Shortly after Iraq invaded Kuwait on Aug. 2, President Bush asked oil companies for price restraint. Two tense months' worth of numbers make the outcome clear. Oil companies have delivered on the President's request.
In the 2 months that followed the invasion, the near month futures price for light sweet crude on the New York Mercantile Exchange jumped by 90%. In the same period, the U.S. average retail gasoline price climbed by 22%. Put another way, gasoline's feedstock cost climbed by 43cts/gal; price of the finished product rose by just 24cts/gal.
THE GASOLINE PRICE LAG
By the simplistic passthrough analysis that bedevils political discussions of these matters, the price of gasoline not to mention other petroleum products-should have increased by 43cts/gal along with crude costs. That it did not reflects two phenomena cursedly absent from official notice.
One hushed phenomenon is the functioning of markets. When the price of something rises, especially when it does so suddenly, consumers at first increase purchases in anticipation of shortage; they later moderate their use of the product so that demand eventually falls. U.S. gasoline demand has followed that pattern since the Iraqi invasion. Oil & Gas Journal's moving 4 week average of U.S. gasoline demand began the postinvasion period at 7.787 million b/d and climbed unseasonably to more than 7.9 million b/d at times in August. Last month the trend reversed. By the first week in October the figure had fallen to less than 7 million b/d.
Gasoline supplies have been adequate, so slackening demand explains some of the 19cts/gal product price lag behind surging feedstock costs. But it can't account for all of it.
The rest of the explanation comes from the other unmentionable phenomenon-price restraint. Contrary to popular allegations, refiners don't turn a knob to set nationwide gasoline prices. They can freeze prices at retail outlets they own, of course. Some did so in August, quickly exhausting supplies of price-frozen retailers and drawing charges of predatory pricing from independent competitors. A more effective way to exercise restraint is to create as much product as possible as long as feedstock remains available.
That's what's happening. U.S. refinery capacity utilization has averaged more than 90% throughout the crisis, repudiating silly consumerist charges that oil companies are crimping output to cash in on higher prices later. Prices have increased despite the high operating rates because business people all along the distribution chain recognize feedstock supply jeopardy when they see it. They worry about replacing what they sell. Especially in a business where inventories turn over quickly, uncertainty about future supply makes current supply cost more.
MANUFACTURING A SURPLUS
But refiners have moderated the price rise by manufacturing a gasoline surplus-to the point that a few cargoes have found their way to tighter markets in Europe and touched off another unfounded controversy in the U.S. Moreover, the effort hurts. Since mid-September, spot and futures crack spread margins net of transportation and processing costs-a rough gauge of overall refining profitability-have been negative most days. Normally, when refining becomes a money-losing proposition, refiners trim crude runs. Yet capacity utilization remains high. Refiners are restraining prices.
For their exertions and sacrifices, refiners deserve applause. They also owe their consumers a warning. Plants can't operate at maximum capacity indefinitely. Businesses can't lose money forever. A crude supply crunch looms. While the restraint lasts, though, it's just what the President requested.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.