguish between the different businesses oil companies are in:

There are the folks that drill for oil, find it, and then sell it on the open market. Since the cost of drilling for oil is relatively fixed, I would assume the profits in this business are driven almost entirely by the price of oil on the open market. Clearly, this is not set by the oil companies, but by commodity traders around the world. Just like people who play the stock market for a living, it seems clear to me that companies that sell oil will make higher profits when oil is trading at $70/barrel than when it’s trading at $50/barrel. And good for them, too. They’re taking the risk (what if oil dropped to $30/barrel?), and they deserve the reward. Asking them to sell their oil to anyone but the highest bidder would be as ridiculous as asking a farmer to sell his corn, sugar, or cotton for less than he can get for it.

Then there are the folks that sell gasoline for a living. Some of these folks are probably independent gas station owners and don’t work for oil companies at all, but let’s think about them for a second anyway. Oil is a key raw material in the production of gasoline, so if the price of a barrel of oil goes up, I’d suspect the price of a gallon of gas would go up. Higher prices at the pump don’t necessarily mean higher profits for the gas station. They could simply be passing their higher costs along to you.

Where it gets tricky is when you consider companies like ExxonMobil, who both drill for oil and sell gasoline. As discussed previously, there’s no reason to believe that the cost of getting the oil out of the ground has changed significantly (is there?). And since they don’t have to buy the oil on the open market, their cost of producing gasoline shouldn’t increase that much either. So why the high prices? My guess is it comes down to supply and demand. If they sold gasoline at $2/gallon instead of $3/gallon, people would buy a lot more of it, and they would eventually run out. Remember the gas lines in the 1970′s? Opposite problem (supply was restricted by OPEC, as opposed to demand skyrocketing due to the industrialization of China and India), but the same result: if you price too far away from the equilibrium, you can create a shortage. This makes inherent sense to me, but I don’t know enough about the mechanics of the oil industry to say for sure. Can anybody help out?

Oh, and while we’re at it – does anyone know what percentage of oil produced in the world gets converted to gasoline? Many folks (including the president) are describing the long-term solution to this problem with ideas like hydrogen-powered cars. How much of the problem will we have solved if we have hydrogen powered cars built in factories that are heated by oil, powered by electricity that is produced with oil, and made out of petroleum-based plastics? I think there’s more to breaking our “addiction to oil” than just getting rid of the SUV’s. Thoughts?

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