Thursday, September 01, 2005

Pricing power of Oil Companies?

Just to summarize a major finding from the Independent Review of Oil Industry Deregulation (cited in my previous post):

Q: Is there evidence that market power is manipulating prices in the downstream oil industry?

A: None whatsoever. No evidence has been produced regarding collusion of the industry players, whether implicit or explicit.

Stupid congressmen or senators though may point to phenomena such as price matching as evidence for collusion. That is, competitors often charge the same price, with near-simultaneous adjustment of prices. As the Report blandly puts it: "Similar prices may also arise due to competition." By the way, I found similar (in many cases, exactly the same) prices on a variety of products across several supermarkets. I guess we should hale SM, Robinson, Rustan's, Cost-U-Less, Shopwise, plus innumerable smaller retail groceries, to court for anti-competitive practices!

Contra the claim of collusion, after deregulation (1998 vs 2005), the following are observed:

  • The oil company share in revenues has fallen from 23% to 16%.

  • Two of the top players, Petron and Shell, have earned a Return on Equity of only 3.0 to 3.7 percent.

  • The new players' market share has risen from 4.3 to 13.3 percent. In certain sectors their share is large; in LPG it is 43%. They now account for one fifth of the gasoline stations in the country.

  • Domestic fuel prices have risen more slowly than international fuel prices.


Henceforth any Senator or Congressman advocating "Reregulation" should first publish a point-by-point refutation of said study. The refutation should itself be critiqued by experts and academics, not least the authors of the Independent Review Report. That is my dream scenario for an intellectually respectable debate on the oil "crisis". I have a funny feeling though that instead, the usual stupidity will just play itself out. "August halls of congress" my ass.

30 comments:

micketymoc said...

Am avidly reading your work. Despite the lack of comments (so far), I hope you keep this up. I also hope some "progressive" elements try to begin a point-counterpoint discussion on this, just to make the discussion interesting.

Econblogger said...

Micketymoc,

Thanks. I am keeping it up - more out of the cathartic kick than anything else. If you know some "radicals" out there who would like to react to this, point them here! It would be lots of fun!

Anonymous said...

Oil companies are gouging the American public and getting away with it. That gas was bought weeks and months ago at much cheaper prices. If grocery stores suddenly raised food prices overnight like oil companies are allowed to do, there would be rioting in the streets. Have you ever seen your coffee, orange juice or soy product go up in price almost every day? No, because the American people would not stand for it. Defeat every politician that gets money from oil companies or continue to pay higher and higher gas prices. It's that simple.

Econblogger said...

Hi anonymous,

Thanks for commenting. I don't have information at hand on the behavior of American oil companies. However the fact that globally prices are rising means that the fuel price increases afflicting American consumers is not uniquely caused by oil companies, but must find an explanation in the international market.

Unlike agricultural products, oil is a nonrenewable resource, whose sources globally are very limited. (Southeast Asia for example has no native petroleum sources, except Malaysia and Indonesia.) Hence when global market forces trigger increases in price, options for expanding domestic supplies are highly limited.

What global forces have triggered increases in fuel prices? Here is an analysis (with data) from econbrowser. It explains, correctly I think, how rising global economic demand - a large chunk of which is from China - is driving fuel prices up.

Finally, there are significant periods in which the oil price drops. So it is not true that prices are always going up. At the start of the 1990s prices were about 30 dollars a barrel, falling to just 18 dollars by the late 1990s, before picking up from 2001 onward. The price decline in the 1990s was a great disincentive to increasing refinery capacity - I believe during this time there were almost no new investments in refineries in your country. Bottlenecks at the refinery level (rather than from oil drilling per se) are another major source of price increases. Perhaps now under higher prices, investment flows to refineries will pick up again.

Anonymous said...

Maybe we should check how quick the Big Three oil cartel has been jacking up prices from Jan. to July 2005 viz. Dubai oil prices.

There have been reports from reputable sources that we are being gouged by as much as P3.00 per liter of diesel due to over-recoveries and unwarranted price hikes. In other words, the deregulation regime could have been giving the Big Three a license to gouge the public by imposing increases far more than necessary.

Oil is a strategic resource and should not be left with profit-hungry corporations.

Econblogger said...

Anonymous,

I have an idea where your information is coming from. It is from Ibon, this page. The method, based on "rule of thumb", is spurious. It ignores the other evidence in the Report (which you ought to read), such as low return on equity (mainly because Petron and Shell have yet to recoup their significant recent investments) during the period of regulation. Furthermore the other players have not set their prices 3 pesos lower (Flying V, Total, Seaoil, Petronas, etc.) The margin earned by the oil companies has been eroded during the deregulation period (whereas it was high when the Oil Price Stabilization Fund was able to assure them of good returns.) Finally, relative to the MOPS benchmark, local prices have risen less than international prices.

