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Profit Maximization Keeps Gas Prices Higher When Oil Prices Fall

Posted on: Thursday, 8 September 2005, 12:00 CDT

Sep. 8--Does it seem that gasoline prices rise just as quickly as petroleum prices, but fall much more slowly when oil prices go down?

The answer is yes, and economists who have studied the issue can explain why.

Lynne Kiesling, senior lecturer of economics at Northwestern University, said the phenomenon of quickly rising but slowly falling gasoline prices at the pump is known as "rockets and feathers." The price rises like a rocket, and falls like a feather.

"We all need to remember that the primary role of prices is to transmit information about scarcity," Kiesling said.

Service station operators, particularly those owned by major oil companies, have nearly instant knowledge about the fluctuating price of wholesale gasoline and are able to raise prices almost in real time.

Kiesling said there is a natural desire not to lower prices too quickly -- you make more money that way.

"Profit maximization is the motive of every individual in life," she said. "Its part of human nature."

Stephen Brown, director of energy economics at the Federal Reserve Bank of Dallas, has studied retail gasoline pricing.

"Gas prices do tend to rise more quickly when oil prices are rising, than they fall when oil prices are falling," Brown said.

He said that while prices can shoot up rapidly, it on average takes eight weeks for the decline in price to equal the rise.

Retail gasoline prices rise with wholesale prices more quickly now than in the past.

"It is almost simultaneous," Brown said. "The market has sped up."

And it is not just gasoline.

Brown said the rockets and feathers phenomenon is found in most commodities, even the prices of wheat and flour.

Crude oil and wholesale gasoline prices have declined somewhat, as production and refining in the Gulf of Mexico revives. Hurricane Katrina largely halted pumping and refining in the Gulf last week, and significant damage remains.

Crude oil prices have dropped 9 percent since reaching a record $70.85 a barrel on Aug. 30. The International Energy Agency's 26 member nations have committed to making available about 2.1 million barrels of oil and fuel per day for 30 days.

"We may end up with more crude and heating oil than we would have without Katrina," said Phil Flynn, vice president of risk management at Alaron Trading Corp. in Chicago.

"There are a lot of imports on their way, and production may be close to normal by the end of the year," Flynn said. "In two weeks there may be a flood of imports as the IEA barrels reach us."

Crude oil fell $1.59, or 2.4 percent, to $64.37 a barrel Wednesday on the New York Mercantile Exchange, the lowest since Aug. 19. Prices still have gained 49 percent in the past year.

Wholesale regular gasoline declined 3.28 cents, or 1.6 percent, $2.0222 a gallon, the lowest since Aug. 26.

Bloomberg News contributed to this report.

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Source: Chicago Tribune

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