Oil Strikes and Gasoline Boycotts

Note to readers: This article contains discussion about the relationship between supply, demand, and price. Check out my other article A cap on the price of gasoline is a bad idea – and the Nintendo Wii can tell us why for a review of the basics if you like.

With the rising cost of gasoline, many motorists are looking for relief. Recent price increase do not seem to correlate with any real visible changes around them – and frustration results. This frustration has turned into attempts at action for many, hoping for any way to reduce the amount of money spent on fuel.

There are many proposed solutions to the issue, however they tend to fall short. Let’s take a look at a few of them.

Strike!

This is a popular one that comes around at the start of every driving season. The premise is that drivers stick together, and for (a day/3 days/a week) decide to say “screw you!” to the oil companies and not fill up at all. This will cause billions of dollars of losses, and force the oil companies to drop prices overnight.

Let’s address the first point, that this will cause the oil companies to lose billions. For simplicity, let’s assume there are two ways this could turn out:

  1. Everyone stays home during the strike, buys zero gas, and then resumes normal activities afterwards. (a “strong” strike)
  2. No one buys gas during the strike, but still goes about normal activities and has to buy gas later. (a “weak” strike)

We can agree that the premise of this strike is to reduce demand – which will cause the oil companies to respond. Let’s see how demand is affected by each of these scenarios.


In the first scenario, it’s like a few days of gas buying dropped off the earth. If we look at a graph of daily (blue bars) and average daily (red line) consumption, we can see that at the end of the gas strike, things are looking pretty good. Average demand has gone down! The companies have to respond!


Well, hold on a second. Time marches on, after all. Let’s take a look at this a few days later. Well damn, it looks like average demand is marching right back up again, since we really haven’t changed our habits for the long run, just for a few days. So demand is the same as it was before!


Now lets look at the second scenario a few days after the strike. Like before, at the end of the strike things look pretty good. But it gets even worse than before. Since we didn’t stay home and just kept driving, now we really, really need to fill up our tanks. So daily demand shoots through the roof as we play catch up, and our long term average demand spikes up (the exact opposite of what we wanted!) and then settles down to where it was before. Again, no change in the long run.

Well, you’re missing the point Geoff, some would say. The “weak” strike definitely wouldn’t work, but the “strong” strike still took out a few billion dollars for a few days, didn’t it?

Well yes, of course it did. Unfortunately, this is spread out over many companies – you’re a rounding error. If this loss continued for months and years, companies would start to feel the pain – but at this point, you’re no more aggravating than a large supply contract that was settled a few days later than expected. These companies are very good at not being bullied. Oil is a very cyclical industry, those companies than cannot weather a storm quickly fail.

Boycott!

Well fine! That won’t work, but let’s change our strategy. Instead of a gas strike, let’s pick a specific company (say Shell), and simply not purchase gasoline from them. Shell will watch it’s profits sink while the other companies make tons of money, say “screw this!” and reduce gas prices so they don’t go under.

At first this seems reasonable. The only problem arises when you ask yourself what the real change in supply and demand is. Supply hasn’t changed, the companies aren’t doing a damn thing. Demand hasn’t changed, we’ve just switched gas stations. Hrm, how is this going to work? But regardless, we aren’t buying from Shell! They’ll have to reduce prices, then the other companies will follow! Right?

Well, not quite. Let’s take a simplified look at the “flow” of gasoline between companies. The “futures market” (like a stock market that trades gasoline contracts instead of companies) prices gasoline, and matches sellers to companies that need gas. These companies then sell gas to you.

So let’s take away one of those arrows. Assume a perfect boycott, and not a soul purchases gas from Shell. Everyone is now buying from other stations, but there’s only one problem. Overall demand is the same, but our new “per station” demand is higher.

The immediate reaction to this higher per station demand is higher prices. “Wait!” you say, in the long run demand hasn’t changed! Gas prices should stay the same at worst! Well, you’re right – in the long run. In the short run prices spike up as gasoline stations experience temporary shortages. Now, these stations need to get more gas from somewhere to sell to all the new customers they have. It’s obviously available, it just needs to get to the station – but where from?