If you have good evidence of collusion and price gouging, please point me to it and I'll feature it here. Otherwise, I stand by my post!

f said...

it is good that there are other people out there too thinking straight about this issue. we really need to educate the public about the economics of this.

"price gouging" is such a useful term when bashing business. but in free market environments it really does not make any sense. suppose there was a typhoon and the local store starts raising their listed price for eggs, is this price gouging? no, that's just the firm adjusting to market forces, people are demanding it more, and supply is restricted you got to increase prices "to ration" it off to those with the greatest demand and to signal to other producers to supply this market.

one quick check to see if the oil companies are passing higher prices than cost to philippine consumers is to check how much of exchange rate movements is being pass-through all the way to retail prices. i'm guessing this is even less than one, with the more open industry environment now and contestability of markets because of the new players.

plus any person out there who thinks there is collusion going on can as an individual file a complaint, as the existing Oil Deregulation Law has provisions against antitrust. it's time to put politics out of the energy markets and other markets in the philippines, let free markets decide!

Anonymous said...

It is so nice to see arm-chair economists debate about there being no such thing as price gouging in time of natural disasters. May your belly never be hungry or you be forced to eat your economist books for nourishment when you cannot afford to buy essential staples. You can't get more than three economists in a room to agree on anything, why should you listen to them explain away the insane profits of oil companies who engage in profiteering at our expense.

Econblogger said...

f,

Needless to say, I agree with you.

Anonymous,

Regarding the issue at hand, which is the oil market, what natural disaster are you referring to?

May you never have to suffer eight-hour power outages because government needs to "ration" energy.

Incidentally, it is not true that no three economists can reach an agreement about anything. Most economists worldwide agree that price controls in the oil market is a bad idea. Just look at the widespread disapproval in the blogsphere about Hawaii price controls, mostly written by economist-bloggers.

Anonymous said...

So, you are saying with a straight face that there are no differences between the various schools of thought regarding economics. Please who were your professors? May we have their names.

We speak of the natural disaster at hand, Sir. Today gas was $6.00 per gallon of gas in Atlanta. Of course this price spike was due to a loss of equilibrium in the polar ice cap in conjunction with the price of sorghum in Upper Volta. You see thats why we must pay such high gas prices! Oh, the dismal science and its wayward disciples!

Econblogger said...

Anonymous,

I am well aware of the various schools of thought in economics. We professionals study them all, and on the basis of the evidence we discard those that don't work well in describing the real world. Marxist economics for example, which in its original form predicted a falling profit rate, has been repeatedly falsified all over the industrialized world. The labor theory of value also has failed dismally; rather, it has been found that prices are determined not only by historical labor costs, but also by demand factors as well as other cost components.

Now let me tell you what constitutes evidence that your price-gouging hypothesis is correct:

a. Oil companies that possess very high and persistent rates of return, relative to rates of return in other comparable economic sectors. (If you do find such evidence, please check if there are stringent government regulations that prevent free entry into the business: that's the source of competitive power in the first place.)

b. A cap on fuel prices that results in higher supplies of fuel, rather than shortages.

c. Rate of increase of domestic fuel prices that are persistently higher than international fuel prices, is good evidence of localized market power.

Or similar such findings. Simply citing the high prices of fuel in Atlanta simply doesn't hack it, because regular supply-demand analysis can explain that very well.

Your sarcasm and ad hominem attack does not constitute sound argumentation, Sir. I suggest you back your stand with information based on the real world, and not on the ideas of some defunct pseudo-economist.

f said...

Anonymous,

Using tired punchlines does not make for an alternative and logical explanation for what you are observing.

what do you think will make oil suppliers divert more oil supplies to atlanta and other hurricane affected supply lines faster? a price ceiling that states they could not charge no more than $2.25/gallon or a price that aligns the demand intensity of people in that geographic area with what it takes to divert oil supplies to that area?

before katrina the cheapest way to take gas to the southeast was by pipelines coming out of the gulf of mexico state refineries, now it has to come from the western and eastern seaboard.

now if you are getting paid over $1 a day, should you be painted as somebody who is gouging your employer? because you know half of the world is able to live on $1/day.

Anonymous said...

