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Can anybody suggest why normal competition isn't working here? One would expect providers of an identical product to push their prices down to the minimum profi

Can anybody suggest why normal competition isn't working here? One would expect providers of an identical product to push their prices down to the minimum profitable level to compete with others doing the same. From a consumer point of view, why is Texaco (for example) not charging significantly less for its fuel (while still retaining a healthy margin) and capturing all the market, triggering similar in other providers and a general downward price pressure? Is it in fact a demand vs supply thing, and even if they had a bigger market they couldn't supply it due to limitations on production and refinery capacity?

refurb 4y ago
Because in a resource and capital intensive industry the good years pay for all the costs to date. In bad years you might break even in terms of variable costs but contribute nothing towards capital costs. Gasoline variable costs might be [cost of oil] + $6/bbl, while full baked in fixed and variable costs are [cost of oil] + $25/bbl. It looks like profit now only because the capital expenditures were in prior years. It’s like building a house for $500,000 cash and asking the landlord why they charge $2,000 a month in rent when their costs are only $500 per month in property taxes, maintenance and insurance. The oil industry and many other similar industries couldn’t survive if they only charged the marginal cost of extraction and refinement and ignore the fixed costs of operation.
bretpiatt 4y ago
The constraints are in the shipping and refining. When demand goes up exploration and production (firms who find and get it out of the ground) get to charge more as end users fight over the limited supply. Due to environmental regulations it is very difficult to build refineries, pipelines, import / export terminals, etc. This is why when prices go up from $65 to $105 you do not see production companies increase supply further to get the extra sales, there's no way for them to get another barrel to the end customer.
- akrymski 4y ago
  I don't buy this argument. Assume the oil has already been dug up and refined. Two gas stations next to each other: Shell & BP should compete on price to the point that minimum profit margins are established. This doesn't happen because it's not in their interest to compete. Instead it's in their interest to collude and maintain prices as high as possible knowing full well that a new player won't enter the market any time soon. The oil cartel is alive and well.
  - lotsofpulp 4y ago
    Gas stations are almost never owned and operated by a major oil company. It is quite famously a business that immigrants get into due to its low barriers to entry, and they set the prices at the pump of their gas station. Location is the most important factor in how much more a gas station owner can charge relative to other gas station owners. If you want to see how much gas costs at near zero margin, open up the Costco app and you can see all the fuel prices nationwide. Although Costco only sells Top Tier gas, but that should be comparable to other brand name gas stations such as Shell and BP and Exxon. California offers good data here going back 20 years: https://www.energy.ca.gov/data-reports/energy-almanac/transportation-energy/estimated-gasoline-price-breakdown-and-margins https://www.energy.ca.gov/data-reports/energy-almanac/transp...
    - sithadmin 4y ago
      It's not just that they're not owned/operated by the oil companies in the US; they don't even obtain their supply of fuel directly from the oil company. Every gas station takes delivery of commodity-standard fuel from midstream distributors that operate pipelines and storage terminals. The only thing that differentiates between the Texaco gasoline on one side of the street and the Shell on the other is the proprietary additive blend that is mixed in at the storage terminal when an order is filled. Gas retailers in a given region are generally all beholden to whatever the market dictates the 'generic' fuel pricing will be. The majors have a lot less control over that than most folks think they do.
    - akrymski 4y ago
