The Weiner Component #133 – The Free Market & the Cost of Gasoline

English: A typical Valero gas station, in Moun...

English: A typical Valero gas station, in Mountain View. Photographed by user Coolcaesar on August 23, 2005. Category:Images of California (Photo credit: Wikipedia)

Valero Energy Corporation

Valero Energy Corporation (Photo credit: Wikipedia)

Not many weeks ago, on July 31st 2015, there was a short article in the Los Angeles Times entitled “Valero profit rises on high gas prices.  It stated that California’s sky-high gasoline prices brought about a record high second quarter profit for refiner Valero Energy Corporation, that operating income from its two California refineries had soared to $295 million for the quarter which ended June 30 or to more than eleven times more than the $24 million earned in that quarter a year earlier.  Valero had posted a second quarter profit net income of $14 billion up from $651 million for that quarter a year earlier.

About a week earlier, on July 26th there was a one paragraph blurb in the same newspaper: “Record profits at refineries – The surge in California’s gasoline prices this year, coming as oil prices have fallen and refining costs have remained stable, has helped refineries collect record gross profits on each gallon of gasoline – as much as $1.17 a gallon in May.  That compares with a more typical gross profit (equal to refinery costs plus profit) of 49 cents a gallon in recent years, state data show.”

With Exxon Mobil’s Torrance refinery operating at less than 20% of its capacity other refineries in the state have seen a dramatic increase in their profits.  The capacity of the Torrance refinery is ten percent of the state’s total and twenty percent of Southern California’s total refined oil.  The Torrance refinery had an explosion in February of this year and probably will not return to full service until the end of the year.  It seems that one or another refinery in California is always partly or completely off line and there always seems to be a shortage of gasoline in the state.  Presumably these problems seem to continually raise the cost of gasoline at the pump to about one dollar or to one dollar and fifty cents higher that in the rest of the country.  We are supposed to be living in a free market economy where the consumer gets the best product at the best price.  Is this true?

At the end of July of 2015 the price of gasoline at the pump had dropped to slightly less than four dollars a gallon while the price of crude oil had gone down to under fifty dollars a barrel.  About a year ago a barrel of crude oil was one hundred dollars or more.  There are generally 42 gallons of refined gasoline that comes from one barrel of crude oil.  At $4 a gallon that means that $168 is the amount made from each barrel of oil.  That is a profit of over 66 percent on each barrel of crude oil.   Valero has its own gasoline stations and sells its gasoline retail at the going price.

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The Free Market as envisioned by the Scottish economist, Adam Smith, in his 1776 book, An Inquiry into the Nature and Causes of the Wealth of Nations, was a reaction to the accepted economic system of the day.  At that time mercantilism was considered a proper approach to economics.  That theory stated that the wealth of a nation consisted of how much gold that country possessed.  The more gold it had, the richer it was.  And these economic systems then were usually controlled by the kings.  Smith’s theory brought about the modern development of capitalism and the market economy.

Briefly and simply: The nation’s true wealth is based upon the productivity of the country.  This is all the goods and services produced within a given time, a fiscal year expressed in the currency of the nation, which was mainly gold.  Money, at that time, being precious metals, mainly in the form of gold coins.  The value of goods and services, that is, all the productivity would be exchanged for their specific value in precious metals.  The value of the specific goods and services would be determined by both the levels of skill of the population, the extent of natural resources that are available or can be acquired by the particular nation, and what other people were willing to pay for the product or service.

In terms of what is going to be produced Smith’s theory of production was based upon the concept of supply and demand.  Entrepreneurs would supply certain goods and services in return for the profit they could make by doing so.  This was Smith’s “invisible hand,”  the profit motive which caused the system to operate.  If the item or service was highly desired then the price people were willing to pay for the item would rise because the supply was below the level of demand.  The higher price, in turn, would bring more producers into the field greatly increasing the supply of the particular item.  As the amount of the item increased beyond the demand the price would drop.  It could actually drop below the cost of its general production.  This would force the less efficient producers out of business and the price, as the supply dropped below the demand, would rise again.  Eventually a state of equilibrium would be reached where the supply would equal the demand.  With a large number of product producers it would be difficult to maintain the equilibrium and the price would continually oscillate.

The consumers, on the other hand, would attempt to get the goods or services at the lowest price possible.  Presumably the lower the price the greater the demand.  This would be their part of the “invisible hand.”  Both sides would be motivated by profit and cost.  There would be a continual process of exchange going on that would allow the consumers to eventually have most of their needs met by getting the goods and services they need at the best possible price and at the most efficient level of production.  Both the successful entrepreneur and the consumer would emerge positively from this exchange.  The inefficient entrepreneurs would have gone bankrupt.

To work properly this system requires a very large number of producers so that the consumers would have a large variety of choices as to how to spend their money and acquire the various products they require.  Today outside of regional agriculture, which produces perishable food products, and the stock market, which can work on rumors or general assumptions that may or may not have any relationship to reality, the principles of supply and demand only function in a very general way or not at all.

