Folks,

In this week’s article for Energy and Capital, I try to explain, once and for all, that gas prices aren’t high because of gouging by Big Oil, and why boycotts don’t help bring prices down. If you’ve ever received one of those email chain letters that told you not to buy gas on a certain day or from a certain company (like the one that went around again this week), then please forward this article to whomever sent it to you. It’s high time people started to understand the way this system really works.

–C

There’s a Hole in the Bucket

2007-05-18

By Chris Nelder

That does it. Time to set this record straight.

If I get one more email petition asking me not to buy gasoline on some day or another, or from one company or another, I’m gonna scream.

Some consumers actually decided not to buy gasoline yesterday, because an email chain letter suggested that if enough of them stayed away from the pumps on May 15, it would bring prices down.

Get a grip, people.

Such tactics could never reduce the price of gasoline. And that chain letter has been going around since 1999.

One instance claimed that if all 72 million MySpace users participated in the "gas-out," it would bring the oil companies to their knees by depriving them, at $30/tankful, of $2 billion in revenue that day. (Huh, I only wish I could fill up my tank for $30!)

Eeeyeah . . .

Before I get into this flawed math, allow me to cite yet another nursery rhyme . . . after all, everything we needed to know we learned in kindergarten, right?

Sing along, now:

There’s a hole in the bucket,

Dear Liza, dear Liza

There’s a hole in the bucket,

Dear Liza, there’s a hole.

Then fix it, dear Henry,

Dear Henry, dear Henry

Then fix it, dear Henry,

Dear Henry, fix it.

With what shall I fix it,

Dear Liza, dear Liza?

With what shall I fix it,

Dear Liza, with what?

OK, that’s enough.

If you remember the song, it goes on for many more verses, until Liza finally has to tell Henry to use the bucket to go get the water that he needs to wet the stone, to sharpen the axe, to cut the straw that he will need to fix the hole in the bucket.

Which brings us back to "D’oh!"

Those who supported the boycott were on the right track in believing that gasoline prices are a function of supply and demand.

Where they went wrong is the scale, and the logic.

Refusing to buy gas on one day, or from one retailer, is about as effective as waving a hanky in front of a charging bull.

It is true that 72 million times $30 is indeed over $2 billion. (Never mind that a majority of those 72 million MySpace users probably aren’t of driving age anyway, or that 72 million is just 30% of the number of drivers out there. Those who forward email chain letters probably don’t get out their pencils and check the math very often, so we’ll give them a break on that point.)

But the U.S. consumes 384 million gallons of gasoline every day. That’s 1.3 gallons for every man, woman, and child in the country, every day, or 1.6 gallons for every licensed driver, every day!

How effective could any boycott be . . . even a widely-supported one?

But never mind that either. The real fault in the argument is much simpler.

Those people didn’t avoid buying any gas at all. All they did was buy it on a different day!

Duh-HUH!

Demand is demand. Shifting it from one day to another accomplishes nothing.

Actually, a sudden drop-off in business like that is likely to hurt the gasoline station operators the most, and they’re the ones making the least profit along the entire supply chain, just a few pennies a gallon.

Indeed, on the futures market, which is where the prices of crude oil and gasoline are actually set, gasoline prices have actually gone up since the boycott.

Why?

Because the U.S. consumes 21 million barrels of oil a day, every day.

There’s a big, fat hole in the bucket.

And that’s the main reason–not Big Oil’s profiteering–that gasoline is now at an all-time nominal high, at $3.10 per gallon.

(Shoot, that ain’t nothin’ anyway. Out here in California, the average hit $3.45!)

Let’s trace these prices back to their source, and the reasons why they’re high should make themselves clear.

First, demand is high, and has been on a relentless upward trend for years. Here’s a chart of monthly consumption of gasoline since January 2000:

That annual sawtooth pattern is trending continuously upward, at the rate of about 1% to 1.5% annually, right along with economic growth.

Along with high demand, we have falling supply. Gasoline inventories declined for 12 consecutive weeks between February and April, in the sharpest such decline since the EIA started tracking the data. The drop was 34 million barrels, or 15%.