      BP and Shell are vertically integrated and mostly definitely do own a large number of gas stations at least here in Europe. However the owner doesn't really matter in this hypothetical example as long as BP and Shell actually control the price at which oil is sold.
slifin 4y ago
Why would Texaco lower their prices? Oil companies know if they restrict the supply the price skyrockets and they directly benefit The world is so reliant on oil and cars that people don't lower their dependencies they just pay the new price
- slifin 4y ago
  More context here: https://www.youtube.com/watch?v=AQbmpecxS2w https://www.youtube.com/watch?v=AQbmpecxS2w
  - 0des 4y ago
    Also, see: Enron, California power market manipulation
    - ZeroGravitas 4y ago
      Or the Tesla battery in Australia that paid for itself incredibly quickly, not because it was physically needed by the grid, but because it stopped gas power stations from dicking with supply and demand to maximise their own profit.
altacc 4y ago
Glibly, because the theory of self-correcting markets only works in economists' minds, not in real life. Oil price is affected my many variables including speculation, supply & demand, latency and panic buying, but the supply is artificially controlled to maximise price and political leverage. If OPEC decided to announce a significant increase in production then the price would drop. But there is no real incentive for them to do this as they are maximising profits already and selling more for less doesn't benefit them long term. some of the oil producing countries want to exert political influence via oil supply (especially Saudi Arabia), essentially forcing forgiveness for bad governance and human rights abuses.
- rkangel 4y ago
  But actually the underlying price of crude hasn't been ridiculous, whereas the price of petrol at the pump has skyrocketed. It's the gap between the two that has grown and hence oil company profits.
  - lotsofpulp 4y ago
    Crude price is historically high: https://www.macrotrends.net/1369/crude-oil-price-history-chart https://www.macrotrends.net/1369/crude-oil-price-history-cha...
- refurb 4y ago
  But apply the same logic to any other product. If you made widgets, and you knew demand was 5 units, would you make 20? Of course not. The power of OPEC has also decreased over time as other sources of oil have made up a larger percent.
- pibechorro 4y ago
  Self correcting markets work. They dont work like you think they should. The timeline is longer and the correction may not be fuel prices going down, rather alternative solutions popping upbto replace a no longer affordable solution.
- imglorp 4y ago
  It's across the industry -- they're all rocketing vs the market. Collusion? Or maybe they just came to the same conclusion that scare-quotes "inflation" is in the media so it's a swell time to pretend.
tr_user 4y ago
I mean the simplest explanation is that there's a price fixing cartel where everyone benefits by not trying to undercut each other.
- NovemberWhiskey 4y ago
  No; the simplest explanation is that increasing demand for a product with limited supply increases in price. That's literally Econ 101 - no cartel required.
  - Avshalom 4y ago
    Cartels are also econ 101. And OPEC is quite famously a price fixing cartel. and 101 means "so simple it's basically wrong but we have to start somewhere" anyway.
teeray 4y ago
Also, why did it take oil companies this long to figure out they could collectively charge whatever they want? Why did we ever have low prices after having high prices years ago?
- lotsofpulp 4y ago
  Because outside of OPEC, they are not colluding with each other, and in general, the more they extract and sell, the more profits they earn.
- NovemberWhiskey 4y ago
  One reason is because although the short-run price elasticity of demand for fuel is almost zero, the long-run is not. i.e. if fuel prices stay high for months, consumers keep filling up their cars, keep buying the same fuel-inefficient cars they always have, keep making the same number of trips If prices stay high for years, consumers start looking for other transport options, start buying more fuel-efficient (or electric) cars, etc. Also: when oil companies make outsize profits during normal times, you get people with pitchforks calling for heads which is bad PR; and you get certain stripes of politicians calling for price controls etc.
