Follow up on How to Stop Paying So Much for Gas

New information is being released by the IAEA that is confirming the logic presented below.  To see those reports, read on to the bottom of the article where the links are provided.  

A reader recently questioned on a Facebook link exactly how the logic works that by filling up with less gasoline, that prices might be affected.  I am following up with this article, which copies the response to the question that was posted on Facebook.  Click the link to see the previous article titled "How to Stop Paying So Much for Gas" if you haven't read it already.

       

The logic is explained a bit more in a previous article linked in this one. The idea is maybe better explained this way. Imagine that your family currently purchases seven 2 liter bottles every week, one for each day, and you purchase them all in one day. Then imagine that this is common practice among everyone to do this. Stores and suppliers then would expect to meet specific demand, meaning production, logistics, and inventory management need to be timed well to meet the demand. Also, because large quantities (7 per customer) are purchased in blocks, stores would know that they can charge a bit more if demand were to ever outpace their supply for a day or two.

Now imagine that instead of buying seven 2 Liters all at once, instead you buy a 3 day supply, and then imagine almost everyone changes to do this. This does a number of things to the distribution model. One, it means that there will be a sudden oversupply of soda bottles at the stores. Due to this, stores will either discount the items, because they know a truck with more bottles are coming, or they will find a place to store them, which decreases the margin the store gets for selling the product. Also, because there are now 2.333 more transactions occurring to sell the same amount of bottles as before, the store will either try to normalize by lowering price (buy 3 get 3 free!), or will tell the supplier not to ship as much product.

The supplier then has a few options. Store the excess supply they are receiving from production, at their expense, or lower costs to their downstream to move product, or tell the producers to slow production.

Now, most producers have specific mathematical models on how much product they must create in order to maintain profitability. If they lower production, they will almost assuredly run at an operating loss because though they might be able to furlough employees on the production line, the mothballed equipment on the accounting books will be depreciating on the books regardless. So, producers have that option (which shareholders will not like because it means a decrease in shareholder equity), or the factory can store the excess at their own expense, or they can lower price and *increase* production to maintain revenue levels and profitability. Doing so reduces price for everyone downstream.

In effect, this is what the OPEC nations did for decades that made oil prices per barrel get into the low teens. They produced lots and lots of oil to meet specific revenue numbers, knowing that if they didn't produce as much oil, even though they could fetch a higher price for what they did produce, their revenues would in fact be lower because they would allow more competitors into the market (such as US competitors), who would jump on the prospect of producing oil at 60 per barrel, but would never even think to produce it at 20. 

It is the same thing that is causing the glut in natural gas prices, but even at historic lows, producers are producing more than ever. 

Whether at the beginning of the supply chain model or at the end, disruptions of the model can and do have impact on the bottom line: price. The article is proposing that now that OPEC producers are no longer able to flood the world in oil (there is too much demand), that we as consumers disrupt their demand models. Futures traders would be spooked (I don't want to be holding a futures contract in gasoline if there ends up being too much supply on hand in July), meaning prices would go down, and mid stream producers (refineries) would lower prices as well to entice buyers. Refineries wouldn't be able to "stop" producing gasoline, because it is a bi-product of oil feed stock that produces many other chemical products. Slowing production at the refinery would reduce output for all products, some of which carry higher margins than gasoline. Refineries have been known to loss lead on gasoline for that reason.

Lastly (whew), human behavior is to binge on supply. Take the soda example. When you buy lots of soda in advance, most of the time you go through it faster than intended. The same goes for gasoline. And you'll be able to take advantage of price fluctuations since on that chance you come across a station with a really low price, you'll have at least a half a tank of empty space to stock up on it.

But don't take my word for it. It is open for debate and discussion. Let's find holes in the logic to improve it.

The interesting thing is that just today, the IAEA is confirming that the US is putting a lot of oil on the market.  This increase in supply, along with reported "demand destruction" are going to hold prices lower.  Let's keep up the pressure on prices from both the demand side and the supply side.

How to Stop Paying So Much for Gas

Previously, I wrote a few blog posts on how to "short" sell the oil companies as prices of gasoline increase. If you haven't read them, you can take a look at them here for some economics backrground of why this idea works.

