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?
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.
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.
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”?
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.
It’s a contrived example.
This isn’t hard to understand
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.
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.
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).