- stepanhruda 4y ago
  Because it’s difficult to verify how much who extracts, so very easy to extract more than agreed upon and earn more at the cost of others. This case is literally used as an example in an economics class.
- ZeroGravitas 4y ago
  The theory advanced in the video someone else posted is that they always knew they could push it too far and get blowback. But now it's their last throw of the dice so they're going all in. Previously they had to care about the next 40 years worth of profits, now they know there's a cliff edge coming, which brings new strategies to the fore.
NovemberWhiskey 4y ago
>One would expect providers of an identical product to push their prices down to the minimum profitable level to compete with others doing the same. That is not a definition of "normal competition", unless production capacity is free and infinite and barriers to entry and exit are zero. Transportation fuels have almost zero short-run price elasticity; so of course supply shocks cause swings in prices.
lotsofpulp 4y ago
> Can anybody suggest why normal competition isn't working here? One would expect providers of an identical product to push their prices down to the minimum profitable level to compete with others doing the same. Is there evidence it is not working? Ramping up production and refining capacity takes time. Barriers to entry might be higher too due to drastic increases specifically in the hard, manual labor required for gas to get to the pumps. And of course, simple inflation would cause nominal prices to rise. These profit margins do not look they have spiked unreasonably. A little spike is to be expected as there is a lag between when demand ramps up and supply catches up. https://www.macrotrends.net/stocks/charts/SHEL/shell/profit-margins https://www.macrotrends.net/stocks/charts/SHEL/shell/profit-... https://www.macrotrends.net/stocks/charts/BP/bp/profit-margins https://www.macrotrends.net/stocks/charts/BP/bp/profit-margi... https://www.macrotrends.net/stocks/charts/XOM/exxon/profit-margins https://www.macrotrends.net/stocks/charts/XOM/exxon/profit-m... https://www.macrotrends.net/stocks/charts/CVX/chevron/net-profit-margin https://www.macrotrends.net/stocks/charts/CVX/chevron/net-pr...
ZeroGravitas 4y ago
In oligopoly theory there's the kinked demand curve idea. Basically, you know that all of your competitors have some control over their price. If you drop your price, not because you're cheaper to produce but just willing to take less of a cut they can all match you on price, leaving you all back at square one but poorer. You know that, they know that, you know that they know that you know that. Still think a price war is a good idea? Your boss probably doesn't.
- mcphage 4y ago
  Which is why nobody competes heavily with Texas Instruments over their absurdly priced calculators—sure, you could come out with a better product, at a lower price, and still make a healthy product. But TI's prices are only so high because they can be, and they're very able to drop their prices if need be to price you out of the market.
  - IIsi50MHz 4y ago
    Casio :heart: (and even those seem overpriced for the components they use).
jdsully 4y ago
This is an industry the government is actively fighting. Short term there are profits but long term the outlook is bad and these projects need to pay off over decades to make sense. Take Keystone XL as an example. Billions were spent only for it to be cancelled on the eve of construction by a new president. This is not a good industry to invest in long term. The correct response is to milk existing infrastructure until it is no longer serviceable rather than trying to add new capacity.
evandijk70 4y ago
I think it is because the supply of oil is ultimately limited. Current estimates are that we have oil left for about 47 years. Nearly all of that is already owned by some oil company, but not counted as an asset. Therefore, oil companies can profit immensely if the price of oil increases.
lordgrenville 4y ago
It's called https://en.m.wikipedia.org/wiki/Tacit_collusion#Conscious_parallelism https://en.m.wikipedia.org/wiki/Tacit_collusion#Conscious_pa...