I am reviving this discussion again because prices typically start to ramp up in the late spring for summer driving, and because I've been seeing Facebook posts telling everyone to fill their tanks full, among other things, to save money. You can view that article text here. There are a few reasons I don't agree with filling a tank full if you are driving only relatively short routes (around 50 miles per day or less). The biggest reason is explained in more detail in my previous articles, but briefly it has to do with "just in time" distribution. Energy distribution models today are highly efficient, and the distributors are counting on meeting certain demand numbers on average. Meaning they are expecting most people to fill their tanks full at each fill up, and will work to meet that demand. But, what if we change the demand from what they expect it to be? Remember supply and demand curves from your Econ class? There will be too much supply, and the price will go down until the curve reaches equilibrium again.

So, how can we do this? By not storing gasoline for the oil companies by filling your tank full and getting a 500 mile range of driving before having to fill up again. Instead, fill to half full or to a dollar amount that gets you somewhere near the half tank mark. There are plenty of gas stations around these days along most driving routes that making 2 or 3 stops per week will not make you lose much time. It might even save you from wasting time and gas idling at a red light if you stop at a station on a corner.

Another reason I don't see a need to fill to full unless driving a very long distance is that many tanks these days are 17 to 20 gallons. That's a lot of flammable fuel, first of all, and it isn't weightless either (meaning it does take energy to haul it around. Whether it is negligible or not is debatable). More importantly, cars that were much less fuel efficient in the 1950's and 60's had tank sizes around 16 gallons. If a tank that size was fine for a car that got 10 mpg fuel efficiency, why do I need to fill up with 20 gallons in a car that gets well over double the mpg's? If anything, 8 gallons should be fine. Something tells me they want us to buy more product for more revenue... kind of like how restaraunts have increased portion sizes so they can charge more, without you feeling completely ripped off. Fill to half full, and they'll think twice about their pricing models.

Yet another reason is that most cars these days have fuel pumps that won't be affected by low fuel levels, as long as you don't run out of gas. And they have built in screens to keep out any debris or settled material (which would end up at the bottom of the tank whether half full or not, which goes against the claims of the Facebook posts), and even then most tanks are built with very good materials these days that won't corrode easily.

Do you really need more reasons? Another reason is the widely used rule in investing of dollar cost averaging. Everyone knows you want to buy low, sell high. But how do you time it just right? Even highly trained professional traders get it wrong. Dollar cost averaging theorizes that if you just buy at smaller, more frequent, but evenly placed intervals, your cost basis will be better than if you try to time the market, or buy in lump sums (i.e., filling to full). Gasoline prices are volatile, and that is where dollar cost averaging by buying 2 or 3 times a week and filling only half full will help. This means that because you'll be filling at quite a few different gas stations along your many routes, you'll be averaging a better price than you would otherwise. And chances are you'll be able to take advantage of a "dip" in prices when you drive by that gas station with a ridiculously low price and you only have an 1/8 of a tank left, further averaging down your overall cost of gasoline.

Lastly, we all know it is human nature to conserve, or at least to remind ourselves to be more economical with, our goods when we see a limited supply. Hoarding, or in this case filling to a full tank, can lead to an increase in consumption just because of feeing comfortable in our bounty. Who knows, you may save two or three percent off of your weekly gas cost just due to the fact that you are more aware and keeping yourself from making unneeded extra trips because in the back of your mind, you don't want to have to stop at a gas station sooner than usual.

Follow-up: How To Short Sell The Oil Companies

In a previous article, I wrote about how we can collectively work against the oil companies to help improve gasoline prices.  (See the previous article before reading further if you haven't read it already.  Then come back to this article.) We should keep doing that, as now traders and firms like Goldman Sachs are seeing that demand might not be meeting with supply, and oil has been off its highs so far this week.  Keep it up America!

In full disclosure, I am not currently short on oil.  In fact, I am actually long DBO ETFs in one of my portfolios, and have no plans to change my position anytime soon.  I think energy long term is a good play.  But gasoline prices are too high, and unsustainable (in my view) at these levels, and I believe could impact the economy come summer time (like we saw in the perfect market storm of 2008).  I do have another interest in seeing fuel prices decrease, and that is I need to book some flights to Hawaii soon and would love to see some benefits in reduced airfare from lower aviation fuel prices.  Long shot, I know, but I can hope!

