Friday, November 04, 2005

How to Gouge Passively by Joe Exxon

The huge oil company profits after Katerina aren't from simple price gouging. It's more subtle, but equally insidious. It's the Refineries. The fact is the domestic oil refiners have an incentive to underbuild. Under normal conditions, the refinery capacity might be adequate to meet ordinary demand. The refiners might even make a little more money if they built extra capacity for demand peaks. The thing is, they make A LOT more money ($50 Billion for Exxon?) if they do not build that capacity and there is a shortage. Simply, the supply curve (short term domestic) is much steeper if they don't build that extra capacity. When there is a shortage because of a hurricaine or whatever, the profits are huge compared to what they would be in the same circumstance if the refiners built a litte more capacity. Because of this incentive, they may actually underbuild vs what is required to optimize even normal demand. It's a kind of passive profiteering. Draw the little rectangles under the curve for relative profits (or read Exxon's quarterly), and you will see what I mean.

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