Tuesday, September 04, 2007

Got the physics right but the economics wrong

A year ago, the Arizona Republic published an article on how consumers weren't getting what they paid for because they were buying "hot" gasoline. Last Friday, they did it again.

Each time drivers fill their fuel tanks in Arizona's simmering summers, they likely see $1 or more evaporate.

Because gasoline expands in the heat, that's the estimated dollar amount of energy they purchase but they never receive...

"Arizona is the epicenter of hot-fuel rip-offs," said Judy Dugan, a founder of OilWatchdog.org, which is calling for gas stations to compensate for the temperature of gas they sell. "With the weather Phoenix is experiencing now, every time you fill the tank, you could be losing a dime a gallon. It's an extra penalty for living in the desert imposed on you by the oil companies and oil refineries."

A year ago I sent in the following letter to the editor which they declined to run.

No, Arizona consumers probably haven’t paid $115 million extra for “hot” gasoline. Even if they have paid extra, one thing is for certain, they haven’t paid it to “big oil.”

The basic claim is that gasoline expands at higher temperatures and hence a consumer gets less mass (and energy) for the same volume of gasoline at a higher temperature than at a lower temperature. Since Arizona consumers buy higher temperature gasoline, the assumption is made that they aren’t getting as good a deal as they would at a lower temp.

That’s probably not true.

As noted in the Arizona Republic’s article, dealers buy gasoline in bulk so they pay a temperature adjusted price. This ensures that they get the mass and energy they contracted for regardless of the temperature and hence volume.

That means that through the distribution chain, up to and including the dealer, “hot” gasoline is not an issue. It is only the next transaction in the chain, from the dealer to the consumer, that may have a problem.

Let’s suppose that dealers are selling customers a “mini-gallon” instead of a temperature adjusted gallon. Since all of them are doing basically the same thing, the “mini-gallon” is essentially the same size in any given area like Phoenix. Since dealers compete with each other, they set their prices based on what their competitors are doing. If one store realizes that they are selling a “mini-gallon” and can sell it for a bit less and still make money, they will lower their price to gain market share. The competitor across the street or down the road will also lower their price in order to remain competitive and retain their customers.

In very short order, given the competition, every dealer will be selling a “mini-gallon” for less than a temperature adjusted gallon. Are you really paying more for “hot” gasoline? Probably not.

The other assertion is that “big oil” is making a killing off of “hot” gasoline. For that to happen, two things have to be true. First, the competitive mechanism I described above must not work. Second, “big oil” must own the dealers.

Most of the gasoline retailers in Arizona are not owned by the major oil companies. They may sell a national brand, but they are independent and set their own prices. You can check this for yourself by looking at the business license posted in each store. It will tell you who the owner is, and with a few minutes on the internet, you can figure out if they are part of “big oil” or not. Mostly, they are not. So if anyone is making money off of “hot” gasoline, it’s the dealers, not “big oil.”

While the Arizona Republic’s articles on “hot gas” have gotten the physical science right, they have made some incorrect assumptions about the economics.

Another (published) letter writer has a different take.

I had to chuckle when I read about how gasoline expands and contracts due to temperature, resulting in some sort of windfall for oil companies or station operators ("Not getting what you pay for at the pump," Republic, Friday):

It's simple economics that if costs to deliver gasoline are raised as the result of requiring temperature compensation, the price of gasoline will go up to pay for it. That's in the article, but you have to read the whole thing...

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