I also have seen other researchers write similar things about other commodities, such as food related goods.  Below is what Smartmoney.com had to say on the topic of stockpiling (which is what are doing in effect when we fill our tanks to the brim instead of just filling with a half tank more frequently).

Consider this example.  There are over an estimated 247 million registered vehicles in the US.  The average tank size is around 20 gallons.  That means, if we are keeping our tanks above half full, we are storing between 4.94 billion (at full) and 2.47 billion (at half full) gallons of gasoline, at our cost, not the oil companies' cost.  We are storing billions of gallons of gasoline for FREE, so that we can drive around town for a week without filling up (even though most cities and towns have a plethora of fueling stations along the routes we drive).  Imagine what would happen if we were storing a half tank or less of gasoline (less than or equal to 2.47 billion).  We would immediately stick almost 2.5 billion gallons of product back on the oil companies' "shelves", since their numbers are set to meet the demand at that rate of draw.  How's that for some perspective?

Smartmoney.com:
...

There's also an unintended consequence of stockpiling, says David Bell, a professor of marketing at the University of Pennsylvania's Wharton School of Business: You'll actually end up using more of what you've stockpiled than you would otherwise. In theory, doubling the number of soda cases bought would result in a supply that lasts twice as long, but it's more likely that you'll go through it faster, or simply be less frugal about its use with extra on hand. You could even end up throwing out food that expires, rejecting out-of-fashion items, or simply forgetting about the cans of corn stashed behind the hats and mittens in the basement.

Still, buying before prices rise can be smart – in small doses. Most supermarket and drugstore items go on sale just once every 10 to 12 weeks, says Teri Gault, founder of The Grocery Game. If you're loyal to a certain brand, buying extra when you spot a sale is smarter than paying full price the following week when you're actually out. On fashion, retailers sneak in bigger price increases on trend items because consumers can't easily monitor cost like they do for wardrobe staples such as trousers and T-shirts, says Tennant. Many of those items are available now at end-of-season clearances, and can be picked up for a song. And avoiding hyped-up eBay ( EBAY: 29.98*, -0.46, -1.51% ) prices on discontinued items by stocking up is usually a sound strategy, too.

Ultimately, the decision may come down to cash flow. If charging six months worth of dry goods means paying extra interest charges on credit card debt, it's not worth the savings, says Randy Allen, an associate dean for The Johnson School at Cornell University.

Read more: Will Stockpiling Save You Money? - SmartMoney.com http://www.smartmoney.com/spending/budgeting/will-stockpiling-save-you-money-1298583519761/#ixzz1Gm8Ox5Y4

Additional notes: When gasoline is sitting in your tank, it is evaporating.  Why pay out of your pocket just to let more droplets of gasoline disappear on your dime.  Make the oil companies pay that expense themselves by buying less gasoline at each fuel-up, which forces them to store more gasoline and worry about their own storage tanks' evaporation rates.  While many articles show that the evaporation rates are pretty negligible (less than 1 gallon per year at 60 degrees Fahrenheit), I still need to do some more research on what the rates are like when it is over 90 degrees like most of America is during the summer months.  Also, when liquids slosh around, there is more evaporation.  There are also arguments about cars that have evaporation collection systems which reuse gasoline that might help mitigate your losses.  Additionally, E10 or higher Ethanol gasoline is said to evaporate even more due to the alcohol content.


However, even if you are not benefiting from less evaporation, you may stand to benefit from increased gas mileage by not hauling around so much liquid in your tank.  As the power of your engine increases (4 cyl, V6, V8) the benefits decrease: meaning you'll see better gas mileage for half tanks in a 4 cyl than you will in a V8.  But remember, these are just added benefits, so if you don't receive these benefits because your car is bigger or has cool vapor catching gizmos, it doesn't matter.  The bigger benefit is short selling the oil companies, over-supplying them with excess inventory, by not filling up a full tank when you go to the pump.  They will soon see that they have too much gasoline product on hand and reduce the price to get rid of it.


