The price of gas

In the oil patch where I worked, we separated the exploration and production side of the business (my side), known as "upstream" from the refining and distribution (your local gas station) side, known as "downstream." Even though I had no contact with or insider knowledge of the price of oil, people still asked me why the price fluctuations? Here's my theory.

Oil is in the ground and you have to do something to get it out, then you have to do something to create a usable product and then you have to distribute it to the consumer. This all costs money, but the costs are relatively predictable. What is not predictable is what you will pay for it. Economics 101 says price is a function of supply and demand and both can vary depending on geological forces, the weather and politics on the one side (none of which are predictable) and what people are willing to pay for the product on the other. In the market place, price is not set by what something costs to produce but what people will pay for it. You should have bought gold last year and be selling it now.

Oil is primarily bought and sold on the open market although there have been some long term agreements between suppliers and distributors (and nations) to guarantee the price based on production costs and a need for a steady and predictable supply. This was very much the case where production, transportation and infrastructure costs are very expensive (like for liquefied natural gas) and the producer needed a long term contract to recuperate significant upfront costs. Oil is simpler to handle so to some degree you can keep it in the ground or in a tank until the price goes up and the profit margin is higher.

Occasionally you'll see an e-mail scam telling people you should boycott certain gas stations who buy their oil from terrorist sponsoring countries and buy only from others that produce locally or buy from responsible source countries. This is totally untrue. That is not how the global oil trade works and distributors buy where they can. I suggest you check it out on www.snopes.com anytime you get unsolicited advice over the internet.

So here is what is happening. Supplies of oil have peaked or will in the near term. We might find more, but we've looked in all the easy places and it is very likely that we are on the downside of the oil production curve on a global scale. On the demand side we are willing to buy gas for vehicles too large for the purpose here in the USA plus buy cheaper goods and services from India and China where the new wealth increases energy demand on a scale equal to our own. The price of gas is going to go up until we find an alternative and stop buying or using it up so fast. You can bet on it.

(by Marc Adami, Guest Columnist)