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SuperModels Recent articles: • The rebuilding-Louisiana portfolio, 8/30/2005 • Readers pick 7 stocks with double potential, 8/24/2005 • 18 stocks for the bull market's last gasp, 8/18/2005 More... | SuperModels Who's really to blame for $3-a-gallon gas? It's easy to get mad at the big oil companies, but the real story is far more complex. Here's the story behind the story, plus four energy sector picks. By Jon D. Markman Gasoline costs a lot in the U.S. today, so it just feels like a good idea to blame the big oil companies with accusations of gouging and windfall profits. But like most high-octane emotional reactions, this one is wrong, as youd need to breach every tenet of capitalism to lay all the fault at the oil giants feet. And even if you still think they deserve a touch of anger, as investors youre better off joining them than fighting them. The reason that gasoline costs $1 or more per gallon today than a year ago is simple: Hurricane Katrina kicked our supply lines down a crooked staircase, and a painful kink emerged in the commoditys complex worldwide distribution system. Although it seems unfair at times, its a fundamental principle of our great economic system that the most efficient way to allocate a scarce resource is through price. When there isnt enough of something valuable to go around -- whether its caviar, Manhattan property or reliable home-run hitters -- in a market society we let the item go to the highest bidder. This is eBay 101.
In the case of gasoline, many consumers do not seem to yet grasp the difference between crude oil, the price of which is declining of late, and the stuff that they pump into their car, which is getting more expensive. One is the raw material, while the other is a finished good. Its the difference between the price of raw cotton and an Armani T-shirt. You wouldnt expect a sharp cut in prices at Bloomingdale's just because cotton futures prices fell, and neither should you expect a 1:1 change in the relationship between oil prices and gas prices. The Shell game Moreover, many dont seem to grasp the difference between the large, vertically integrated companies (such as Royal Dutch Petroleum Related news and commentary on MSN Money The confusion largely comes from the fact that neighborhood filling stations typically obtain marketing support from oil giants in exchange for a promise to buy a certain percentage of their products. The station owner then plasters the giants name all over his business as an advertising ploy. While it might look as if the corner station thats boosted its unleaded price to $3.50 is owned by Royal Dutch because all the garish yellow signage says Shell, in fact the business is more likely owned by an independent entrepreneur who lives down the street. The oil companies themselves control very few gas stations anymore. The gougers, if there are any, are thus not the oil companies but local guys who are exploiting a short-term supply disruption to make some extra profits in a generally low-margin business. Stations generally make more money on their convenience store beer and Twinkies than on unleaded. Crude, crude everywhere, but Right now there is plenty of crude oil in the worlds pipeline, but a scarcity of gasoline. Katrina knocked a considerable amount of crude-oil production out of commission in the Gulf of Mexico, to be sure. But as a gesture of goodwill, and to make a buck, our allies in the Organization of the Petroleum Exporting Countries, such as Saudi Arabia and Kuwait, agreed to produce more than their usual allotments to keep world reserves stable. At the same time, the U.S. government agreed to release tens of millions of barrels of crude oil from the Strategic Petroleum Reserve, an energy piggy bank started 30 years ago after the Yom Kippur War between Israel and its Arab neighbors disrupted supply. You can have all the oil in the world and still run short of gasoline, however, if major refineries are out of action. Refineries are large, smelly, unattractive plants that crack crude oils hydrocarbons into the stuff that makes modern life go, such as heating oil, kerosene, jet fuel, the feedstock for plastics, diesel and automotive gasoline. Few U.S. states have ever wanted these noxious beasts on their coastlines, so the ones built in loosely regulated Louisiana half a century ago make something like half of all the refined crude oil products in the country. When Katrina blasted through, her high winds and storm surge knocked these plants for a loop, and the partial shutdown caused 10% of the nations entire supply of gasoline to vanish in a weekend. Many medium-sized refiners, such as Tesoro Because there are a lot of sophisticated buyers at wholesale, prices settle at an equilibrium that reflects the cost of production plus a small premium demanded by a dislocated supply. Once the winning bidder ships the gasoline home to his station in East Crawdad, Ala., however, he may have no competitors for his product and can charge a price that reflects local demand plus a premium that reflects area residents unwillingness to travel farther for a lower price. So even though the Alabama station might have received free signage from Shell, the oil giant has virtually no say, and gains nothing, from potentially outrageous local price hikes. Rather than just getting mad at the local station owner, motorists can either blow his nefarious scheme by finding local gasoline in more competitive markets -- or join him, to some extent, by becoming an energy industry stakeholder.
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