re: Oil and gas baws - refining question

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Demand has not changed

Supply of oil has but supply of gasoline has not yet changed. It will in the future. But the gas in the retail tank was created with oil before the supply shock.

Will gas prices come down before the supply shock ends?

Supply and demand rules state that prices will go up but the timing can’t be explained purely by economic principles.

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There are a bunch of factors but ultimately it’s pretty well-known that gas prices rise faster in response to an oil spike than they fall in response to an oil dip.

The first thing you have to realize is that all of the companies throughout the supply chain are going to set prices based on replacement cost, not actual cost of inventory. Gasoline is a fungible commodity. When a storage terminal loads gasoline into trucks to send off for final blending, they don’t know what refinery that specific batch came from or when it was delivered to the storage terminal; it’s all commingled/unbranded until it gets to the final blending terminal.

At retail stations, owners simply aren’t going to sell gasoline at a loss. When there is a spike in their wholesale cost, they all raise prices immediately. Consumers are not as scrupulous though. When you need gas, you need gas. Some consumers will stop at the same station regardless of price. Others will stop at the same intersection regardless. Very few will shop an entire region for lowest price, and virtually none are in a position to simply not buy gas until the price falls. Gasoline demand is highly inelastic. So when the wholesale price falls, it’s a slower process of price competition over days/weeks before the retail price really corrects.

In other words there’s a floor for retail prices set by the wholesale price, but there’s no equivalent ceiling.

Going back to the first point - it’s also worth noting that refineries don’t really buy oil at spot prices. The oil they’re refining today has been under contract for quite some time. So they may “underpay” for oil, relative to the price of their outputs, immediately after a spike in the price of crude oil. But the inverse is also true - they may “overpay” immediately after a dip in the price of oil. Theoretically it all comes out in the wash for the refinery over the long term.

Speculation is another factor though, and there is reason to believe that speculative trading in oil/commodity futures adds a significant premium to the price of gas.