If people are starving and chaos is erupting and a few are taking advantage of the situation by excessive profiteering either in a war or natural disaster situation then they should be shot or hung as an example. History is replete with governments taking such action. Political expendiency will triumph over mere economic theory everytime. If I was an ambitious politician in Atlanta right now, I would skip any talk of price ceilings and make a very public example of certain gasoline price gougers. The public would be appeased and my political future would be ensured. Economic theory is fine and dandy "all things being equal" in the classroom but when you deal with humans in the real world, one can never know what may lie next. How do you factor in Human sentiment?

Econblogger said...

Anonymous,

History is also replete with examples of witches and heretics being burned at the stake. I suppose shooting the sellers would be a wonderful way to increase supplies in the affected areas. Human sentiment is nice, but it doesn't repeal the law of supply and demand.

Anonymous said...

The law supply and demand will take care itself in the long run. In the short term, shooting two or three price gougers should do the trick in getting the rest to comply. I am advised as I write that the Gov. of Georgia has said "If they abuse our citizens, if they gouge them, they'll pay the consequences," Georgia Gov. Sonny Perdue declares.
I would hope the Gov. of Georgia is smart enough to call the nation's media in when they conduct these "show trials" for price gougers. If so, he is sure to win re-election in a landside!

Econblogger said...

Yes, anti-market policies are popular. Just the use of the term price-"gougers" demonstrates this very well. However, argumentum ad populum is a common fallacy. Anon, it seems you do believe in supply and demand, though in the long run. So it's merely the short-run issue on which we differ. I remain unconvinced though. It seems you prefer shortages and rationing to the more straightforward allocation via prices. This will create more chaos, rather than less. The creation of shortages will trigger a round of panic-buying - exacerbating shortages, and probably secondary markets where price "gougers" may be your next door neighbor - or even you.

Anonymous said...

I believe in markets to a degree. I work in government and know that many large corporations like oil companies often seek and receive unfair advantages vis a vis their competitors or even against the public. We speak of the wisdom of the market, yet market forces are routinely distorted by the actions of governments and corporations acting in tandem. The U.S. Government unwisely allowed large oil companies to become even larger by swallowing up other oil companies. This in effect has created monopolistic control of the nations energy industry by increasingly fewer and fewer companies. If I were in control, I would actually enforce the Sherman Anti-trust act and force many of these companies to spin off many of their assets much like we did with old Ma Bell or AT&T. Competition is a wonderful salve against high prices and poor service.

Anonymous said...

Thousands Complain to Feds on Gas Gouging
Sep 01 7:52 PM US/Eastern


By H. JOSEF HEBERT
Associated Press Writer


WASHINGTON


Soaring gasoline costs prompted thousands of complaints Thursday to federal officials about alleged price gouging and demands by some members of Congress for an investigation into gasoline markets.

The Energy Department reported more than 5,000 calls to its price gouging hotline from motorists around the country, although officials emphasized there was no way to immediately determine how many of the allegations were valid.

Department spokesman Drew Malcolm said the reports were being turned over to the Federal Trade Commission.

The states with the most complaints were North Carolina, Georgia, New York, Pennsylvania, Texas, Illinois, Tennessee, New Jersey, Michigan and South Carolina.

Meanwhile, attorney's general from a number of states held a telephone strategy session to discuss the rapidly escalating gas prices and possible investigations into gouging. Prosecution for price gouging is generally a state matter unless it involves some form of collusion or other activity in violation of federal antitrust laws.

Gas prices jumped 35 cents to 50 cents a gallon overnight in some areas pushing to well over $3 a gallon after Hurricane Katrina shut down nine Gulf Coast refineries, disrupted gasoline pipelines to the Midwest and East and stopped 90 percent of the oil production in the Gulf of Mexico.

"If we get consumer complaints about (gasoline) prices, we'll look at those complaints to find evidence of anticompetitive conduct," said John Seesel, the FTC's associate counsel for energy issues.

But Seesel said the FTC has no jurisdiction over an individual gas station operator raising his price, no matter how high, unless there is some collusion among retailers. A number of states, however, have anti-gouging statutes. Following FTC policy, he declined to say whether any investigation were underway.

On Thursday, Attorney General Troy King of Alabama initiated a private telephone conference with a number of his colleagues from others states to discuss strategy in response to the rising gas prices and reports of huge overnight spikes by some gasoline retailers. No details about the private discussion were available.

There have been isolated cases of unusually huge price jumps, including a gas station in Georgia that briefly charged $6 a gallon when competitors ran out of gas. In Michigan, there was a price jump of nearly $1 a gallon overnight, although prices then receded, according to Rep. Fred Upton, R-Mich., who drove around his district on Thursday to gauge prices.

