Gasoline marketplace (a bizarre bazaar)

It all starts with the price of crude oil. Each day tens of thousands of contracts to buy and sell crude oil and petroleum pass through the New York Mercantile Exchange. Buyers and sellers have exchanged contracts to deliver crude oil for $41.72 a barrel during July. This is just like GE stock now selling for $30 a share. It has nothing to do with cost or value – it is just what willing buyers and sellers agree to.

The person who promised to deliver oil in July for $41.72 can be made very frightened by the following events: 1) China has entered the world oil market purchasing several million barrels a day. 2) The U.S. economic recovery has pushed demand above expected levels. 3) Iraq has not delivered expected quantities of oil. Pipelines, both in the north and south, have been sabotaged. 4) Terror and unrest in the rest of the Middle East may disrupt supplies. 5) Political unrest in Venezuela may limit oil from that source. A promise to deliver August oil may look more attractive at $50 a barrel.

That $41.72 a barrel or the $50 a barrel has nothing to do with the cost of oil, the availability of oil, or how much oil is left in the ground. It is just a number reflecting what willing buyers and sellers agree upon. This stuff is simply Economics 101. If the director of a refinery in Houston would radio-phone the captain of a tanker on its way through the Straits of Hormuz and say, “We don’t need it – take it back,” the word would spread in the oil marketplace and the price of oil would drop $20 a barrel overnight.

The quoted price of crude oil is a “benchmark” number. The price will be higher or lower depending on sulfur content, etc. The situation in gasoline is much worse. Here is a quote from the May 22 Economist: “Because of a hodgepodge of environmental regulations, the country’s petrol market is Balkanized. The industry has had to develop lots of ’boutique’ fuels to meet local demand.”

If a particular refinery is down for repairs, the impact can rattle through the entire system. Regulatory uncertainty has reduced investment in new refineries. We rely increasingly on imported product (gasoline, diesel oil, etc.) as well imported crude. Overseas producers hesitate to increase capacity because they too feel the same regulatory uncertainty.

If the manager of a gas station calls his supplier and states, “I need another 10,000 gallons by Wednesday,” and the supplier replies, “How about Friday?,” what do you think happens to prices at the pump on Thursday? In the days of John D. Rockefeller the petroleum market was small and could be manipulated by a few men. Now, the worldwide petroleum market is so large (80 million barrels a day) that such hanky-panky is impossible.

The increasing cost of petroleum also reflects the falling value of the dollar. Oil prices are denominated in dollars, as the dollar decreases in value against other currencies the dollar price of oil must increase.

As for me? I am bullish on Schwinn.

Richard C. Hill, of Old Town, is emeritus professor of mechanical engineering at the University of Maine.