Rafi Mohammed

Skyrocketing Gas Prices at the Pump...A Confluence of Events or a Price Gouging Conspiracy?

Posted on May 17th, 2007 (0 Comments)

Let’s face it, filling up at the pump is no fun these days…and there doesn’t seem to be much relief on the horizon. I thought it’d be interesting to get to the bottom of what’s causing gas prices to surge.

There are 5 key steps to transforming crude oil pumped out of wells in a far off desert into gas readily available at your local filling station: (1) Extracting and selling crude oil, (2) Transporting crude to refineries (via tankers and pipelines), (3) Refining crude to produce gas, (4) Transporting gas to service stations (via pipelines and tanker trucks), and (5) Retail sales at service stations. A “hiccup” at any one of these stages can “pump up” gas prices. The two culprits behind today’s market environment of gas prices approaching $4 a gallon seem to be: (A) the strategic actions of crude oil suppliers and (B) limited refinery capacity.

The equation with respect to crude oil supply is pretty straightforward: OPEC = CONSPIRACY. OPEC is a cartel of 12 oil producing nations that supplies roughly 40% of the world’s oil production and holds two-thirds of the world’s oil reserves. OPEC makes no effort to disguise its ability to influence prices…its mission statement includes the goal to “coordinate & unify the petroleum policies of Member Countries…” In today’s market environment, in spite of rising gasoline prices, global oil consumption is projected to grow by 1.4 billion barrels per day in 2007. The problem is on the supply side, between the third quarter of 2006 and first quarter of 2007, OPEC has conscientiously decided to cut its production by 1.1 billion barrels per day (all figures from the Department of Energy). As a result, crude oil prices are rising.

That said, OPEC isn’t 100% responsible for today’s high prices. Yesterday, experts testifying before a Congressional panel investigating gas prices placed the blame on increased consumer demand and fixed production of gasoline by refineries (which has been interrupted by an unusually high number of recent outages). I was surprised to learn there are only 142 refineries in the United States, which produce 17 million barrels of gasoline per day. The problem is that Americans fill up their tanks with 22 million barrels of gasoline everyday. The daily gasoline deficit is made up by imports. In this tight supply situation, you can see how an outage can spike prices.

If the primary bottleneck is lack of refineries, why not just build more refineries you may be wondering. Given that a new U.S. refinery has not been built since 1976, conspiracy theorists speculate oil companies are deliberately not adding capacity to control prices. Responding to these criticisms, oil company supporters claim new refineries are expensive (multi-billion dollar) and time-intensive investments (at least 5 years to build) that no community wants in their backyard (having an oil refinery next door is not exactly idyllic). Additionally, with the government openly discussing its goals of reducing gas consumption, some claim building a new refinery represents a significant financial risk. Under these circumstances, would you invest your money to build a new refinery? I’m not sure if I would…Oh and by the way, if you believe there is an oil company conspiracy, why not invest in their stocks and reap your share of their financial windfalls?

I’d love to hear your comments. Given the general interest on this topic, I plan on writing future blogs on gas prices. On another note, thanks to Richard Gottleib for including me in his excellent toy pricing article, which was picked up by CNNMoney.com.

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