The factoid thrown around is that roughly 20% of the world’s oil supply travels through the Strait of Hormuz. Since it closed, my local gas prices in one area of the US midwest have gone from $2.60 to now $4.10 presumably as reserves have been used up.
I could understand a 20~30% increase in price to correlate with the reduction in supply, but what are the economic factors that lead to what feels like such a disproportionate increase?
There’s a common misunderstanding that reduction of supply by x% will increase price proportionally. This is being taught in basic economy classes but it comes with assumption of preftectly flexible market. This is NOT how things are in real life.
In real life manufacturing runs at less than 100% capacity and as long as it’s below that number price doesn’t move. Manufacturers usually prefer to increase production first and rise prices only after reaching full saturation. Once it happens market turns into auction: prices rapidly grow until somone is unwilling to buy. If demand is inflexible (meaning it doesn’t react to price changes by much) this can be very brutal.
There is a concept in economics called price elasticity, which is how the market adjusts to changes in supply and demand. If there are more alternatives for the product or the product is a luxury, the price is usually considered “elastic” as people will stop using the good over paying more for it.
Oil is price inelastic. For a lot of equipment, there isn’t an immediate substitute for oil and people need oil to do a lot of important economic activities. So, if there is a reduction in supply, a lot of people will pay more money to make sure they get their oil, which drives up prices far more than the lack of supply would normally suggest.
That being said, goods are usually more price elastic in the long run. For instance, people might choose an electric car right now over a gas powered car because electric cars now are a lot cheaper in comparison for total use costs.
Its a commodity that only sum can reduce usage of. People who commute to work by car and don’t have an alternative can’t stop buying much less gas. Maybe they can get a carpool thing going but that is not easy at all. So like countries reducing the work week by a day or make it mandatory wfh will allow many people to reduce 20% but the trucking won’t be able to reduce. so people reduce only when the economics force them to. Factories might shutdown if the cost of fuel is over what they can seel for and such.
There is actually no reason for those two percentages to be the same, they derive from different concepts.
The price balances at the point where demand and supply are equal. If the market was balanced before, and supply shrinks by 20%, that means the price rises until 20% of demand is priced out of the market.
You can think of it as a bidding war among the 100% of previous demand for the remaining 80% of supply. The 20% poorest, or more precisely the 20% most price-sensitive, on the demand side, loose this bidding war and don’t get any of the remaining supply.
If 95% of the demand can afford a 20% increase in price, then the bidding war just continues.
If 90% of the demand can afford a 35% increase in price, then the bidding war just continues.
If 85% of the demand can afford a 50% increase in price, then the bidding war just continues.
If 80% of the demand can afford a 60% increase in price, then that’s the new balance of the market.
Think about all the oil you use as a regular person- for heating, transportation, fertilizer for your foods, etc.
Now say the price goes up by 20%. Would you, in response, consume 20% less? Would you heat your home 20% less and eat 20% less and go to work 20% less? Of course not.
The estimated 20% reduction in worldwide crude production means, somehow, somewhere, as a world we have to use 20% less oil. Then the question is, how high does the price have to rise to force people to consume 20% less?
How expensive will it have to get to force people to heat 20% less and eat 20% less and drive 20% less? I don’t know, but it’s going to get worse, because we aren’t there yet.
Oil is globally priced so even if you have your own production in America, prices go up there as well. It benefits the producers a lot but leads to higher prices for the
slavesconsumers.You will therefore have oil in America but Asia and China will have a huge crisis since 80% of the oil from Hormuz goes to those countries, and now its cut off by Americas blockades.
So higher prices in America, but it forces China, India, South Korea and Japan to try and buy oil from America.
So this war is about making those countries depend on Americas goodwill for resources. If they dont go along with what Trump is saying, no deal.
Not true.
Prices here in South America have not gone up.
The only reason prices would go up globally would be capitalism, if you trade it for profit.
Nobody should be allowed to profit from burning fossil fuels.
Which country? Consumer fuel prices have been subsidized to artificially suppress them in a number of places, Brazil for example. The profits are still being made but the rise in prices is being shifted onto the public via govt. debt so it gets paid through future taxes instead of showing up immediately at the pump.
