Wednesday, September 21, 2005

Blowing Harder Than Rita and Katrina

Bill O'Reilly is nothing without a bogeyman. A few years ago, it was the American Red Cross, which had been reluctant to commit then-current donations directly to 9/11 victims. Under the withering fire of O'Reilly's flaming dragon, the Red Cross relented. Bill saved America from the big, bad wolf, and his ratings are through the roof. Bill, if you had not noticed, is now very rich.

"Looking out for you" is his motto. Indeed.

Now, the target of his demagoguery is Big Oil. The current witch-hunt is to find the imaginary individual who secretly controls gasoline prices. He wants to know who decides what price gas stations charge each day for product. At the same time, he attacks the five major oil companies for making enormous profits.

I guess profits are bad, for some reason. Personally, I prefer to do business with companies that are profitable, especially when continuing supply is important. If you are losing money, or are otherwise financially weak, you may not be around long. But Bill thinks oil companies ought to "give back" some large percentage of their profits, for seemingly altruistic reasons.

Imagine a hurricane victim who lost his house, car, and personal possessions-- maybe even a family member. He is dislocated and out of a job. Suddenly, the oil companies toss out their profits to lower gasoline prices. Oil stocks drop like rocks, maybe taking other Fortune 500 companies with them. So now our hurricane victim is unemployed, and his 401k or pension collapses as well. Terrific outcome. Thanks for looking out for "the little guy", Bill.

Back to the oil industry. In order to be useful in your car, crude oil must be refined into gasoline. In any complex supply chain-- such as the oil business, with crude product, transportation, refinery and more transportation-- that industry will be no more productive than its worst bottleneck. The pinch point, so to speak. When refineries are operating at 100 percent of capacity, look no further for the pinch point. Even if crude oil dropped in half to $30 a barrel, gasoline will get more expensive when refineries continue to sell everything they can possibly make.

O'Reilly tells us the problem is that there are "only" five oil companies, and they are in collusion to control prices. Five is plenty of competition. And, when they are selling 100 percent of what they can make, there is no need to collude on anything. Prices will rise until people stop buying gasoline. Period.

Economics is a study of human nature, and there are two fundamental laws that drive prices: the laws of Supply and Demand. The Law of Supply says that as the price of a commodity rises, supply will tend to increase. With oil at $65 a barrel, you can bet the Arabs are pumping as fast as they can. Conversely, as price declines, so will supply. Human nature.

The Law of Demand is the inverse: as price increases, demand for a commodity tends to decrease, and when price decreases, demand will increase. The combined forces of Supply and Demand determine price. And if demand is high, and supply cannot increase-- we are running refineries at capacity-- prices will certainly go higher. If prices get high enough, people will just as certainly find a way to buy less gasoline. When that happens, prices will stop rising, or will even decline. Human nature.

Pretty simple, eh? You bet, but for a demagogue, rather inconvenient. Much better to invent scandal and get ratings. After all, if viewer "demand" for Bill's show increases, the price he charges Fox News for his show can go up as well. I bet Bill understands that market just fine.

So Bill, why not investigate the real scandal here-- no new refineries built in 30 years. Capacity has increased incrementally over the years, but not one new refinery. And you can bet, if BP Amoco could get a jump on the competition by adding a new refinery or two, they would do so in a heartbeat. No collusion needed, just the desire to seek profits. Human nature.

Who limits refinery construction? The political Left, in the false name of "the environment".

But that's a demagogue of another stripe.

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