The answer is of course to buy it from Shell. Our only hope at this point is that Shell will panic, see that it has this excess gas, and dump it on the market at a reduced rate. Let’s assume that Shell does exactly that. Huzzah! We finally did it! Reduced gas prices!

Well, unfortunately for you, Shell is not run by idiots. They know that overall supply and demand hasn’t changed, just that no one buys from Shell anymore (assuming our perfect boycott is still going strong). So, prices end up stabilizing back at the old market rate (since there’s the same amount of people buying gas, and the same amount of gas available, we’ve just changed companies), and Shell ends up selling gasoline to the other companies (assuming best case of no excess transportation costs).

So assuming the best case scenario, we get a price spike, followed by a price dip, followed by the same damn price as before. Since we haven’t changed overall supply or overall demand, the overall price will not change.

Lessons

The current energy situation is a deeply complex mess. Proposing simple easy solutions that require little effort makes everyone feel better – but does nothing. If internet petitions and email forwards worked on their own, world hunger would have already been abolished.

To those proposing a gas strike – I propose to you a different solution, the public transit swarm. Get everyone you know to give up a car for a workweek and take public transit. Get enough people so that it’s a huge goddamn mess, subway stations are tied up, buses are jammed, and the situation is so bizarre that the media is forced to pay attention. Shout as loud as you can that the reason we drive so much is because the alternatives frankly suck. Have you tried walking to get your groceries in a suburb? Does the bus stop anywhere near your workplace? Does it bother to show up on time?

We need real alternative solutions that will reduce our overall demand on gas. Bringing attention and social acceptance to faster, cleaner, and more efficient public transit systems is a great start.

To those proposing a boycott of a specific company – I propose to you a different solution. Boycott car manufacturers who insist on producing cars with poor gas mileage. Buy an efficient car, or don’t buy one at all. A more efficient fleet of cars on the road reduces demand, and Ford can’t simply sell excess cars to Toyota that magically become greener – so a boycott of lazy companies who are more focused on bells and whistles rather than green technology is more effective.

I don’t mean to insult anyone proposing these solutions – but simply to make you think them through. Your motivation is admirable. Let’s work together to create cost effective sensible approaches to energy policy.

A cap on the price of gasoline is a bad idea…

And the Nintendo Wii can tell us why.

First, let’s back up a bit and describe how the market for gasoline works. Gasoline is a commodity (gasoline from Shell is effectively the same as gasoline from Exxon), and everyone knows the price (due to those giant signs on the side of the road). This means that we can model the gasoline market using basic economics and we should be able to draw some reasonable conclusions. Ready?

Supply and Demand Curves

Supply Curve

Let’s talk about supply and demand. We all know that the “law of supply and demand” somehow determines prices apparently – but what exactly is happening? Well, let’s start with a “demand curve”.

This describes how much consumers would want (demand) for a certain price. A typical gasoline demand curve can be seen on the right – if the price is really high (Point A), we’ll only use a car for essential trips (low demand). If the price goes down (Point B), we’ll use more and more until we’re driving everywhere. Sound reasonable?

Demand Curve

Now let’s look at supply curves. These curves describe the behaviour of the other side – the guys that produce gasoline. If the price of gasoline is really low (Point C), you’ll only sell it if you can cover your costs (generally). As the price of gasoline increases (Point D), more and more supply is available. This is a result of higher prices allowing higher cost methods to be effective. If a new extraction method costs 50 bucks a barrel, you better be able to sell it for more than 50 bucks or else there’s no point. An example supply curve is on the left.

Market Price

Supply and Demand Equilibrium
So we have a supply curve, and a demand curve – so what? Well, now we know what the price of gas is! How exactly? Well, let’s put the supply curve and the demand curve overtop of each other. We can see this on the right – any ideas of what the price of gas is?

