Gas prices, part 2? The explanation.

I've been listening and watching like the rest of you for a few days and wanted to try to explain the gas price spike for those of you that might be convinced they're irrationally high. Several people, including many media commentators have made the superficially reasonable argument that A) Any increase in gas price didn't affect the gas already in the ground and therefore B) gas stations should therefore charge some reasonable profit margin based on the price they already paid for the gas they have.

This scenario would work if prices were relatively flat and non-volatile. In fact, during normal economic times (most of the 90s for example) this is the pricing model that was used by gas stations. It's why you used to see 4 different prices on 4 different gas stations at the same intersection.

However, to understand what's going on now you have to understand the logistical model that gas stations work under. Gas stations buy huge underground storage tanks that usually hold between 4 and 7 days worth of supply. They get these tanks filled up at regular intervals and pay bulk prices at the time of delivery. Prior to the crisis a gas station was paying approximately $2.20 per gallon... add the $.275 sales tax and a 2-4 cent profit margin and you've got your gas price. But remember... they weren't paying $2.20 per gallon... They were paying, say, $33,000 for 15,000 gallons... and that if prices rise to say $3.50 per barrel (or $52,500 per 15,000 gallons) then they have to be able to have $52,500 on hand to be able to buy their next shipment. If they don't then they have to borrow it.

What's that you say? Well, sure Jeff, but then they can just sell that shipment at $3.50 per gallon and make their money back. Well, that would be true if it was going to be a permanent price jump OR everyone was on the same shipping schedule OR the price jump was smaller. If ANY of those three things was true then we wouldn't see this spike like we're seeing. Unfortunately we're not.

If the prices were staying high then they could just go into debt a little now and raise their prices slowly over the course of a week up to the new level. The sticker shock wouldn't be as bad and they wouldn't lose any good will with their customers (well, they'd lose less anyways).

If everyone was on the same shipping schedule then gas stations could count on all the gas stations in their area to be in the same boat they were so they could be safe from being undercut. Unfortunately, they're not.

If the price jump was smaller then they could just suck it up and price their gas a couple cents higher then their neighbor and rely on customer loyalty and location to keep business coming. Customers don't often care about a 2 cent difference if it means they have to turn left and then make another left vs. making two rights. Customers WILL care if it's a 50 cent difference, however.

Those are the factors that have driven the price up. I'm not saying that there isn't some price gouging going on. But the notion that  gas stations should just, "Charge the price they paid" or that they should only charge "A couple cents more than the current price" is absurd.

Now, all that addresses gasoline costs at the pump. What I'm less certain of is the distributor services that get the gasoline to the gas stations... there seems like there's real Oligopoly potential there and I'm less familiar with that side of the industry.