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Why gas prices rise quickly and fall oh, so slowly

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By James McCusker
Herald Columnist
Published:
Sailors, economists, bird watchers and commodities brokers have at least one thing in common: they know about Brent.
Brent are a type of small goose, a waterfowl known in the U.S. more commonly as brant. They are about the size of a mallard.
The North Sea Brent oilfield, named for the bird but very, very large, is now used as one of the main pricing standards for the international oil industry, which is why "Brent" and "Brent Crude" are familiar term to economists, commodities traders and financial markets.
The recent rise in gasoline prices in the U.S. has led consumers to wonder why prices were going up while domestic production was setting new highs, and why gasoline prices rise so quickly but decline so slowly.
A portion of the answer to the first question involves the incredibly complex system of oil exploration, extraction, refining and distribution that is easily thrown out of balance enough to create temporary shortages. Recently, for example, inadequate capacity in our pipeline system created a bottleneck that boosted at-the-pump prices but that was only a partial contributor to the run-up in prices.
The main force behind gasoline prices is still the duck-sized bird called the Brent, the main international pricing standard for a barrel of crude oil. That bird has caused more trouble than the Maltese falcon. When the global price of crude oil goes up, we follow. Our domestic production is part of the global system and is not large enough to dominate or even lead its pricing.
The complex system that takes oil energy from discovery to our gas tanks is amazing for its engineering, adaptability and resilience. System failure is complexity's wing man, though, and in the oil industry those failures cause supply disruptions and higher prices.
Theoretically, those price increases should be temporary, but they seem to stick around for a long time. When prices do go back down they move as slowly and reluctantly as an up-late texting, bleary-eyed teenager preparing for school.
The reasons behind that are built in to the economic structure of the oil business. The petroleum industry is what economists call an oligopoly; that is, just a few sellers. The basic characteristics of oil production and distribution lend themselves to significant consolidation and economies of scale, with the result that over time there are fewer competitors in the market.
Economic studies of the behavior of oligopolies began in the early 1930s with the work on what was then called "monopolistic competition" by Edward Chamberlin here in the U.S. and Joan Robinson in England. Oligopoly has also received the attention of two outstanding mathematicians. The first was Jon von Neumann who, with Oskar Morgenstern, linked economic decision-making to game theory. The second was John Nash, the brilliant but erratic and mentally troubled mathematician whose life was portrayed in the movie, "A Beautiful Mind," whose work on game theory and decision-making resulted in his sharing a Nobel prize in economics.
Whether all this attention from mathematicians was healthy for economic theory in the long run is questionable, and there were certainly unintended consequences. Nash's work turned out to be the route to a market valuation system for derivatives, which may or may not turn out to be a good thing for our economy. Derivatives and game theory also became the hot areas for Wall Street firms, with a resultant employment boom for economists and mathematicians who followed the money.
All that math and money tended to crowd out the economic theory work by Chamberlin and Robinson, although Paul Krugman resuscitated it with his Nobel-prize-winning work on foreign trade, in particular, reviving the important role played by economies of scale.
Even a thumbnail history of oligopoly theory leaves the distinct impression that the economics of this kind of market is pretty jumbled up and this is not wholly inaccurate. What we do know, though, is this: Oligopolies like oil companies prefer price stability and non-price competition. They have a fear of downward price slides and price wars, but if the cost of crude oil rises they will all raise their at-the-pump prices to accommodate it.
The oil industry's market structure also is inventory-based and this itself creates a bias against at-the-pump price cuts. If the market price of gasoline goes down, every gallon of gas sitting in a filling station's underground tanks and in the gigantic storage tanks that support these stations loses value. To minimize losses, businesses move their prices down as slowly as they possibly can.
The combined result of oligopolies' behavior and the inventory effect is a system where gasoline prices are greased-lightning upward and very sticky downward. It puts drivers in a very uncomfortable position. So buckle up.
James McCusker is a Bothell economist, educator and consultant. He also writes a monthly column for the Herald Business Journal.
Story tags » Energy & Resources

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