Explaining Oil Prices
06/11/09 - ChicagoBoyz by Shannon Love
A detailed article. Only an incomplete excerpt here.
[edited] Oil prices are headed up even though the world economy is headed down. What gives? Shouldn’t a declining economy lead to decreased demand which keeps down prices?
Well, yes and no. Oil is a strange commodity. It doesn’t change price and availability in the same pattern as other commodities that are based on natural resources. This strangeness arises out of the technology of oil production, distribution, and refining.
(5) Distributors and refiners can’t store oil: This is the most important factor of all. There is no economical means of storing large amounts of oil save pumping it back into the ground. The big oil tanks you see around are just temporary buffer tanks at refineries or the ends of pipelines. Once oil comes out of the ground anywhere in the world it is going to be an end product within a maximum of 120 days.
Most other natural resources can be stored for long periods. Distributors and refiners of those commodities can store up against falling prices or to take advantage of suddenly increasing prices.
Once oil is pumped it is going to move through the system to be sold as an end product, as inexorably as a boulder rolls down a mountain.
Once the extractors pump the oil and hand it off to the distributors, the oil has to be consumed by someone. In principle, it wouldn’t matter if the price dropped to zero. They can’t store oil, so they’d just have to just give it away.
When people suddenly stop driving in response to high prices, an economic downturn, or some unforeseen major event, the supply of oil takes weeks or months to adjust. In the interim, gasoline prices drop like a rock.
The current rise in prices comes from a similar effect. 30 to 120 days ago, extractors believed that future prices would be low so they stopped pumping as much oil. Since they have no central coordination, and since no one knows how much oil is actually pumped at any given time, too many extractors stopped pumping at once.
When the supplies get short, retailers can’t just order up more end products and refiners can’t just make them. They both have to wait for the extractors to decide to pump more oil and for the oil to make its way through the system.
The price is set by gas stations to just sell their supply. A price too high doesn't sell as much. A price too low results in running out, angering customers late in the day. So, supply and demand actually set prices.
No Price Gouging Here
Higher prices in emergencies is not gouging. It actually helps a lot, if it is allowed.