If interested, you can read more on efficiencies here:


http://www.creditinfocenter.com/wordpress/2008/07/24/increase-mileage-gas-tank-full-or-half-empty/

Economics of Gasoline - How To Short Sell The Oil Companies

High gas prices are back.  It's time to review ways to save money on gas.

But I don't intend to talk about conserving gas through substitution to biking, running, or riding the bus to work.  The problem of high fuel prices goes far beyond that, and could easily cause setbacks in the US economic recovery - if there really is one.

Let's start with good ol' reliable supply and demand.  Prices are higher right now because the traders who buy oil on the commodities exchanges are saying with their pocket books that the supply of safe, reliable production of oil is heading lower relative to demand.  Whether we agree with their assessment is irrelevant.  But what is clear is that we need to shift the supply curve to the right to get prices to come down.  If the traders won't do that, how can we as consumers do it?

Before I go further, I'll point to some interesting info regarding the last time oil had a huge run.  In 2008 saw oil a peak price at  $145.29 on July 3.  Just 10 days later, President George W. Bush announced a repeal of the offshore drilling ban, and oil made a steep and steady decline (along with the economy) to well below $50 per barrel by December 2008.  I don't believe for a second that Bush intended to allow drilling - it was simply  a bluff, an ace in the back pocket.  Even if he did intend to allow drilling, it would have taken years to get production on line.  However, the mere chance that more supply could be coming on line in future years was enough to help the price come down; way down.

Remember, oil is traded in futures contracts.  The futures are trying to predict what the price of oil should be in the coming months.

So, again, how can we as consumers get the price of oil to fall?  Answer: we can use the properties of distribution models and futures trading against the oil companies, and force them to sell gas at lower prices.

Distribution models are everywhere, and these days they are run with high efficiency.  Imagine a tanker filling up with oil right now at a port in Alaska.  There is a port somewhere in Texas expecting that tanker to come to port in the near future.  At that port in Texas, there is a pipeline company expecting to transport the oil from the tanker, and eventually route it to an oil refinery somewhere in the mid-west.  That oil refinery is expecting the oil to come in so they can make gasoline and other products.  There is a distributor expecting to haul that gasoline to nearby stations, and stations that are expecting to sell the gasoline at a certain volume per week.  All of this is done with "just in time" precision to ensure that enough gasoline is on hand to the members down the chain at a time when it is needed.

That's where we come in.

Instead of filling our cars full of gasoline every time we stop to fill - and hauling it around while using it slowly, meanwhile letting the oil companies take our money for gasoline we will not use until sometime in the future - fill up with a half tank of gas, or better, a set dollar amount (that is at or below a half tank), keeping more of your money in your pocket, and paying less upfront for future consumption.  We will be placing "puts" on their future price of oil by paying less in advance for gasoline we'll burn in the future.

Our tank shorting will do two things immediately.  One, it will immediately increase the amount of gasoline inventory every station has on hand relative to their normal draw rates.  When the distribution company comes to fill the tanks for the station, they will not dump as much gasoline off their tanker trucks.  With less gasoline leaving the storage tanks of refineries, they will have to slow production (or pay money to someone else to store the excess gasoline).  Reduced production would mean less oil draw from their pipelines, which would mean the pipeline companies would have to store more offloaded oil from tankers (or pay someone else to store it).  Rather than do that, they offload less oil from the tanker.  The tanker sits in port longer now, since the offloading rate is slowed.  Meaning the tanker company now starts a dispute with the purchaser of the oil over who will pay the costs of the extended stay at port.  Meantime, another ship is already on its way to port with more oil.  That tanker arrives while the other tanker is still docked.  Now the tanker company has to pay to dock the second tanker, effectively "storing" the oil.

Two, rather than allow this backlog to happen and disrupt the supply chain, the oil companies will try to entice us back to the pump by reducing the price of gasoline in an attempt to ease the onslaught of higher inventories.   This action would effectively take some wind out of the sails of the futures prices of oil, which would further reduce the price of gasoline over time.

Let's get started America.

