Gasoline and Diesel Prices:  It's Supply, Demand, and BIG Government (Plus a Salute to Old Friends)

Sam T. Harper

August 2007

FRANKLIN COUNTY, Tn --Back in October, I wrote an article titled “Who controls oil prices? Big oil companies? Big oil governments? Republicans?”  The answer to the article’s title seemed to point to big oil government. Big oil government controls about 40%+ of the world’s oil production. Exxon, Chevron, and all the other evil oil companies pump only about 10% of the world’s production. So much for the power of Big Oil companies.

Now let’s look at gasoline and diesel prices. Of course, they are both driven on a basic level by the price of oil. There is more to it than that.

Last year diesel prices were $.20-$.40 per gallon higher than regular gasoline prices. This year’s diesel prices are about the same and at times lower than the price of regular gasoline because the price of gasoline has risen to diesel’s level. A quick supply and demand lesson and then a look at inventory numbers will tell us why.

Supply and demand is one of the laws of nature. When the supply of something that people want is low, the price is high. When the supply is plentiful, the price is lower. Watch the way Nintendo, Sony, Microsoft, and Apple introduce new games and electronics. Low supply and high prices in the beginning; greater supply later with price decreases.

Fuel acts the same way.

In June, 2006 refiners had to begin making a new low sulfur diesel fuel. This mandated fuel change decreases the amount of diesel fuel that comes from each barrel of oil; so BIG government forced refiners to buy more oil to make the same amount of diesel fuel as before the change.

A year ago, gasoline inventories were 5% greater than they are now. Diesel inventories were 20% lower. Refiners were changing over their equipment to make the new diesel fuel. Due to the diesel fuel bottleneck, they were able to make more gasoline. Gasoline supplies were up, therefore, gasoline prices were down.

Now that the new diesel fuel equipment is in place and the refiners have moved down the learning curve on how to produce it, the supply of diesel has risen.

Sam, you are contradicting yourself. What you just pointed out should drive down the price of diesel fuel and it has not.

Here is why. The new diesel requires more oil to produce the same quantities as before the mandate. So as diesel fuel production ramped back up, the demand for crude oil also increased. As the demand for crude oil increases, its price per barrel increases.

The rising crude prices are reflected in the increase in gasoline prices. To compound the problem, the increased diesel production has “squeezed” out some refinery production time for making gasoline. Gasoline inventories are now below their five (5) year average levels. Again, when supply decreases, prices increase.

I don’t pretend that one government mandate has caused all this fuel price inflation. They are other government mandates I have ignored but that play a part in the story; i.e., the requirement for customized fuels in different parts of the country.

My point is that BIG government is a major variable in what we pay for fuel: both at the crude oil wellhead and at the pump. Remember that the next time you see protesters in front of Exxon headquarters in Texas.

A salute to some long time friends that recently passed away:

Back in the 80’s as I was graduating from graduate school, I took a job with an exploration and production oil company that has since been swallowed up into BP America. The job was a Houston headquarters based two person group that analyzed the economics of various exploration and production projects for company executives. My boss was an older, stern looking man that had years of experience with Exxon and various other oil companies, Joe Pelline. Joe had not hired me. The company official that did retired shortly after I accepted the job. Joe told me later that he went to Human Resources and said that he did not think I should work in his group. (This was before he had met me.) HR told him he had no choice. In the end it worked out for us both quite well.

Joe taught me much about the industry and about life. He often let the other fellow in the group and I present our work to the company officers and Board members. No other headquarters department head did that. Joe’s wit and humor was always a source of enjoyment. After one long, meaningless meeting with a group of Brits, Joe leaned over to me and in his dry wit, asked if we were in the Benny Hill Show.

Early in that job, Joe called me into his office and told me that I had to sign up for the company 401-K. In addition, he had IRS materials on how to fund the then new IRA accounts. I thanked him and said I would take all the material, read it, and then decide if I wanted to use these investment vehicles. That was the wrong answer. He said that I was not leaving his office until I had filled the 401-K application and that I had to bring back proof within the week that I had opened an IRA account. I was a bit peeved at his insistence (I had a large graduate school debt) but did what I was told. Since the day he pushed me into saving for retirement, I have maximized all such investment vehicles that were available to me during my career. It has paid off nicely for me and my family. I am thankful to Joe for that. Today, I push along Joe’s advice to today’s young employees.

I came to know Joe and then his wife, Marilyn, well over the years. They treated me like one of the family. I ate many of Marilyn’s wonderful dinners with them; enjoyed Joe’s homemade apples pies; became friends with their son; got an “assist” in life’s playbook for being partially responsible for putting together their son and his now wife; and had regular political talks with them both. After I married, they accepted my wife into their lives without a pause.

Joe and Marilyn recently died of just plain old age. They had the full lives for which most of us strive. I loved them like I did my own parents and miss them the same.

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