"Prices are averaging $3.19. It's as high as $3.58 from $2.61 on Tuesday," said Upton in a telephone interview. "My sense is the supply and demand equation does not fit a 60-cent (a gallon) increase in the last 36 hours."

"In Illinois, prices are reported to have shot up 50 cents per gallon overnight and the state attorney general received more than 500 reports of price gouging," nine Democratic members of the House Judiciary Committee wrote the FTC, asking the agency to step up its review of gas markets.

"These increases go far beyond anything justified or relating to the market disruptions caused by Hurricane Katrina," wrote Rep. John Conyers of Michigan, the committee's ranking Democrat, and the other members.

Anonymous said...

I do think that in an emergency, letting prices rise is the best policy in the short term. If prices remain artificially low, you need to result in rationing. However, this results in misallocation since the commodity will not go to the person that needs it the most. First, everyone will receive the same amount of the commodity whether or not they really need to use it. For example, I would definitely claim my ration of gas even though it's not really that valuable to me (I tend to use public transportation). Thus, the people who really need it will have less supply to pick from. Second, keeping prices articifically low will not create an incentive for people to increase supply. If all of a sudden, I see commodity prices skyrocket, you bet your horses I will try to find new supplies and sell it in the market. If prices remain low, what's my incentive to do so? Lastly, with higher prices, you automatically limit demand, rather than relying on the goodwill of others.



Unfortunately, price controls will only work if we trust that everybody will sacrifice for the good of the group. Since it does not hit our pocketbooks, society will need to trust me my goodwill in giving up the commodity so that others can use it. It requires belief in "new man/ homo novus", a man who is beyond selfish consideration and believes in the good of the group. A man who is willing to give according to his abilities, and receive according to his needs. If you believe that this is the current state of the world, then yes, I would agree that price controls are the best policy.

You can actually test this by running a real time experiment: let the free market work, but appeal to everybody to conserve the commodity. In this situation, if people really alter their behavior to conserve, we should see demand falling off and prices not rise as high. This is the best method to have an objective metric to measure how people really behave.

With regards to the current state of "high" gasoline prices, in real terms, gasoline prices are still low compared to the 70's oil crisis. Also, the US tried price controls then, and it didn't work. It was Reagan who lifted price controls, resulting in greater oil production and the subsequent return to having a reliable oil supply.

With regards to the comment that oil companies are profitable, that's not really the case. From an ROI basis, they are below the average vs other industries. Remember, in the end, it's ROI, not absoluate amount. If you are only earning 4% return on equity, why invest in gas, when you can invest in stocks or other assets?

It's pretty bad in the Philippines: a barrel of crude oil is $70. A barrel has 42 gallons x ~4 liters per gallon. Thus, at an exchange rate of 56, crude oil costs P23 a liter. Add in refining, transportation, and retail costs, and it doesn't leave that much room for margin. Remember: other commodities sell with retail margins of over 100% (price over costs). If I had the money, I would not invest in gas here in the Philippines.

AT

Anonymous said...

Last Blogger thank you for reading from a press release from an oil Company. You obviously work for an oil company or one of its subsideries. That gas is bascically cheaper now than in the 70's ploy was put out by an oil industry press release awhile back. Your claim that the oil companies are not making any money is ludicrous and based on industry figures. Please go back to your regular job, the oil industry thanks you.

Anonymous said...

Ummm.... to the last blogger, thanks for your insightful refutation of my points!

AT

Anonymous said...

I am just wondering why it seems to me that that you are trying to defend (or probably explain) these oil companies.

My question is, why are they operating like a sari-sari store? Don't they have a market analyst(might be you) analyzing where the price would go today, tommorrow, next week and next month, next year? Dont' tell me, they buy their inventories like an ordinary sari-sari store?

What about the futures market? Dont' tell me they dont hedge? Long or short, whatever they think the price would go?

Most market prices (inlcuding oil) are dependent on many things -- mere perception could do wonder or death. With my humble experience in the U.S. equities market, no one can predict where the market would go, however smart traders, hedge to cover themselves against volatile market.

You are an econonmist and you know what i am saying.

Econblogger said...

anti-market anon,

Lay off on the ad hominem, will ya? I am not taken a cent from the oil companies and I fully believe they are supplying oil to line their own pockets and not to benefit us. However this is not something I care about, becuase we do not depend on the generosity of the butcher and the brewer and the baker and the oil company to supply our needs, but rather we depend on their selfishness.