If there are 300 life jackets on a sinking ship being sold for $10 each on a ship with 300 people on it. No problem.
No, imagine there are only 299 life jackets on that sinking ship.
The 2 people who want the last life jacket might be willing to bid quite a bit higher than $10 for it, even though the supply only shrank by a fraction of a percent.
In short, supply reduction doesn’t carry enough information on its own to imply how much the price will increase. “How fucked are the customers competing to buy the remaining product if they can’t get it” is the other key factor.
But the reality of your hypothetical situation would be fighting not bidding. So I call bullshit on your story.
Supply is controlled, demand is artificially created and nurtured by capitalists because its a way to capture the market.
We are all being manipulated into thinking they are honest when the exact opposite is true.
The straights of Hormuz is closed because the fascists/capitalists are making money, plain and simple.
Good luck living in their reality. Tell the fox that you are not hens and you might survive.
If there are 300 life jackets on a sinking ship being sold for $10 each on a ship with 300 people on it. No problem.
Ohh, I think there’s a problem…
What econ101 does to your brain is not normal. Into to Econ has y’all seeing a sinking ship and the first thing to ask is “how much is this life jacket worth in dollars”?
It’s a contrived example.
This isn’t hard to understand
Its an apologists answer. Keep towing their line trying to reform them and maybe they wont hit you again.
Yes exactly. Replace the life jackets with Pokémon cards and the moral dilemma goes away. Cruise ships are required to carry enough life jackets and to give them to the passengers for free in an emergency. If someone is selling life jackets on a sinking ship then society’s rules have broken down, and it wouldn’t be surprising for people to get violent as they struggle to survive.
Replace the life jackets with Pokémon cards and the moral dilemma goes away.
If I’m on a sinking ship, I don’t think I’m really going to be caring about Pokémon cards.
No, of course not. But that’s not a very charitable take, is it? Obviously the sinking ship situation goes away with the life jackets and the setting for buying the Pokémon cards is more typical, like a convention or a hobby store.
This is just an illustration and has nothing to do with the actual situation. Life vests are free in emergency. You’re making a fuss over nothing.
Completely agree, actually.
This isn’t what I think someone should do. It is morally abhorrent. This is just a contrived scenario to try and prime an intuition to help OP understand why small changes in supply can have outsized effects on price.
If at any point someone sees human suffering or danger and thinks “profit opportunity”, I have a hard time understanding why that person should be permitted to continue to participating in society freely.
Greed.
I posted this in another thread the other day but it bears repeating.
It’s not even really about the refineries not getting any oil supply. Refineries are setup to use SPECIFIC oil feedstock chemistries, if you try to substitute that oil for a different type (light sweet vs heavy sour or mid mid, etc) the process either doesn’t work, or it wastes a significant chunk. To convert a refinery to use a different feedstock, it takes a significant amount of engineering time, then you have to effectively SHUT DOWN the whole unit, redo parts of the equipment, then run it back up, test it, and tweak the process variables. Refineries plan this years out and it takes 6+ months to do if nothing goes wrong. Then, they are basically locked into that new feedstock again.
Doing any kind of supply shock like this is dumb for any number of reasons. It’s even dumber when the critical components to rework the refineries is in shorter supply because people keep blowing up the existing equipment. Lead times on some of this stuff is in the 20+ month range duing normal times.
There will not be an easy adjustment, the 10-20% loss in supply figure is misleading at best. This is going to impact everything that uses oil, plastic, fertilizer, lubricants, valves, electronics, etc and its not going to be a 10-20% impact…
That assumes you can get a different type of crude. If a different refinery is setup for texas light sweet crude, they are likely able to take all the oil Texas can pump, and they have pipelines in place from Texas to them. Even if you convert your refinery you can’t get any of that crude because it is under contract to the other refinery and they can afford to outbid you because their shipping costs (via the pipeline) are lower.
10 years ago (approximately) there was a North Dakota oil boom - the crude from those wells was shipped via a railroad that goes very close to a Minnesota refinery, but that refinery is setup for Canada crude (including a pipeline) and so the trains went right on by without stopping. The oil ended up in East Cost refineries that had been mothballed (that is shutdown) for years, but they were able to take the North Dakota crude and so reopened. I don’t know the current situation - other than a suggestion that the owners of those refineries were not planning to do more than minimal maintenance - that is if something major breaks they would tear down the refinery instead of repairing it (this of course has likely changed several times as the market changes).
