Every spring gas prices go up. They hike even more in the run-up to the Memorial Day weekend and remain high until after Labor Day. Every year we grumble about price gouging and ruthless profiteering just as the higher travel season of summer comes on. Those stinking oil companies have us over a barrel, right? This year it’s far worse. $3/gallon gas with record oil industry profits! What’s up with that?
And every year like clockwork I receive an email from somebody with some grand plan to punish those filthy rich oil companies. It usually boils down to some kind of targeted boycott. One year the plan was to boycott all Exxon stations. Another year it was to not buy gas on a given day of the week. Another year it was to boycott both Exxon and Shell stations.
The whole idea behind these efforts is to create some kind of collective bargaining power—to show consumer muscle in order to ultimately force lower gasoline prices. While it is natural to want to do something to attack the perceived injustice, all of the efforts I have seen suggested suffer from shocking ignorance of how the free market works coupled with childish ignorance of the oil industry.
Let’s start with an Econ 101 look at the free market. Pricing of any commodity comes down to the interplay between supply and demand. If demand goes up while supply remains static (i.e. we start driving more and using more gas as the weather warms up), there is more competition for the same resource, so the price goes up. If supply decreases (as it does temporarily each spring when refineries retool to switch from heating oil production to more gasoline production) there is the same demand for fewer resources, so the price goes up. If demand decreases (i.e. we start driving less as colder months return), there is less competition for the same resource, so the price goes down. If we have a glut of supply (as we did for a brief period in the late 90s) there is the same demand for more resources, so the price goes down.
But all of this is extremely myopic, looking mainly at the tail end of the oil operation from the refinery to your car. When you look back up the chain from the refinery you will find a number of other factors that apply varying degrees of pressure on the market.
The biggest factor is the cost of crude oil. What does it cost to get the stuff out of the ground and ready to ship? This varies greatly depending on a variety of factors. For many years it has been cheaper to get oil out of the ground in the Middle East than anywhere else in the world. However, many are now realizing that these countries’ reserves are not limitless. Many are actively working to make their supplies last as long as possible by limiting production. You don’t want to kill the goose that lays the golden eggs in one fell swoop.
Since oil is a global commodity, political issues in all oil producing countries are a major factor in oil price. All industries have to hedge their bets and make plans for the future. When things are stable, it’s easy to look into the crystal ball and make appropriate plans. But when unrest occurs that ball becomes cloudy. Then the industry has to invest in a variety of strategies that might pan out instead of simply putting almost everything into one basket accompanied by a few contingency plans. The possibility of Iran going nuts and cutting off its supply to spite its face, terrorists attacking oil pipelines and stations throughout the Middle East, the election of a socialist dictator in Venezuela, the war in Iraq, and other similar issues add to the complexity and cost of oil production.
Now for Econ 201. The market is bigger than just you and your neighbors. Other countries compete for crude oil as well. In the last half-decade the world’s two most populous countries, India and China, have experienced economic booms. Societies in these countries are transforming from third world backwaters to modern industrial (even post-industrial) societies. Just as it requires a lot of oil to run the U.S. economy, the demand for oil in these vast developing countries has increased enormously. The global supply of oil is not increasing, but the global demand is. As we learned above, that means that the price of crude oil goes up.
Then we have the government. Federal and state governments levy heavy taxes on petroleum products, particularly gasoline. They’ve got to maintain those roads that we all travel on, and they’ve got to get money to do that from somewhere. Why not levy it on gasoline? It’s kind of like a use fee. These taxes are the second largest factor in the cost of a gallon of gas. The taxes on each gallon of gas are as much as 1000% more than the amount of oil company profit on each gallon. In other words, the government gets more—a lot more—of your gas dollar than the oil companies.
Refining of crude oil eats up another portion of your gas dollar. Refining doesn’t happen for free. Due to environmental concerns, we have not added a new refinery in the U.S. for thirty years (although, one is under construction). We have, however, dramatically increased the capacity and cleanliness of existing refineries. But if we had more refineries we could refine more oil.
Now let’s understand how distribution works from that point until you have the gas in your car. Refineries have distribution centers where tanker trucks pull up to fill their tanks, kind of like a gas station on a larger scale. People directing the tanker trucks that supply your local gas station make decisions on filling those trucks somewhat akin to the way you decide where you will buy gas. They assiduously check the prices. They weigh factors such as distance from the drop point, available supply at the refinery, how urgently the retailers need the product, etc.
A lot of you think that if a truck has a particular oil company’s logo on the side, the gas in the tank came from that company’s refinery. This is not always the case. Most companies buy from any refinery that offers the best value based on the various factors I mentioned above. Federal rules require all gasoline to meet the same standards for each octane grade. Federal law permits oil companies to add ‘additives.’ This usually occurs at the retail station. Oil companies do not have to disclose (except to regulators) what is in its additives (it’s a big secret), but federal law basically requires additives to be inert. The additives leave a chemical signature that can be useful for some needs, such as crime solving. In other words, the additives generally add little or no value to the consumer.
The upshot is that the gasoline you buy at station A and its competitor, station B across the street is pretty much the same stuff. So you might as well get the least expensive gas, unless you make your decision based on other factors (i.e. restroom cleanliness, selection of junk food, etc.) Also, the fact that refineries will generally sell gas to any supplier that is willing to pay for it means that they will sell their gas even if their own outlets do not sell it.
Finally we come to the retail point. Gasoline retail stores are often franchises that are not directly owned by the oil companies. Of all the major factors in the cost of a gallon of gasoline, these guys are one of the least. They keep less than 2% of the sales price. They operate on a very slim margin.
That’s why they work so hard to remain competitive with nearby retailers. They are constantly playing a game of trying to make 1.23% instead of 1.21%. If they price too high, they lose customers. If they price too low, they sell high volumes but still don’t make enough money. And if they sell more than a few cents too low, state regulators will investigate them for selling below cost (which is illegal under most conditions).
They make huge margins on everything inside the store. One store operator reported pulling in $10,000 monthly just on corn dogs and potato wedges. You can bet that they make a lot more on a gallon of slush drink than they do on a gallon of gas.
So, what would happen if everybody boycotted Exxon retailers this summer? We’d hurt a lot of small business owners that run the Exxon franchises, but we’d have just about zero impact on the oil company itself. What if we all refused to buy gas each Wednesday? This would only have an impact if we in truth reduced our usage by 1/7th. We most likely would simply make up for it by buying more gas the other six days of the week.
For a boycott to work, it has to have a staggering impact. None of the boycott efforts that have been flown by me would do that. The number one reason is that they suffer from poor design. The number two reason is that you simply won’t get enough people to go along with it. How many people do you think would actually take the kind of action suggested in an email campaign? If it were highly successful you’d get maybe 1% of the drivers in the nation to go along with it. Would the oil companies even notice? Most likely they would come up with marketing campaigns that would more than counteract any negative impact. Also, while personal drivers are important, unless you get a significant number of businesses involved, the impact will remain low. How many businesses that rely on vehicle transportation to make money would be willing to go along?
I am not saying that people upset over high gasoline prices should do nothing. What I am saying is that the boycott campaigns suggested by emails I have received are the wrong thing to do. It might give you a sense of smug self-justice, but the overall effect on the market will be unnoticeable. If you want to stick it to the oil companies, you need to first educate yourself about how the market functions and how the oil industry works. Then you have to devise a market method that will have the ultimate outcome of lowering gasoline prices.
That’s a tall order. Many have tried it, but nobody has really succeeded. The point is that simple, juvenile boycotts won’t work. In other words, stop sending me ridiculous emails about boycotting gas stations.