Monday, May 14, 2007

Pretzel Logic

I understand the theory of supply and demand. Pretty much all of us do. I used to teach it to fifth and sixth graders when my daughters were in school. I brought in donuts, gave each class member an envelope stuffed with Monopoly money and auctioned off the donuts.

To simulate real life conditions, not everyone had the same amount of Monopoly money in their envelope. Some students were relatively rich, others were relatively poor. There also were not enough donuts available for all the students. That illustrated too many people chasing too few goods and services.

The first donut auctioned off for a measly sum – maybe five dollars. I’d hand over the iced confection to one smiling student while the others salivated. Invariably, everyone wanted the next donut for the same price the first sold for. But alas, there were even fewer goods now, so I said I wanted more money for the next one. That made a lot of the “poorer” students drop out of the bidding. I’d sell the second donut for a princely sum and thereby demonstrate the forces of supply and demand. As the supply of donuts dwindled, prices rose.

I would eat a donut myself and watch the student’s eyes widen as they understood the impact on supply. I gave one to the teacher as “payment” to my supplier for use of her classroom. The students got creative. One group, working as a team, pooled their funds, bid for and won a donut then shared it, each taking one bite. Another time, I auctioned off the empty box just for the crumbs it contained.

But now I’m getting off track. My point is this: while supply and demand pressures are simple with donuts in a classroom full of hungry elementary students, it’s not quite so easy with gasoline prices and thirsty vehicles.

I just spent $75 to fill up my truck with gasoline valued at $3.14 a gallon (should have done that three days ago when it was “only” $2.99). As gasoline prices rose for the summer driving season, I also read that oil prices decreased about three bucks a barrel.
I was confused. How could that be? Raw material prices fall, finished product prices increase. Oil prices go up, gas goes up. Oil prices go down, gas goes up. Heads I win, tails you lose.

Since oil prices are speculative of future demand, it seemed that a drop in oil should equal an automatic and noticeable drop in gasoline prices. But, not so.

That’s where the complications arise. Oil is not gasoline. It has to be refined. Apparently, several refineries are offline as a result of fires and other problems. And that during the start of peak driving time for vacations. In fact, raw oil prices could be dropping because of the shutdown refineries since speculation may be that less convertible oil will be needed in the next several weeks.

So, we have a diminished supply of gasoline at a time when the demand for the precious fluid is on the rise. And prices rise. Just like they did for my donuts.

The thing is, I didn’t really have just one box of donuts. I brought in enough for everybody. I just chose not to disclose that or my supply and demand illustration would have been useless.

So, oil companies: we get it. Now bring out the donuts for all of us.