Gasoline Production Being Reduced By Refineries

This is not good news for those who have been watching the gasoline market. Refineries are lowering production of America's lifeblood - gasoline. Forget the credit crunch, this squeeze will have the same effects, or worse, as a slowed money supply. See the story below, and keep reading:

http://www.msnbc.msn.com/id/12400801

There are some things you can do. For instance, I learned that due to chemical reasons and physical laws such as vapors in liquids, temperature differences, and the effects that different pour rates can have in relation to this, if you "pour" or pump your gas slower, it will increase the amount of gasoline you get while decreasing the amount of vapors that end up in your tank. This significantly increases your gas mileage. I have tested it over the last 2 weeks and had spectacular results. My car is rated at 25 MPG city, and 30 MPG highway. I have been getting 36 MPG!

You can also use reverse supply tactics. Why put money in the oil company's bank accounts when you can keep it in yours. Just buy a half tank of gas when you fill up. If the entire country were to do this (basically ration themselves creating "game theory -like" results), the daily gasoline supplies and reserves would increase, almost overnight. Fill trucks would have to go out and fill stations much less. This would then cause a reaction from the gasoline companies, who have to pay to store large quantities of gasoline, to sell it at a cheaper rate to generate cash flow and revenues, and to get rid of increasing stockpiles of gasoline (retailers reverse supply or use reverse logistics all the time. What do you think happens to the products you return to the store? They are sold at a discount later. Filling a half tank of gas is like returning a half tank of gas at the same time). Secondary "discount" markets for gasoline would rise due to the fact that the supply chain would be broken at the endpoint - the pump - as less gasoline would be pumped daily (a half tank would be "returned"). Can you imagine the day when stations have a 15% off sale to get people to the pump? Then let's make it happen!

See the following for some basics on supply chains:

http://en.wikipedia.org/wiki/Supply_chain_management

http://en.wikipedia.org/wiki/Reverse_logistics

http://en.wikipedia.org/wiki/Transaction_cost

Also, knowing you will only have a half tank of gas before your next fill-up (the next time you will have to spend actual money) will also make you think twice about driving someplace. You can also do a "gas budget" where you pay attention to how many miles it takes to get somewhere. Then figure out the cost of the gasoline it took. This will help you realize the cost of your day to day activities, and help you budget your gasoline expenditures.

Ensure full inflation of your tires every time you fill. And don't use gas company credit cards. They make lots of money in interest each time you do.

Buy non-middle eastern oil. Nearly every domestic oil well has been uncapped recently due to the potential revenues that can be generated with oil over $100 a barrel. When I was in Texas 4 years ago, many farmers had oil wells that were capped off, awaiting better times for oil. This is not the case anymore. As a farmer, if you can pump just 10 barrels in a day, you'll add about $30,000 a month to your bottom line these days. So help support our country's oil supply by buying domestic oil. A quick google search will tell you who the domestic companies are.

Invest stocks in Natural Gas companies, and then buy a natural gas car. A nat gas car costs about $8 to fill which gets you about 350 miles. With oil as expensive as it is, Natural Gas demand is going up, and so are the stocks of the companies who produce it.

Open a business, and use your trips for business purposes to write of gasoline taxes.

Send this to your friends. I hope it helps!

Tijs

--
Tijs Limburg
Chairman and CTO of DMX - Digital Media eXceleron, Inc.
Get eXcited!
http://www.dmxed.com/

Blogs:
http://phystrings.blogspot.com/
http://getoutofthedark.blogspot.com/

The "Don't Tread on Me" Flag: The First Navy Jack is enjoying renewed popularity these days thanks to an order from the Secretary of the Navy that directs all U.S. Navy ships to fly the First Navy Jack for the duration of the War on Terrorism.

--
Tijs Limburg
Chairman and CTO of DMX - Digital Media eXceleron, Inc.
Get eXcited!
www.dmxed.com

Blogs:
http://phystrings.blogspot.com/
http://getoutofthedark.blogspot.com/

The "Don't Tread on Me" Flag: The First Navy Jack is enjoying renewed popularity these days thanks to an order from the Secretary of the Navy that directs all U.S. Navy ships to fly the First Navy Jack for the duration of the War on Terrorism.