The information on ROI is from teh Securities and Exchange Commission, as stated in the independent Review cited in my post. Did you read it?

Your statement about hedging in futures markets appears pointless. Are you arguing that all the market movement is sheer speculation? There is some speculation in the short term price volatility, but the fundamental movements are driven by supply and demand.

Anonymous said...

With regards to the point on hedging:

Hedging goes both ways. While it is true that one can hedge against higher oil prices (thus making money/offer low prices when the price of oil soars), one could also lose tons of money if oil prices drop (due to competitive pricing pressure). Let's say I purchase an oil futures right now for $60/barrel. If prices drop to $40 next year, I'm stuck with very expensive oil that I can only unload at a lost. Furthermore, if I try to limit my loss by charging the equivalent of $50/barrel, it would be the leftists/citizenry who would argue that I'm making money.

In a highly competitive market with pricing pressure (from the market as well as government/politics), I'm not entirely sure hedging can protect you adequately from price swings. It helps a little, but does not solve the problem.

AT

Anonymous said...

How can you guys always speak about the market this and the market that to solve all basic economic problems when governments and businesses regularly collude to distort markets. In fact, all countries do it. Whether, its France protecting its wine industry or OPEC colluding to set the price of oil. How can the market in and of itself be the end all? Please answer that?

Econblogger said...

Last poster,

"Government and business", you said. That says it all. The example you gave of France and its subsidies shows that France is NOT following the free market.

As for OPEC, yes that is a clear example of market power, with states coordinating business interests across several exporting countries. However this poster child of oligopoly was defanged in later years, especially the 1990s where they were helpless in preventing a collapse of oil prices. The current oil price spike is unrelated to their market power, and has everything to do with demand growth coming from China, the US, and India, coming head-to-head with capacity constraints on the production and especially the refinery side. In short, the usual demand-supply story.

Anonymous said...

econoblogger:

That was very interesting information but you failed to answer the question. Let me rephrase it in another way. How can markets be expected to solve all economic problems when they are constantly being subverted by governments and business coming together to distort supply and demand? OPEC for example since 9/11 has exhibited a new solidarity vis a vis the United States to drag its feet in the face of requests to increase oil production and thus ensuring that demand will always outpace supply. Are there market forces or political forces dictating the price of oil. The answer is both! Thus the market is compromised.

Econblogger said...

Anonymous,

What is your evidence that OPEC has been "dragging its feet"? None except your own assertion.

On the other hand, there is plenty of evidence to show that OPEC countries are approaching their maximum production capacity. Hence your claim that they are deliberately restricting supplies is false.

To see how limited extra capacity is, check out this link from the Energy Information Agency:

http://www.eia.doe.gov/emeu/steo/pub/3atab.html

How well have OPEC members been able to raise prices? Their record is not very good. Prices have normally fallen in real terms since the 1970s, except for two episodes connected to security concerns in West Asia: the Iran revolution, and the first Persian Gulf war. See this document (it was written in 2002, so the capacity data is a bit old, but its review of the historical record remains valid.)

http://www.econlib.org/library/Enc/OPEC.html

Private sector market forces are not in control of the price of oil. Rather regular supply and demand determines oil price, which outside any single sector's or organization's control.

As I said earlier, only government intervention can serious disrupt the free operation of market forces within an economy. Precisely such intervention is discouraged by shifting to market-oriented policies.

Anonymous said...

My information about OPEC is political. It seems the Arab/Muslim world is very unhappy about a perceived anti-Arab/Muslim bias by the United States and therefore is less than cooperative and honest about increasing supply. In other words, they are perfectly happy to see us pay high prices. It benefits them greatly. In addition, having greatly reduced their investments in the United States after 9/11 they have insulated themselves from any negative economic impacts to the U.S. economy. Sometimes, its more useful to speak to people on the ground rather than reading a report from a bureaucrat sitting in London or New York.

Econblogger said...

Anon,

Your point on field work is well taken. However I bet another observer doing field work may report exactly what the data is saying - OPEC is operating at near capacity. It all depends on who you talk to.

I know because I've done a lot of field work in my profession - talking to farmers, small manufacturers in rural areas, fishpond operators, government officials, big business owners. It's easy to get contradictory opinions on just about ANYTHING. So don't for a minute think I'm an "armchair economist." I've seen the real world. Economics works.

Because of this all anecdotal evidence can only be preliminary and cannot be used to contradict data. You need actual hard information regarding the dubiousness about the capacity data before you can dismiss it in favor of your "field work".