Good morning & happy Monday! Hope you had a wonderful Easter!
Teach a parrot the terms ‘supply and demand’ and you’ve got an economist.”
Thomas Carlyle, Scottish historian & philosopher (1795-1881)
Two years ago this week, something historic happened that had never occurred before. On April 20, 2020, oil futures contracts went negative, meaning that oil producers had to pay companies to take the oil off their hands … an unheard of event. Since when does any business make a product and then have to pay someone to take it???
What a difference 2 years makes, huh? 2 years ago the national average price for a gallon of gas was $1.938 (U.S. Energy Information Administration – www.eia.gov). Today if you find gas at twice that price you would be posting on Facebook about the great deal you found.
This is a perfect case study of supply and demand, so let’s take a quick Economics 101 lesson 😊
Supply and demand are the fundamental principles of economics, and they are at work in virtually every economic interaction (including stock market prices … but I’ll address that another time)
Here’s the principal:
High demand and/or low supply = higher prices
Low demand and/or high supply = lower prices
So, 2 years ago, we were at the height of Covid lockdowns (remember: 2 weeks to flatten the curve 😉). Runways turned into airplane parking lots, all cruise ships were stuck in harbor and the roadways were eerily empty. So, the DEMAND for oil plummeted. When demand goes down, what happens to prices? They go down as well.
Why? Because, if I own a gas station all the sudden the demand for my product goes down dramatically and then my competitors lower their prices, I in turn have to lower my prices as well. If there are 2 gas stations right next to each other and one is charging $4.15/gallon and one is charging $3.49/gallon, which station are you going to go to? Obviously, the one with the dramatically lower price. I can’t charge a lot more than my competitors or there will be no one buying my product.
Two years ago, how did oil companies respond to the dramatic decrease in demand? They reduced their oil output, which reduces the SUPPLY. This started bringing gas prices back to a more normal level as 2020 was drawing to a close ($2.284/gallon in December 2020)
What’s happened since then? DEMAND has skyrocketed. People are traveling again, life has returned to normal for the most part and people are booking flights, taking cruises, and going on road trips. Higher demand = higher prices.
On top of that we have the current U.S. government policy of reducing SUPPLY (stopping the Keystone XL pipeline, not granting permits for new oil wells, etc.). To make things even worse on the supply side, the world is fairly united in wanting to punish Russia for its unprovoked attack on Ukraine by reducing oil imports from Russia … so now there’s even less oil available for purchase globally … SUPPLY dramatically decreased.
So, why do you need to get a loan before going to the pump? Because DEMAND is a lot higher and SUPPLY is a lot lower.
The supply and demand forces are in full force in the oil industry, always have been and always will be. It’s not good, it’s not bad, is just is what it is.
How could we lower gas prices? Only 2 choices: increase supply and/or reduce demand.
The beautiful thing about the free market is that supply and demand tend to balance out over time. If there is strong demand for a product or service then that demand will be met with that product or service.
A few quick examples on that and I’ll wrap this up.
I’m a big Tampa Bay Lightning fan. Let’s say I’m accustomed to paying $50 for a ticket. If I find tickets for $10, what am I going to do? I’ll probably buy a bunch of them and I’m probably going to tell my other hockey friends about it. That is increasing demand for those tickets which will cause the prices to rise. Alternatively, let’s say I paid $50 for a ticket and I’m really excited to attend the game but I find out that I can sell my ticket to someone else for $300, I might be tempted to sell my ticket because the demand is so high that I can turn a nice profit on my ticket and watch the game on TV. In this example the SUPPLY is the same (same number of seats in the stadium) but the DEMAND varies based on who they are playing, if it’s a weekend or weekday game, if it’s a playoff game, etc.
In July 2020, I flew round trip to from Tampa to Alaska for $414. DEMAND for flights we super low due to Covid, and the SUPPLY was very available (still empty seats on the plane). I just looked at tickets to Alaska for this summer … seems like $1,069 is the going round trip price for the same weeks I flew 2 years ago (www.orbitz.com, TPA – ANC, 6/26-7/11, price quote as of 4/11/2022). Higher demand = higher prices.
Supply and demand. At work with oil, at work with hocket tickets, at work with plane tickets … at work all the time.
I hope this was not too boring, but I just wanted to provide some backdrop to what is going on in the economic world today.
Please feel free to reach out if I can provide additional thoughts that might be helpful.
Have a blessed week ahead!