refurb 4y ago

Because in a resource and capital intensive industry the good years pay for all the costs to date. In bad years you might break even in terms of variable costs but contribute nothing towards capital costs. Gasoline variable costs might be [cost of oil] + $6/bbl, while full baked in fixed and variable costs are [cost of oil] + $25/bbl. It looks like profit now only because the capital expenditures were in prior years. It’s like building a house for $500,000 cash and asking the landlord why they charge $2,000 a month in rent when their costs are only $500 per month in property taxes, maintenance and insurance. The oil industry and many other similar industries couldn’t survive if they only charged the marginal cost of extraction and refinement and ignore the fixed costs of operation.

bretpiatt 4y ago

The constraints are in the shipping and refining. When demand goes up exploration and production (firms who find and get it out of the ground) get to charge more as end users fight over the limited supply. Due to environmental regulations it is very difficult to build refineries, pipelines, import / export terminals, etc. This is why when prices go up from $65 to $105 you do not see production companies increase supply further to get the extra sales, there's no way for them to get another barrel to the end customer.

akrymski 4y ago
I don't buy this argument. Assume the oil has already been dug up and refined. Two gas stations next to each other: Shell & BP should compete on price to the point that minimum profit margins are established. This doesn't happen because it's not in their interest to compete. Instead it's in their interest to collude and maintain prices as high as possible knowing full well that a new player won't enter the market any time soon. The oil cartel is alive and well.
- lotsofpulp 4y ago
  Gas stations are almost never owned and operated by a major oil company. It is quite famously a business that immigrants get into due to its low barriers to entry, and they set the prices at the pump of their gas station. Location is the most important factor in how much more a gas station owner can charge relative to other gas station owners. If you want to see how much gas costs at near zero margin, open up the Costco app and you can see all the fuel prices nationwide. Although Costco only sells Top Tier gas, but that should be comparable to other brand name gas stations such as Shell and BP and Exxon. California offers good data here going back 20 years: https://www.energy.ca.gov/data-reports/energy-almanac/transportation-energy/estimated-gasoline-price-breakdown-and-margins https://www.energy.ca.gov/data-reports/energy-almanac/transp...
  - sithadmin 4y ago
    It's not just that they're not owned/operated by the oil companies in the US; they don't even obtain their supply of fuel directly from the oil company. Every gas station takes delivery of commodity-standard fuel from midstream distributors that operate pipelines and storage terminals. The only thing that differentiates between the Texaco gasoline on one side of the street and the Shell on the other is the proprietary additive blend that is mixed in at the storage terminal when an order is filled. Gas retailers in a given region are generally all beholden to whatever the market dictates the 'generic' fuel pricing will be. The majors have a lot less control over that than most folks think they do.
  - akrymski 4y ago
    BP and Shell are vertically integrated and mostly definitely do own a large number of gas stations at least here in Europe. However the owner doesn't really matter in this hypothetical example as long as BP and Shell actually control the price at which oil is sold.

slifin 4y ago

Why would Texaco lower their prices? Oil companies know if they restrict the supply the price skyrockets and they directly benefit The world is so reliant on oil and cars that people don't lower their dependencies they just pay the new price

slifin 4y ago
More context here: https://www.youtube.com/watch?v=AQbmpecxS2w https://www.youtube.com/watch?v=AQbmpecxS2w
- 0des 4y ago
  Also, see: Enron, California power market manipulation
  - ZeroGravitas 4y ago
    Or the Tesla battery in Australia that paid for itself incredibly quickly, not because it was physically needed by the grid, but because it stopped gas power stations from dicking with supply and demand to maximise their own profit.

altacc 4y ago

Glibly, because the theory of self-correcting markets only works in economists' minds, not in real life. Oil price is affected my many variables including speculation, supply & demand, latency and panic buying, but the supply is artificially controlled to maximise price and political leverage. If OPEC decided to announce a significant increase in production then the price would drop. But there is no real incentive for them to do this as they are maximising profits already and selling more for less doesn't benefit them long term. some of the oil producing countries want to exert political influence via oil supply (especially Saudi Arabia), essentially forcing forgiveness for bad governance and human rights abuses.

rkangel 4y ago
But actually the underlying price of crude hasn't been ridiculous, whereas the price of petrol at the pump has skyrocketed. It's the gap between the two that has grown and hence oil company profits.
- lotsofpulp 4y ago
  Crude price is historically high: https://www.macrotrends.net/1369/crude-oil-price-history-chart https://www.macrotrends.net/1369/crude-oil-price-history-cha...
refurb 4y ago
But apply the same logic to any other product. If you made widgets, and you knew demand was 5 units, would you make 20? Of course not. The power of OPEC has also decreased over time as other sources of oil have made up a larger percent.
pibechorro 4y ago
Self correcting markets work. They dont work like you think they should. The timeline is longer and the correction may not be fuel prices going down, rather alternative solutions popping upbto replace a no longer affordable solution.
imglorp 4y ago
It's across the industry -- they're all rocketing vs the market. Collusion? Or maybe they just came to the same conclusion that scare-quotes "inflation" is in the media so it's a swell time to pretend.

tr_user 4y ago

I mean the simplest explanation is that there's a price fixing cartel where everyone benefits by not trying to undercut each other.

