Oil and Perverse Incentives

Oil on the Brian src="http://www.hybridcars.com/images/stories/oil-on-the-brain-book-100.jpg" />

Hybrid owners have different reasons for switching to a gas-electric vehicle. Some are motivated by a concern for the environment. Others are waging a small political protest against OPEC. And some folks are tired of getting burned by high prices at the pumps. Despite the varied and overlapping motivations, all hybrid owners attach a deeper significance—vague as it may be—to the fuel so easily pumped into our tanks.

If you have ever paused for a moment at the pumps to wonder where the stuff comes from and what it took to get it there, then race over to the bookstore—preferably on foot or bicycle—to pick up a copy of Oil on the Brain: Adventures from the Pump to the Pipeline by Lisa Margonelli. In the book, Margonelli chronicles her suspenseful journey from a gas station in San Francisco to a Texas drilling rig to the trading floor of the New York Mercantile Exchange, and then to Iran, Nigeria, Chad, and Shanghai. I sat down with her for an interview at the Oakland, Calif. office of the New America Foundation, where she is a research fellow examining the promise and possibility of a post-oil world.

This excerpt, focusing on gas stations and refineries, is the first of four parts. You’ll find links at the bottom of this page to other interview topics.

Pennies on the Gallon

Bradley Berman: What should drivers know about the people who sell gasoline to them?

Lisa Margonelli: The people who run independent gas stations make about five cents per gallon. Sometimes they make less on actually reselling the gas. They’re leveraged. They have to borrow money to fill their tanks. And then they need to respond to the wholesale market and the retail market at the same time. Their customers are very sensitive to high prices. They’ll cross the street for a difference of two cents to go to another station. So they need to keep their prices low, but at the same time, the brand name stations are getting a deal from the refiners who will sometimes lower the prices to create competition on the corner. It’s tough to run an independent gas station.

And then you have to deal with consumers’ hostility. People think they are being ripped off by the corner gas station, when in fact, A, I would argue that they are not being ripped off. And B, the places where profits are taken are far up the supply chain.

BB: Why are they not being ripped off?

LM: I think that gasoline is extraordinarily cheap in the United States. It’s cheaper than almost any other fluid. The dangers of transporting it and storing it are huge. And its value to the economy is huge. There are a lot of hidden subsidies that keep the price low. You pay a lot for gasoline on April 15th that you don’t really think about, in terms of subsidies to the oil and gas industry, in terms of supporting things like the Strategic Petroleum Reserve, and you pay a lot in terms of quality of life in ways that you don’t really realize. But the actual physical price is not that high, and it could be higher.

BB: As vulnerable as the indy gas station owners to price fluctuations, the distributors are getting even more squeezed.

LM: Yes. The distributors are making about a quarter of a cent per gallon for deliveries. When you think about what that means, the risks that they are taking as they transport the stuff, it’s pretty huge. They are also very dependent on the wholesale market. Because demand is so close to supply right now in the United States, particularly in certain markets like California, a tiny outage in a single refinery can cause a big price spike. And it can happen over the period of ten minutes. There’s a huge price spike which totally changes the way a distributor would need to calculate and ship their goods. So, it’s a very moment-to-moment kind of job, and yet it goes on 24 hours a day.

BB: In the book, you describe one of the distributors named Mark Mitchell…

LM: Mark graduated from Stanford and was quite highly ranked as a tennis star. He followed his parents into the oil and gas industry, and worked on delivery. He’s a very smart businessman, but you still see those quick twitch tennis muscles going. This kind of business requires someone who can really think and react on their feet.

BB: And yet you describe him as really stressed out.

LM: Totally stressed.

BB: And at the end of the day, he drove home in his V8 Lincoln.

LM: (Laughs)

BB: You carry this paradox throughout the book. His life is controlled by fluctuations in the market, and by our unceasing demand. And yet he’s driving a gas guzzler.

LM: Right. But the last line in the chapter, he says “My next car is going to be Prius.” In that segment of the industry, people realize that over the last 10 or 15 years Americans demand for gasoline has increased by about 1.7 to two-something percent per year, every single year. Every one percent in California is, I calculated, 18,000 tanker truck loads. What that means is that for every one percent per year, you’ve got that many more tanker truck loads on the freeway, and you’ve got that many more cars on the freeways. You’re ending up with this kind of log jam, or backup in the pipeline. And the infrastructure is really stretched to capacity. And people in this business realize that more than anyone else.

Optimizing the Beast

BB: If gas stations and distributors are burdened, then the refineries are at a breaking point.

LM: Well, some of them have broken actually. That’s part of why prices are so high.

BB: Who suffers when it breaks?

LM: We all suffer when it breaks. The people who really suffer are the people who work in the refineries and live around them when there is some sort of accident. The accident in Texas City in 2005 was huge. Fifteen or seventeen people were killed. More than 100 were injured. It was terrible.

BB: An event like that makes headlines, but on an ongoing basis, there are little accidents.

LM: There are little refinery accidents constantly. Sometimes, they’ll release some hydrocarbons or some volatile organic chemicals. Sometimes, they are releasing something worse. Sometimes it’s a catalyst. There was a long-term release of a catalyst up in Martinez, Calif.

BB: In the end of the chapter on refineries, you write:

“I imagine a big machine of interdependent gears and economies and chemical reactions reaching out toward the gas pedals of those cars on the freeway, and back to the oil field far away. I find this vision strangely comforting, because it suggests that consumers could make rational choices to prepare—optimize the best—for five, ten, and twenty years in the future. But will we?”

LM: That’s the big question. I don’t think we will until prices get high enough that people move beyond the momentary panic and outrage, and really start to rationally view it. My metaphor right now is that we need to stop acting like the people who go to the slots in Vegas, and we need to start acting like professional Poker players where we really look at the cards on the table. When you look at this from the beginning of the supply chain to the end, we absolutely have to make changes and we have to follow strategies of least risk, which means reducing the amount of gasoline we use, and investing in things like hybrid cars and other types of dramatic fuel-reduction technologies, rather than investing more in gasoline which just goes out of our bank account.

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  • sean

    Some points:
    1) Car makers in China has more brain than ones from the Big Three.
    2) There are some dangerous hawks from Wall Street Journal.
    3) Unfortunately, oil companies and the Big Three donate too much in election campaigns!
    4) The Big Three has no – or very poor – visions.
    5) John Howard, PM of Australia admitted that the war in Iraq is partly because of “energy secutiry”. Well, if you spend more money than you can earn (or more resources than you have), you’ll end up robbing other people’s money/resources. It’s as simple as that.

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  • Rajesh Sharma

    The Future cars should be energy efficient,environment friendly and safe:
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  • Jim Hanley

    Lisa Marginelli is totally mis-informed about the “ORIGIN OF CRUDE OIL” which is a “ABIOGENIC RENEWABLE SOURCE”, and this knowledge has been available since approximately 1875!
    And this has been proven beyond any doubt what-so-ever!

    “PEAK OIL” is lying propaganda, meant to keep people from knowing the amount of avaricious greed the MONOPOLISTIC AMERICAN CABALS are capable of!
    And the elimination of the “SHERMAN ANTI TRUST” AND OTHER CONTROLLING trust-busters eliminated by those two OIL DYNASTY RATS IN THE WHITE HOUSE have permitted the present price of Gasoline to increase from 99 cents in 1999 before those two greedy rats seized office to $4.00 per gallon now 3/2008!