And why were gasoline inventories low? Because refiners have been running at around 85-90% capacity this year, and haven’t been able to keep up with demand for finished petroleum products.

Well then, why have the refineries been unable to keep up?

The answer is complicated. But it boils down to a couple of key factors.

First, the U.S. refinery system never really recovered from "Katrita." According to a senior EIA oil analyst, 800,000 barrels a day of US refining capacity is still offline, which translates into about 400,000 barrels of lost gasoline production each day, or nearly 3 million barrels a week.

Second, we’ve been running our refineries full-tilt for several years now, and that’s not how you’re supposed to run them. They need seasonal maintenance. After all, we’re basically talking about machines made of metal that have to run at high temperatures and pressures.

We’ve been overdriving them because we haven’t been able to build new refinery capacity to keep up with demand. We have added some capacity over the last decade or so by expanding existing refineries, but we haven’t built a new refinery in this country in over 30 years.

And what happens when you overdrive a hot, pressurized machine?

Things break. Metal gets fatigued, seals get worn. You wind up with explosions and fires and failures and shutdowns.

And that’s the final reason why the refineries haven’t been able to keep up. Because that deferred maintenance finally came home to roost, and several incidents knocked a couple of refineries offline for a while.

And that’s also why my favorite hedge against rising gasoline prices is going long on the domestic heavy sour crude refiners, particularly Valero (VLO) and Tesoro (TSO). They’ve both had spectacular runs already, but their days aren’t over yet, not even close. They’re in the catbird seat. Invest a little in them and your gains can balance out your losses at the pump.

So here we are, caught between the rock of refinery capacity and the hard place of demand.

We all want to drive off somewhere and have a nice vacation over Memorial Day weekend, right?

But that signals the beginning of the summer driving season. We’re supposed to have a nice store of gasoline put up and ready to burn by this time of the year.

This year, we don’t. In fact, we’re on track to have the lowest inventories of gasoline ever for Memorial Day.

Gasoline inventories are well below the average range for this time of year, and crude inventories are near the upper end of the average range.

In fact, as oil industry analyst Robert Rapier has observed, "In order to avoid going into the summer driving season below the lower end of the range, we would have to see three consecutive weekly gains that have not been seen this century–fueled by very strong import levels (or record-breaking demand destruction)."

Now, over the last three weeks, refinery utilization has finally started to pick up again, and domestic production has increased by half a million barrels a day.

We’ve made up the remaining shortfall by importing finished gasoline, amounting to more than 1.5 million barrels per day for the week ending May 11. That’s the fifth highest level of imports ever, and the highest since a year ago.

Should refinery utilization and imports continue to increase, gas prices could start to come back down a little.

But in all likelihood, gasoline inventories will remain lower than normal through the summer, and the price will probably remain around $3/gallon.

It should be abundantly clear to anyone that there is an extremely tight balance between supply and demand, and it wouldn’t take much–another refinery outage, a hurricane, a terrorist attack–to push prices straight up again.

So, as the old saw goes, the next time you point the accusatory finger at Big Oil, remember: there are three others pointed back at you.

There’s a hole in the bucket.

Which is why the EIA had to go to the trouble to put this incredibly obvious statement right on their "This Week In Petroleum" web page:

"If prices are high due to supply and demand factors, and consumers cannot directly increase supply, reducing demand is left as the main option for consumers."

How shall we do that, dear Liza, dear Liza?

How about not driving at all one day a week?

Even better: Friday, May 19, is National Ride Your Bike to Work Day. Everybody who participates in that will, in fact, reduce demand and help moderate prices. That’s a whole lot more effective than forwarding some email chain letter. Now that would, in fact, reduce demand and help moderate prices.

And with that, I have to get out the topo maps and figure out where I’m going four-wheeling on my Memorial Day vacation. Might as well, while I still have a truck that can do it and the gas to run it on. Smoke ’em if ya got ’em, peoples.

Until next time,

–Chris