A Boycott Won't Do Anything

A little over one year ago, I posted an article entitled “It's Not The Oil Companies.” In that article, I argued that oil and gasoline prices had nothing to do with evil machinations by “Big Oil,” the laws of supply and demand, President Bush, or any other of the kooky conspiracy theories of the far left. One year after writing that article, we are once again daily barraged with calls to conduct one-day boycotts of gasoline stations. Once again, I am compelled to disabuse the public of the notion that they can have any effect on the price of gasoline. However, before we get into the detailed statistical analysis, certain things from that article are worthy of being repeated.

“Big Oil's” profit due to the sale of a gallon of gasoline has been remarkably consistent over time at approximately 9 cents. In contrast, the Federal Government takes 18.4 cents per gallon in taxes. Here in California, the State assesses an additional 32 cents per gallon in taxes. If “Big Oil's” profits are “obscene,” (in the words of Sen. Clinton), then the Federal Government's and State's profits are twice and 3.5 times as obscene, respectively.

Although Exxon recently reported the largest corporate profit in history as measured in hard dollars, this belies the fact that their profit percentage was still only 9%. Quarter after quarter there are corporations that earn 20% or more profit margin. The US historical average for all corporations is 12%. “Big Oil” is earning a below average return on their investment while still delivering a commodity that fuels the modern world. This is because they pump much of the return into activities designed to generate more oil (and more taxes for the insatiable Government).

It seems, however, that as soon as someone is elected to Congress, he forgets that there are no simple answers in life. To Democrats, the solution to high gas prices is more taxes. To Republicans, the solution is drilling in ANWR. Neither action would be efficacious in the long run because petrochemicals are traded exclusively as a commodity. The price of a barrel of oil is set by speculators, not market conditions.

The idea that a single day boycott (or a boycott of any length, for that matter) can lower gasoline prices is even more ludicrous than the idea that assessing “windfall” taxes on the oil companies will. To understand this, it is first necessary to realize that gas is gas. The only thing that makes Exxon gas different from Shell gas is each company's proprietary blend of additives (mostly detergents and cleaning agents). These get added to the delivery truck after it tanks up at a fuel depot. This is why you pay more at Shell than at Rotten Robbie. Shell charges a premium for their intellectual property (the additives); Rotten Robbie just buys plain gas.

Gas companies routinely trade inventory in order to balance deliveries to different parts of the country (i.e. Exxon may have a surplus in the NE and a deficit in the SW, while Shell has the opposite situation). Each depot has tanks holding each company's additive, allowing the depot to serve all customers with any available gas stocks. While it is true that some of the oil companies own refineries and private depots, the fact remains that since they are constantly horse trading their inventories, there is no way to cause one company to gain enough excess supply to drive the price of gas down because gas is gas. If this were not the case, so-called independent stations could not exist, as they would have no gas supply.

On top of that, even if the whole country were to participate in the boycott on the same day, the oil companies would just sell their supply in another country. This would also happen if Clinton gets her way with the added tax. The supply will be diverted to another country with a lower tax burden.

Further complicating the picture is another little-known secret of the oil industry. The rules say that as soon as you put a barrel of oil into the system at any point, you may take a barrel of oil out of the system at any point. This is one reason why drilling in ANWR will not help. Since North Slope oil has an extremely high sulfur content, virtually none of it can be refined in the US. So although the global supply of oil would increase with every barrel produced, the US stocks would not change (in fact, they could go down due to the rule above). However, since the price of a barrel of oil or gas is completely independent of actual inventory, the net change in stock would have no change in price, as will be shown below.

Before we move to the statistical analysis, we turn our attention to one final item, and that is how oil is actually traded. In the commodities world, traders essentially bet on what they think inventories will do over a given period of time. When the news report tells you that stocks of distillates are 5% lower than they were this time last year, the collective response should be a resounding “so what?” Whatever conditions existed last year that lead to certain buying and selling decisions have no bearing on whatever conditions exist this year that lead to different buying and selling decisions. And those decisions have nothing to do with actual market conditions since by their very nature, they are dealing with future events.

While it is true that a given event can be expected to have a certain outcome, there is no guarantee that that outcome will come to pass. Thus, if some oil workers in Nigeria are kidnapped today, it is reasonable to expect tomorrow's output to be lower. But that does not guarantee the output will still be lower 1 month or 3 months from now, the standard lead times for petrochemical contracts. And 3 months from now, irrespective of the actual market conditions, there is no market correction because the speculators are then betting on what will happen in the next 3 months.

Thus, the price of a barrel of oil today was set 3 months ago. Front-month contract pricing (the price one company pays another to “borrow” oil) was set 1 month ago. Both prices were set by speculators based on what they expected inventory levels to be at some point in the future. The contracts that they close today are for future deliveries based on expected future inventories. Week-to-week, month-to-month, or even year-over-year changes in actual inventory levels in actuality are an insignificant variable that goes into pricing decisions. Yet the speculators use these changes (especially negative changes) to drive huge price fluctuations. It cannot be said enough: since the price paid today is for a future delivery of oil, actual inventory today has no bearing on that price.

So now, as promised, here is the statistical analysis that should prove once and for all that actual inventories have no bearing on gas and oil prices. I do not flatter myself that this will put to end the endless speculation of various conspiracies, but anyone willing to think rationally about this should easily come to the conclusion that these little boycotts will not change prices now or in the future. And for those who may not trust my numbers, the source document can be found at: tonto.eia.doe.gov/dnav/pet/pet_stoc_wstk_dcu_nus_m.htm

On the short list of things that Federal agencies are good at is keeping data. An examination of the data reveals some interesting information. If we look at month-end total inventories (excluding the Strategic Petroleum Reserve) of oil from 1920-Feb 07 (the last month for which the chart contains data), we find that on average, US oil stocks have been 302,675,000 barrels. The standard deviation over this time period is 67,451,000. This is equal to about 3-days consumption. This means that on average, at the end of the next month, there will be either 3-days less oil or 3-days more oil than at the end of this month.

Things get more interesting if we look at only the last 10 years worth of data. The month-end average from 1987 to the present is 321,986,000 barrels with a standard deviation of only 23,378,000 barrels. Which means that over the last 10 years, the purchasers of oil have maintained inventory levels within 1-days consumption regardless of price. Even more telling is the fact that the total inventory reported for the week ending 11 May was 342,220,000 barrels (within 1 standard deviation). If supply and demand were truly an issue, oil should be priced near its historical average.

How about for gasoline supplies? This data only goes back as far as 1945 with the historical month-end average being 197,360,000 barrels of refined, ready-to-use, automotive gas. The standard deviation for this time period is 42,141,000 barrels. Over the last 10 years, the figures are 213,300,000 barrels in stock and 12,588,000 barrels standard deviation. As of 11 May, there were 195,235,000 barrels of ready-to-use gas at the depots waiting for distribution. This is nearly 99% of the historical average and less than 2 standard deviations from the 10 year average. Again, gasoline prices should be very near the historical average.

The most important point here is that despite “unexpected refinery problems,” seasonal variation, kidnappings in Nigeria, embargoes from Saudi Arabia, Halliburton, and Bush, the total amount of gasoline sitting around waiting for distribution to your corner gas station has been remarkably consistent. The same is true for oil inventories.

It's not rocket science. There is no conspiracy to enrich the CEOs of the oil companies. There is no shortage of oil or gas. There is no need to assess new taxes or raise old ones. Gas and oil prices are high today because a group of commodities traders believe that they will be incapable of doing what they have been doing for nearly 90 years – keeping average inventories in a very tight range. In essence, they are betting on their own incompetence.