The reason for this is the fact that the number of producers of goods and services is limited.  Product manufacture is expensive, setting it up requires large amounts of money.  Consequently the factory system was developed from the 19th Century on.  Having limited producers or factory owners gave them more control over price than the consumer had over demand or price.  This, in turn led to monopolies toward the end of the 19th Century.  These gradually fell under partial control from the governments of the countries in which they existed.  Outside of the two examples of the free market has never really existed.

It is also important to realize that monopolies are not just giant concerns like Standard Oil was at the beginning of the 20th Century, they can also be regional or contained within a small city.  If a city contains only one hospital or only one supermarket, or, for that matter, one anything that provides some product or service, then that is a monopoly and it can charge virtually any amount for the good or service.  Of course it can’t be so high that it will force the consumers to go to other areas to acquire the good or service, but the price could be higher than it would cost in other places.  And that, it seems, is the situation with gasoline in the state of California.  To a slightly lesser extent it is the situation with gasoline throughout the United States.

Presumably the goods and services, the productivity of the country would constitute the wealth of the nation and the people of the nation would determine by their demands for the various products of what that wealth would consist.  Is this theory true?  The answer is obviously sort-of.

The products needed for a society to exist can be rated as necessary, pleasurable, and extravagant.  Necessary services and products are what is needed for life: food, clothing, a proper shelter, in most areas of the country an automobile for necessary transportation.  Anything that is required to maintain a functional standard of living would fit into this category.  Pleasurable items would be raising the necessary items to a higher level of comfort.  The choice of foods would be much more varied and expensive, clothing and housing could be carried to the level of ostentation.  The automobile would be far more fancy and expensive and there would probably be additional vehicles for every member of the family.  The extravagant level would mean that he or she could afford to have anything that money could buy.  All this would be bound to levels of income or in the case of many executives to their level of compensation.

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In the United States during the period after the Civil War (1865) to shortly after the turn of the 20th Century, 1917, when the U.S. entered the Great War (W.W.I), the country underwent a rapid movement into industrialization.  The railroads were extended westward from shore to shore, the westward movement occurred, the country changed from being mostly a rural nation to an urban centered one, and the factory system developed and became universal.  It was during this time that the country moved from being a nation of multitudes of small concerns to oligopolies and monopolies.  Virtually every major industry had become a monopoly or oligopoly.  John D. Rockefeller, the owner of Standard Oil, had a reputation of refining not only oil but also many of the state legislatures and even parts of the Federal Government.

It was at this time in 1913 that the 17th Amendment to the Constitution was passed bringing about the direct election of U.S. Senators by the citizens of each state.  Prior to that time the Constitution had the Senators directly elected by the State Legislatures.  The Senate was originally set up as the direct agent of the individual states and represented the states.  What had happened was that by the late 19th Century the Senators had become agents of the monopolies and oligopolies elected by bribed legislatures to represent the companies to which they were originally and still operated as their lawyers.  The monopolies and oligopolies had subverted many of the state legislatures through bribery.  The 17th Amendment was a reform amendment by the Progressive Movement to return the government of the United States to the People.

The Sherman Anti-Trust Act of 1890 went into operation around the turn of the century when both the Progressive Movement and Teddy Roosevelt became President after the assassination of former President William McKinley.  During his term in office Roosevelt became known as a Trust Buster.  The Reform Movement would end with the emergence of World War I in 1914 and would not begin again slowly with the Great Depression of 1929.  It would emerge strongly with the Administration of Franklin D. Roosevelt from 1933 on.  The Great Depression would not end completely until about 1940 with the emergence of World War II.

Since 1945, the end of World War II, the United States has gone continually in and out of social reform.  The Republicans generally have represented big business and the Democrats generally have pushed social reform.  Currently many large companies (corporations today) have been going through mergers and getting bigger.  Even though the Federal Government watches and attempts to keep monopolies from coming into being we seem to be moving in that direction with, it seems, an ever-growing tendency toward companies that are “too big to fail.”

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In the United States and in many other industrial countries of the world the individual owned automobile has become a necessity for general existence.  The distances are too great to walk from one place to another.  The children are taken to school and brought home by car or bus; general shopping requires an automobile; going to and coming home from work requires an automobile.  Virtually most of the general population requires a car.  And, of course, the key to having a car is availability and price of gasoline (oil).  As an example, I have spent my entire working life driving to and from work.

During my lifetime the cost of gasoline has gone up from well under a dollar a gallon to a high of five dollars a gallon.  It currently dropped from over four dollars a gallon to  under three dollars a gallon.  The price of o barrel of oil is currently under $50 a barrel and going down.  If the agreement with Iran is ratified and becomes a treaty there will be a major increase in the world’s oil supply.

In the state of California just enough oil is refined to just meet the demand.  If one of the refineries has to limit its production for any reason then there is a shortage and the price of gasoline and oil profits goes up.  If this isn’t price gouging then I don’t know what is.  Either we need more refineries in Southern California or enough gasoline storage so that the price can follow the supply.  Perhaps the State or Federal Government needs to set up its own storage and supply facilities or/and its own refinery.  After all, the biggest employer in the country is the government.  They sell water and electricity in many municipalities directly to the consumers.  The Federal Government also run agencies like the Tennessee Valley Authority.  If the so called Free Market gouges consumers for their own profit why can’t the Government equally provide the needed goods or services at a reasonable price?