Refiner Profits and Indiana Gas Prices

June 11, 2007

Indiana Writers Group column for June 13 and thereafter
Digital mug shot available on request
438 words

By Dr. Cecil Bohanon

   It is inevitable. As soon as Indiana gasoline prices rise the protest begins: “Big oil interests are ripping us off.” This time it is the gasoline refiners who are the villains. Refiner mark-ups are currently around $25 per barrel of oil. Two years ago they were around $10 a barrel. The difference is showing up in the price Hoosiers pay at the pump.

    What accounts for this run-up in refiner margins? The usual story says that corporate greed is driving the price hikes. But this is a curious theory. If higher gasoline prices are a byproduct of business greed, are lower gas prices a byproduct of business generosity?

    A more plausible theory is that greed is a more or less constant motivation in business pricing decisions, but  a business’ ability to garner any price is shaped and constrained by the impersonal forces of supply and demand. In this view, market fundamentals have allowed refiners to reap higher margins.

    No new refineries have been built in the United States for over 30 years. A refinery, like most any manufacturing facility, requires extensive maintenance for both routine and unexpected causes. It isn’t surprising that 30-plus-year-old refineries, subject to increasingly exacting environmental mandates, have to shut down more often than they did in the past. The March fire at the BP plant in Whiting, Indiana, cut its refining capacity by half according to press reports. This disruption puts a rather obvious crimp in gasoline supplies and thereby places upward pressure on gasoline prices.

    High gasoline prices generating high refinery profits may seem unfair to us gasoline consumers. It is important to remember, however, the role of prices and profits in a free-market economy. High refinery margins in the U.S. send a signal to capital owners throughout the world that there is gold in our market if they can provide additional refinery capacity.

    Although the U.S. regulatory environment ironically limits the ability of greedy capitalist to cash in by expanding refinery capacity here, one can be sure that someone somewhere will take advantage of the opportunity by expanding or redirecting refining capacity. This will inevitably increase available gasoline supplies, put downward pressure on gasoline prices and reduce refiner margins.

    When will this occur? I wish I knew, for I could make a fortune speculating on gasoline price futures. Gasoline prices are notoriously volatile because supply and demand fundamentals are notoriously unpredictable. Yet, it is precisely the ability of price to rise and fall that ultimately balances the market.

    There really is no other alternative to letting the price mechanism take its course.

Cecil E. Bohanon, Ph.D., an adjunct scholar of the Indiana Policy Review Foundation, teaches economics at Ball State University.


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