Emotion will not help you understand fuel prices

Gas prices go up. Gas prices go down. Those of you who think there is a daily 7 a.m. ET conference call where the executives from ExxonMobil, Chevron, Shell and Sunoco decide what the price of gas should be that day are wrong. Fuel prices, just like any other world commodity, are driven by the market. Primarily this would be the laws of supply and demand.

During the past couple of weeks, there has been plenty of discussion concerning price gouging, the evil act of gas station owners taking advantage of you during your time of need. This post will convince you that a quick rise in prices during a supply crisis can be a good thing.

That’s right, I’m going to buck the trend, got out on a limb and be politically incorrect; then you’re going to agree with me and use the E-mail This Post feature to send it to everyone you know.

First, let’s all agree that not having electricity in southeast Texas really sucks. It’s hot in Texas. The only thing worse would be not having any gasoline in your truck to get out of southeast Texas. I’m not trying to make light of the situation in the areas hit by recent hurricanes, only pass on the knowledge that government involvement in consumer pricing will only make things worse.

What it comes down to is this. Would you rather have 10 gallons of gasoline at $7 per gallon, or no gasoline at $4 per gallon?

Quick hikes in the price of gasoline will do two things. First, it will drive people who do not need the fuel out of the market and second, it will improve the chance that gasoline will be available for those who really need it.

The real problems occur when the government forces prices not to increase during a supply crisis. Even threats by government officials to “actively go out and crush businesses that price gouge” can cause supplies to quickly dry up.

As an example, let’s visit with two hypothetical families that were leaving Galveston last week prior to the arrival of Hurricane Ike. Both were headed to College Station and need to travel about 150 miles to get there. Both vehicles get 15 miles per gallon and therefore need 10 gallons of fuel for the trip.

The first family has 11 gallons of gasoline in the tank, plenty of fuel to make the trip to College Station. The second family has three gallons of fuel in the tank, barely enough to make it to the outskirts of Houston.

The first family wants to buy more gasoline – just to be safe – and on the way out of town find prices have shot up from $4 to $7 per gallon. The family is mad, screaming at the owner about gouging them. It’s not fair! They drive off in disgust on their way to College Station.

Family two really needs fuel and pulls into the station after the first family tears away. They find out that the station has 10 gallons left at a price of $7 per gallon. They buy the last 10 gallons, paying that extra $30 for the high-priced fuel.

They are not happy about it and feel that they have been gouged. It sucks, but they make it to College Station before the storm arrives.

Now, what would happen if the government instituted price controls – guarantying a $4 per gallon rate – before the storm? It’s simple, the first family would have purchased the last 10 gallons and the second family would have found the station to be closed and out of gas.

They would not make it to College Station.

Even the threat of criminal investigations by government officials can result in gas station owners keeping prices low and therefore, running out of gas sooner.

So a quick rise in prices – known as price gouging by the emotional among us – can be a very good thing. That’s how a free market without excess regulation works.