NovemberWhiskey 4y ago
No; the simplest explanation is that increasing demand for a product with limited supply increases in price. That's literally Econ 101 - no cartel required.
- Avshalom 4y ago
  Cartels are also econ 101. And OPEC is quite famously a price fixing cartel. and 101 means "so simple it's basically wrong but we have to start somewhere" anyway.

teeray 4y ago

Also, why did it take oil companies this long to figure out they could collectively charge whatever they want? Why did we ever have low prices after having high prices years ago?

lotsofpulp 4y ago
Because outside of OPEC, they are not colluding with each other, and in general, the more they extract and sell, the more profits they earn.
NovemberWhiskey 4y ago
One reason is because although the short-run price elasticity of demand for fuel is almost zero, the long-run is not. i.e. if fuel prices stay high for months, consumers keep filling up their cars, keep buying the same fuel-inefficient cars they always have, keep making the same number of trips If prices stay high for years, consumers start looking for other transport options, start buying more fuel-efficient (or electric) cars, etc. Also: when oil companies make outsize profits during normal times, you get people with pitchforks calling for heads which is bad PR; and you get certain stripes of politicians calling for price controls etc.
stepanhruda 4y ago
Because it’s difficult to verify how much who extracts, so very easy to extract more than agreed upon and earn more at the cost of others. This case is literally used as an example in an economics class.
ZeroGravitas 4y ago
The theory advanced in the video someone else posted is that they always knew they could push it too far and get blowback. But now it's their last throw of the dice so they're going all in. Previously they had to care about the next 40 years worth of profits, now they know there's a cliff edge coming, which brings new strategies to the fore.

NovemberWhiskey 4y ago

>One would expect providers of an identical product to push their prices down to the minimum profitable level to compete with others doing the same. That is not a definition of "normal competition", unless production capacity is free and infinite and barriers to entry and exit are zero. Transportation fuels have almost zero short-run price elasticity; so of course supply shocks cause swings in prices.

lotsofpulp 4y ago

> Can anybody suggest why normal competition isn't working here? One would expect providers of an identical product to push their prices down to the minimum profitable level to compete with others doing the same. Is there evidence it is not working? Ramping up production and refining capacity takes time. Barriers to entry might be higher too due to drastic increases specifically in the hard, manual labor required for gas to get to the pumps. And of course, simple inflation would cause nominal prices to rise. These profit margins do not look they have spiked unreasonably. A little spike is to be expected as there is a lag between when demand ramps up and supply catches up. https://www.macrotrends.net/stocks/charts/SHEL/shell/profit-margins https://www.macrotrends.net/stocks/charts/SHEL/shell/profit-... https://www.macrotrends.net/stocks/charts/BP/bp/profit-margins https://www.macrotrends.net/stocks/charts/BP/bp/profit-margi... https://www.macrotrends.net/stocks/charts/XOM/exxon/profit-margins https://www.macrotrends.net/stocks/charts/XOM/exxon/profit-m... https://www.macrotrends.net/stocks/charts/CVX/chevron/net-profit-margin https://www.macrotrends.net/stocks/charts/CVX/chevron/net-pr...

ZeroGravitas 4y ago

In oligopoly theory there's the kinked demand curve idea. Basically, you know that all of your competitors have some control over their price. If you drop your price, not because you're cheaper to produce but just willing to take less of a cut they can all match you on price, leaving you all back at square one but poorer. You know that, they know that, you know that they know that you know that. Still think a price war is a good idea? Your boss probably doesn't.

mcphage 4y ago
Which is why nobody competes heavily with Texas Instruments over their absurdly priced calculators—sure, you could come out with a better product, at a lower price, and still make a healthy product. But TI's prices are only so high because they can be, and they're very able to drop their prices if need be to price you out of the market.
- IIsi50MHz 4y ago
  Casio :heart: (and even those seem overpriced for the components they use).

jdsully 4y ago

This is an industry the government is actively fighting. Short term there are profits but long term the outlook is bad and these projects need to pay off over decades to make sense. Take Keystone XL as an example. Billions were spent only for it to be cancelled on the eve of construction by a new president. This is not a good industry to invest in long term. The correct response is to milk existing infrastructure until it is no longer serviceable rather than trying to add new capacity.

evandijk70 4y ago

I think it is because the supply of oil is ultimately limited. Current estimates are that we have oil left for about 47 years. Nearly all of that is already owned by some oil company, but not counted as an asset. Therefore, oil companies can profit immensely if the price of oil increases.

lordgrenville 4y ago

It's called https://en.m.wikipedia.org/wiki/Tacit_collusion#Conscious_parallelism https://en.m.wikipedia.org/wiki/Tacit_collusion#Conscious_pa...