GoogleIt Mail IT Print IT PermaLinkGas Crisis Looms. Investors Bet Oil Company Stocks Will Go Up
11:22:49 PM
Written By : Richard SchwartzCategory : News And Comment
Location : Nashua, NH

The first part of the title of this post comes directly from the headline of a CNN/Money article from today.

NEW YORK (CNN/Money) - The impact of Hurricane Katrina on U.S. oil production may be worse than initial reports estimated and could lead to a national gas crisis in the short run, analysts warned Tuesday.

Now, I often admit to being fairly naive about economic matters, but I've driven past several local gas stations today. I filled my tank in the morning, breaking my record from a mere two weeks ago by 10%, though still below $3 per gallon. By afternoon, I saw prices posted at another station in town that were up almost 15% from what I paid in the morning, at $3.29 per gallon. The instantaneous magic of a disruption in the future supply of crude to refineries effecting retail prices for already-refined gasoline eludes me, but I've been assured by experts that it is legitimate. Fine.

When there's a supply disruption in crude oil, and a reduction in refining capacity, I would have thought that the petroleum industry would be in for a few problems. That's what I seem to remember happening in the technology business when there was a disruption in chip supplies sometime in the not too distant past. It seems to make sense, doesn't it? Raw materials are in shortage, their prices go up, your manufacturing capacity is lower than usual and your distribution network in one region is seriously disrupted. You can't produce enough gas to meet the theoretical demand, so prices do go up, but you're still in competition and the higher prices will bring demand down somewhat. As the total market shrinks back, your competitors want to keep as much share as they can, and so do you, so you have to cut margins at least a little. Sounds logical to me, anyhow.

But no, apparently not. According to the bets placed by investors today, my naivity has shown through. In this gas crisis, oil company profits will go up. I checked out four oil company stocks today. Conoco Phillips went up 2.3%. Chevron went up 1.42%. Royal Dutch Petroleum went up 3.14%. Exxon Mobil went up 2.2%. All but Exxon Mobil are trading within a dollar or two of their 52 week high. Exxon Mobil is within five dollars of their 52 week high. All but Royal Dutch, which is much more lightly traded than the others, were well above their three month average trading volume today. Exxon Mobil was at double their average volume. And all four companies experienced a big spike in volume right at the close of the trading day. So clearly, today's investors think that consumers will bear the full brunt of the expected gas crisis, oil company profits will be strong, and the only folks who won't be hurt are the oil companies and their stockholders.

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Comments :v

1. Nathan T. Freeman09/01/2005 04:55:29 AM

Rich, it's not too tough. Current pricing is based on expected replacement cost, passed on to the consumer. However, accounting profit is based on your initial cost for the inventory itself -- the gas you already paid for. So it's a windfall.

Incidentally, just because there is a windfall to the oil company doesn't mean that they reap ALL of the surplus. It may be the case that competitive pressure forces down the cost at the pump to something less than replacement cost, in anticipation of some amount of windfall being used to effectively subsidize that replacement. There's nothing unreasonable about this, but you'd have to know a lot more about oil company cost structures than I actually do to know whether it was true.

The other thing is that the prices are an information signal. As uncertainty of supply increases, and prices rise, consumers are encouraged to curb demand. And it does work -- not on a grandiose scale, but higher prices at the pump lead to less miles driven. It's also an information signal to suppliers. High oil profits attract investment & innovation into the general field, not just for oil, but for energy in general.

2. Debbie09/01/2005 11:51:36 AM

A coworker sent me this link today.

3. Richard Schwartz09/01/2005 08:42:57 PM

@Nathan: One can explain it a million ways, and the current price/replacement cost equation does make a certain amount of sense... even if it does defy common sense that an industry experiencing massive supply problems should be more profitable than they were previously. Or overly niave common sense, anyhow. But from what I've observed the last 20 or so years of investor behavior is short-term goal oriented, not long-term, so I just don't believe that high oil profits during a shortage are going to make any discernible contribution to investment in alternative energy sources.

@Debbie: LOL

And BTW: All four companies did well again today. Looks like the opening up of the strategic petroleum reserve is not expected to do much to lower the replacement cost.

4. Nathan T. Freeman09/02/2005 05:41:41 AM

"so I just don't believe that high oil profits during a shortage are going to make any discernible contribution to investment in alternative energy sources."

What constitutes short-term and what constitutes long-term?

As Exxon, Royal Dutch, etc make billions a year, research into alternative energy solutions becomes more promising, and attracts more dollars. When good X achieves a high rate of profit, the incentive for discovering substitute good Y becomes higher.

By the way, I *know* you have experience telecommuting. That's a substitute good for petrol. And more and more people and companies are becoming incented towards it every day.

5. Nathan T. Freeman09/02/2005 09:03:23 AM

Here's a good set of remarks. Arnold Kling is an exceptionally accessible economist.

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