You also have to remember that since oil is a commodity price driven item, the producers don’t want to overproduce, that means they plan 5-10 years out on speculative demand so there is a lag of up to years before they can expand production in some cases. No one wants to spend billions of dollars increasing production capacity only for the price to fall down on its face again and burn up your investment.
A LOT of the production capacity in Corpus Christie is also about to get shut off since they (the refineries) have essentially fucked their own ability to get water required to refine the oil. The whole region is about to drain itself dry and the state isn’t doing shit to stop it.
Oh. I thought all crude oil was the same crude oil. Thanks for the info.
From a high level, this is about supply chain disruption and market confidence. This 20% impacts the entire world, and there is no clear time frame to any resolution.
Oil is used in almost everything, so the gas at your pump is competing against everything from medical plastics, to jet fuel, lubricants, fertilizer, you name it.
Gasoline for vehicles is a very easy place to squeeze out profits in a very uncertain environment.
even petrolatum that people uses for dry skin, moisturizers,etc. and for topical medication too.
Greedflation: Price gouging by corporations during an inflationary period, especially when the underlying cost of production has not risen accordingly.
Oil products have highly inelastic demand. Most uses for it don’t decrease much when prices change. You still drive to work, trucks still deliver goods, furnaces still heat buildings, etc. There are only marginal cases where people can reduce usage: optional trips, driving instead of flying, things of this nature. Because of how marginal these uses are compared to the more mandatory ones, demand does not respond strongly to price changes. Therefore, prices change significantly more quickly.
Edit: Demand destruction is a thing, however. Maybe you buy a hybrid or a factory closes. No matter what happens with oil prices next year, that factory is still closed and you are still driving the more gas efficient hybrid.
More detailed background: https://en.wikipedia.org/wiki/Elasticity_(economics)
Price is rarely 1% for 1%. Some things people will still use in similar quantities even if there are high price increases (e.g. life saving medication). Others people will stop using even if there are small price changes.
Yeah thats basically the answer summed up in a wikipedia article
Yep.
There’s no necessary correlation between actual decrease in
scarcitysupply and increase in demand because of human psychology. Contrary to what economic theory would have you believe, market participants (consumers/buyers, supplier/sellers) don’t (always) behave rationally. When people hear there’s going to be a shortage of something, they panic and rapidly increase demand which rapidly raises prices.Alternatively, the oil industry knows that it is basically untouchable as long as we’re dependent on oil and can set prices pretty much however they like. “There’s a war” is a popular excuse for increases.
Edit: decrease in supply, of course.
Part of the problem is gas supply is artificially kept low so the gas companies can increase demand and charge more (eg they intentionally underproduce). Because of that when unpredictable shocks hit the system the prices fluctuate wildly. For example during the pandemic no one was driving and the price of gas dropped dramatically in response. Even going into the negative one beautiful day. The oil companies didn’t know this dumb ass war was coming and didn’t have the opportunity to adjust production in preparation. It takes time to adjust the supply line. Yes they like high prices, but if they let it get too high people start talking about gross things like bike infrastructure and trains. And countries experiencing energy blackouts start considering solar panels and battery banks from China. OPEC+ doesn’t like that. Add to that some oil production infrastructure has been blown up - permanently taking it out of the supply line. The shortages are going to exponentially build because there are backlogs and bidding wars. I’m honestly surprised the gas is still this cheap.
Honestly this is just basic economics. If theres less supply but the demand stays the same the prices will continue rising until the demand matches the supply. If you for example say “I will have to buy gas to commute no matter what to make it to work” and many people use fuel like that it will shorten supply and make the prices go higher until people use up less fuel. Ofc I know oil is used for more than just fuel for cars to commute but this is just an illustration.
Thats also why subsidizing the prices directly is highly ineffective as it doesn’t actually mean there is more supply on the market and no incentive to save money. If people use a more limited supply of oil as if it was much as there is normally this will spike the prices again until supply and demand match again. Most likely direct subsidies go directly to the oil companies. And if many countries do this it turns into a bidding contest basically where every (except the oil companies that still supply) lose