If you guessed where the two curves cross, good work! Where the two curves cross gives us:

  1. the price of gas
  2. the amount of gas sold

It’s the single point where consumers demand the exact same amount that producers want to provide. If the price was lower, consumers would want too much and producers wouldn’t produce enough (scarcity). If it was higher, consumers wouldn’t want as much gas and producers would produce too much (surplus).

Now we know how to determine market price. Now ask yourself – what happens if someone (perhaps the government creates a law) says “Nope! That price is wrong! Change it!”.

Price Ceilings

There are a few different terms for this, but we’ll limit ourselves to an enforced maximum price – called a price ceiling. There are two different ways a price ceiling can be implemented.

The first is rather boring – called a nonbinding price ceiling. For example, if gas was currently selling at 3$ and a law was made saying the maximum price is 4$, what do you think would happen? Well, not much is right. It would really only come into effect if prices continued to rise.

So what’s the other type? It’s called a binding price ceiling. Suppose gas was currently selling at 3$ and a law was made saying the maximum price is 2$ – clearly something is going to happen. From our previous discussion about supply and demand curves we know two things happen when price decreases:

  1. consumers can afford more, so demand goes up
  2. producers make less money, so supply goes down

Wait a second… that doesn’t seem to make sense. We have more demand, and less supply? That seems to mean that prices would go up. But they can’t because the law says they can’t. So what happens?

Excess Demand

Excess Supply
Well, not much can happen. It’s the law after all. Prices will stay at the price ceiling, but look at the graph on the right. The quantity demanded by consumers used to be the same as that provided by producers – but now consumers want far more and consumers provide far less. This difference is called “excess demand”.

So what happens if you have excess demand in a market? Well, let’s ask the Nintendo Wii.

Nintendo Wii

Wii Equilibrium
First off, the situation with the Nintendo Wii isn’t purely a result of a price ceiling. It’s very similar however (limited production capacity combined with a price ceiling). Let’s create the supply curve for Nintendo Wiis. Assume we sell at a constant price (suggested retail price), and the factory can produce up to a certain number of units – but no more.

Now let’s put a consumer demand curve over that (right) – we can see that the curves cross and an equilibrium price is produced. Consumer demand at equilibrium is less than the factory capacity, the suggested retail price is appropriate and everything works out wonderfully.

Wii Excess Demand
Now suppose that your executives completely underestimated consumer demand, and are now so far behind that they cannot possibly build a factory in time to satisfy this demand. The demand curve shifts to the right significantly (for a given price there is now much more demand). The Nintendo Wii factory can only produce so much however, and we can see excess demand in the graph on the left. Now we have a problem – if you’re going to make something cheap, there better be a lot of it!

Why you don’t want the gasoline market to act like the Wii market

Both situations involve excess demand. And the problems that occur are effectively identical. For instance:

  • If you’re first in line, you’re golden! No problems, you get your (Wii/gasoline) for a cheap price. Unfortunately, if you’re at the end of the line, no (Wii/gasoline) for you! The market chooses based not on willingness to pay, but on willingness to screw around and hunt for a scarce item.
  • People try to play the system. If they’re at the front of the line, people will buy (a Wii/gasoline), and then try to sell it for a higher price to those at the end of the line.
  • The excess demand still hasn’t gone away. Everyone still wants (a Wii/gasoline). Now it’s just a huge pain to find.

For instance, you could be working a 9-5 job, which requires gas to drive to. You don’t have time to figure out what stations have gas – so you end up buying gas on the black market at a ridiculous price from a seedy guy who spends his entire day wandering around finding gas stations that actually have gas. Not exactly a shining example of capitalism.

So what has the Nintendo Wii taught us in regards to gasoline pricing?

Lessons

Price caps on markets like gasoline don’t solve a damn thing. They sound like a good idea at the start – but the very act of regulation changes the way the market works, and causes an unintended result, shortages. These shortages then tend to reward speculation instead of real investment and progress.

In short, gasoline is expensive because we can’t live without it, and continue to pay whatever price is demanded. Real solutions for transportation and infrastructure aren’t as simple as saying “gas should be cheap, always!”.

“Those who cannot remember the past are condemned to repeat it.” -George Santayana