Bum's Bluff

Not quite what Adam Smith meant...

The following is my amature economic theory (I only got a Minor in Econonics, not a degree!) - I invite confirmations of fact and refutations with fact as well! If nothing else, it makes for interesting coversation.

Any oil company exec will tell you that the rising cost of oil represents an increased cost of doing business and thus that cost must be passed on to the consumer at a relatively equal rate to prevent financial damage from occuring to the company.

However, smart investors know how the market really works! What they know is that Exxon/Mobile, as well as the others, not only run a business as refiner/distributer/retailer, but they also serve as a commodities market middleman. In commodities trading, you are investing in the future price of goods -- if the price goes up on a commodity you own, that directly increase the value of your commodity. However, if the price drops, the value of what you purchased has now lowered. This scares off a lot of would be investors from getting into the commodities market - it can be a get rich quick market, but you can also take a nose dive in a big hurry.
A good Wall Street investor knows that the oil company can act as a safety valve for the risk of commodities trade while still offering, albiet diluted, profit opportunities.

Consumers are used to the fact that when the price of oil jumps to $75 per barrel, the gas pump prices will jump immediately. If the consumer questions why the gasoline that Citgo bought off of oil that had sold for $68 per barrel is now priced at the $75 per barrel rate, they might get a tutorial on how commodities markets work. Increased price in oil raises the immediate "value" of all oil related products on hand.

What consumers need to be asking though is why, in a commodities ruleset, doesn't the price of gasoline at the pump drop just as quickly when the price of oil drops? Under a true commodities model, this should be the case. But here is where the Wall Street investors understand the reality -- the oil company realizes its profits by passing price reductions based up on the actual cost of the oil refined, not the current commidity value.

What other company do you see investors flocking to when their primary cost of production skyrockets?? If the price of steel jumps, the stock in GM can drop. But somehow, that cause-effect relationship just isn't there with the oil industry. The investors obviously know their economics a lot better than the normal guy paying $2.91 per gallon!

posted by Walton @ 12:42 PM