[TheForge] OT--Gas prices, gas shortages, price gouging?

[Andrew Vida]

Rob Fertner wrote:

> Here's how it worked. The Knoxville area has several bulk fuel storage
> depots. Some belong to the chain outfits, others are run by wholesalers that
> supply independent gas stations. In either case, they manage their storage
> levels to maintain a competitive retail price. When the price of gas is
> rising, they maintain a relatively full inventory. This means that on
> average the gas they store always costs less than the current spot price.

	 This is similar in effect to buying and winning on a fuel futures 
contract.  Perfectly legitimate and it actually keeps prices as low as 
they can be for the consumer.  This assumes, of course, no collusion 
between players, which is probably the case.

 > On
> the other hand, when gas prices are dropping, they keep inventories low, so
> they aren't holding a lot of gas that cost them more than the market price.

	This is called "inventory cost".  It costs one money to maintain 
inventory on shelves, and when prices dip below a certain point, you're 
losing money just having the stuff lying around.

> Then along came Gustav, which impacted the ability of refineries to deliver
> fuel to the regional and local bulk storage facilities. That hasn't been a
> huge deal because they were drawing down their stocks anyway. But now Ike is
> headed for Galveston, and the pipelines are being shut down completely. And
> that is where the fertilizer hits the propeller. When you're in a low stock
> condition, you are relying on a steady flow of gasoline to maintain smooth
> distribution. When that steady flow is disrupted, you're only hours away
> from shortages.
> 
> It's been more than a few hours, and shortages are already here.

	Mr. Supply, meet Mr. Demand.
> 
> So the price of a gallon of gas is skyrocketing, even at stations, like
> Pilot, that have enough gas to get through the interruption without going
> dry. So why are they raising their prices? Aren't they gouging?
> 
> Nope. If you've been out in Knoxville at all today, you've seen long lines
> of cars at gas stations. You've seen people filling up cars, trucks,
> motorcycles, lawnmowers and gas cans. They are in a panic mode, and they're
> buying more gas than usual. Even though Pilot has enough to get through the
> crisis at normal levels of sales, there's no way they can sustain sales at
> the rate they are going. So what do they do? They raise prices. By raising
> prices, they discourage people with brains from buying more gas than they
> need. They discourage people from driving more than they need to. In effect,
> they are encouraging conservation by using market forces rather than
> governmental coercion.

	There may be some truyth to this, but methinks a more significant 
factor, which you have not yet mentioned, is the speculative aspect of 
the market.  There is daily bidding in oil and its byproducts.  Bidding 
is just that - groups of buyers bid against each other for current and 
future supplies - that is, short- and long-term supplies of commodities. 
  How high their bids go depends in large part how far up or down they 
feel the market for such commodities will go by some time horizon. 
Those time horizons are engendered in the contract maturity date.  You 
have very short term contracts, say, 30 days, then quarterly, biannual, 
annual, etc.  If a frenzy for short term contracts erupts, guess what? 
You're prices are going to rise rapidly.  There is probably a good deal 
of this speculative effect in play right now because just prior to 
Gustav hitting and once everyone was sufficiently confident of WHERE it 
would make landfall, I can guarantee you that the commodities traders 
were in a bloody speculative frenzy, driven by the fact that the storm 
was a category 3 and that there was x% chance that it would knock out y% 
  refining capacity for z days.  This drives prices up on short term 
contracts immediately and therefore you feel the hit immediately at the 
pump.

	One other aspect of the frenzy goes like this: traders are bidding on 
contracts and are watching the prices like hawks.  If some joker, for 
whatever reason, starts making huge upward incremental bid changes on 
the shorties, other traders will often think that that person  must know 
something that they do not.  "Oh my GOD!!  He must know that Ike is 
goint to destroy a larger (perhaps much larger) proportion of the 
refining capacity than we thought... shit, let's up our bids or we will 
be without supplies and go out of business (or whatever).  This is where 
the real frenzies start and that is one of the reasons insider-trading 
is such a no-no.  And finally, when such frenzies are in motion, the 
cooler traders who bought yesterday at $1/unit can now sell off their 
extra inventory (contracts) at $2/unit.  They have made a shitload of 
cash in a few hours based on frenzy and panic in other traders.  So as 
you can see, there are numerous incentives for wanting to see this sort 
of thing happen in the markets.  Good for the smart traders who got in 
early and bad for everyone else, though not always for the end consumer.

	Sometimes what will happen is that the retail prices will drop below 
the contract price and the speculator who bought at such a price loses 
money - often LOTS of it.  For example, if you buy 100 million of 
barrels of oil on a one year contract at, say $100 per barrel, you are 
gambling that in a year when the contract comes to term, the price of 
oil will be greater than $100/barrel.  If it goes for, say $110/bbl, you 
made yourself a cool $1 billion on your $10 billion investment in 1 
year, which is a pretty decent return.  If you had done this at the 
right time and sold at the peak of $145/bbl, you would have made a 45% 
return on the investment, which is close enough to staggering to call it 
that.  But if at the time of maturity the price went DOWN to $90/bbl. 
you will have lost $1 billion in the same time frame.  It is a gamble 
and commodities futures can be very risky.  Precious metals is a grand 
example of this - one of the worst markets in which to invest unless you 
REALLY know what you are doing.  Countless people lost their shirts 
about 15 years ago when the Rhodium market went up to something like 
$27K/ozt and then precipitously went to hell almost overnight. 
Mitsubishi, as I recall, made a killing on it because they nearly 
cornered the rhodium market in anticipation of shortages of the material 
due to the shut down of two large South African mines for refit. 
Rhodium is an essential catalyst used in converters.  The buy up drove 
prices through the roof.  When the refits completed two years ahead of 
schedule, Mistubishi dumped all their reserves on the market driving 
prices through the floor.  They made many billions on that one.

	The speculative aspect of commodities trading cannot be avoided, and in 
fact it is even a good thing when everyone is playing sanely and with 
both hands on the table.  The problem is that there are scoundrels and 
non-adepts out there who cause plenty of trouble - trouble we rarely 
hear about in the media but feel in our wallets.

> Anyway, that's what happened. Bulk storage facilities were acting to
> minimize the price of fuel and got caught short when the supply was
> interrupted. Barring major damage from Ike, supplies should be flowing again
> in a couple of days, and prices will resume their freefall.

	Yessir, so probably no need to panic unless there is a serious market 
manipulation afoot, which is not that likely though not out of the 
question, either.