Friday, March 16, 2012

Seasonal Variation In Gas Prices

Inflation is high this month.

Most of that comes from gasoline price inflation.

Gas prices inflate every spring. This gives alarmist reporters something to talk about once a year.

There are three reasons for this.

First, gas is refined from crude oil. Refineries are big places with huge economies of scale. Shutting them down is expensive.

Second, governments across much of the country mandate different blends of gas for different times of the year. The whole country changes from a winter to a summer blend twice a year. But, every time they do this, the refineries have to shut down to do the changeover. This always creates price volatility. Further, the summer blend is more expensive.* So, every spring gas prices get pushed up.

Third, we’ve Balkanized our gas production (remember: go to Google and enter “define balkanize). Here’s a map:

This is done by local governments deciding that winter and summer blends aren’t enough for them, and that they need a special blend that no one else has. Each of these colored spots requires its own dedicated refineries. Most refineries only produce one of these colors at a time. This is a big deal because refineries are expensive to switch because of the economies of scale they get only when they’re up and running. In operations research, it’s standard to study how adding constraints to decision-making reduces options and increases prices. Politicians prefer you don’t know this.

* Yes, Obama will be able to deliver declining gas prices just in time for the election: every President is this “lucky”.

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