Did Big Oil Take Advantage of Light, Sweet Crude?

The last twelve months have been quite volatile for the light sweet crude [LSC] futures traded on the New York Mercantile Exchange [NYMEX].  This fact has not been lost on both the macro and micro scales of business and personal finance.  During this tumultuous period, the Dow Jones Industrial Average Index has dropped from $13,121.35 on August 20, 2007 to $11,348.55 on August 19, 2008, a loss of 13.5% (Google Finance, 2008). 

According to the first two charts in this report, as oil moves, so does the Dow to an immediate extent for day-to –day trading, and to a lesser extent over the course of a year.  This correlation certainly should not come as a surprise to those who follow the markets and watch the nightly news, but it is important to see that although the Dow does seem to be effected by LSC, it may not be to quite the margin that is emphatically reported by various pundits across the country. 

click to enlarge images

Of course, this type of decline during a presidential election year becomes great ammunition for a large amount of campaign rhetoric.  Much of this rhetoric has been aimed at the big oil companies, but is the critical nature of the accusations just?  Have the big oil companies been gouging at the pump based on what seems to be speculative crude purchases, or was there restraint in passing on this greater LSC futures cost to American consumers at the pump?  The charts below offer some data to possibly answer those questions from an unbiased perspective of quantitative analysis.  

The volatility graph below aims to demonstrate the general ups and downs of both the average pump price, and the LSC futures price at the end of each week of the past year, as reported by the Energy Information Administration.   When looking at the chart, there does seem to be a marriage of the futures price to the pump price to a certain extent.  Deviations from the center line by the LSC price do often have corresponding increases or decreases to the average pump price.  One important facet to note is that the volatility of the pump price does seem to be more subtle on both sides of the 0% center line. 

For instance, the very large upward and downward LSC spikes of October 2007 and December 2007 are followed by the respective reactions from the pump price, but by a margin of what seems to be about half of the extreme. That being said, the downward spikes also seem to have only moderate negative dips by the pump price.  This effect lends to the thought that the oil barons are holding on to those increase gains as long as possible.

Another series of charts that demonstrates this reaction and counter reaction is data based on an equal starting point and regression analysis.  The objective with this data is to establish both LSC and the pump price at 1 on August 6, 2007 and adjust each accordingly dependant upon each week’s percentage performance.  The reason for this application is that a graph that would show the increases and decreases of $3 and $100 of the average pump price and LSC price, respectively, would offer too much space between and not show as effectively as one that applies an equal starting point.  When entered into a more statistically sound tool such as the following regression analysis chart, there is confirmation of the correlation.

As seen below, there is definitely an unequivocal association between the two lines.  Almost as if the two prices operate in lockstep with one another, even the most subtle of movements in either direction draw the partner line in the same direction.  However, much like the above cited volatility graph, there is a definite top line and bottom line throughout.  The LSC price dominates the higher percentage increase throughout the annual timeline.   The observation that can be inferred from this comparison is that although the prices are married, the pump pricing is by a definitive margin less volatile and more conservatively applied.  That being said, the final steep drop of the LSC price has not been followed by a correspondingly acute downward spike of the pump price, so it could be possible that oil companies and gas stations are attempting to capitalize on the likely final days of the speculation run-up. 

The information presented in this report was in no way attempting to sway the reader into either direction regarding whether Big Oil tried to take advantage of the American citizen during the LSC price escalations.  The intent of this information was to try to encourage an honest and thoughtful debate whether the prices at the pump during this twelve month period were more or less severe than those on the NYMEX. 

Big Oil, as demonstrated by the final graph of gross revenues through the quarters of 2007 and 2008 below, had a great year.  There is no doubt that a large amount of money was made during this time of shrinking household disposable income due to increased gas prices, however, the question remains whether the American citizen was moderately insulated from the full brunt of the futures volatility, or was there definite signs of being taken gross advantage of. 

References:

• Nymex.com: Light Sweet Crude Oil
  
• Weekly U.S. Regular All Formulations Retail Gasoline Prices (Cents per Gallon)
• NYMEX Light Sweet Crude Oil Futures Prices
  
• Google Finance

 

Comments

[Gigem77:]

Refiners over the last year have faced lower crack spreads causing greatly diminished earnings. They have also dealt with increased regulatory burden. They were confronted by much stricter requirements for ultra low sulfur diesel. The use of ethanol as a blending component has been very costly since it cannot be stored indefinitely like gasoline nor transported via existing pipelines.

Look at the charts of their share prices and at the earnings for FTO, VLO or TSO. Refiners have been unattractive investments. Why is the CEO of VLO selling refinery units? Why is XOM selling all of their retail gasoline outlets?

Read the balance sheets of any integrated oil company and see which part of the business generated the most profit. Over the past 18 months, it has been the exploration and production segment, followed by the chemical division and lastly the refining segment. The refining profits have been on the order of 10-15 cents per gallon.

Speculators can buy gasoline contracts . They bid up the price just like they do with oil.

Study the energy business, Ken.

2008 Aug 24 10:08 AM

[Lawrence J....:]

The price of a finished product (e.g., gasoline) is usually less voltile than the price of one raw input (LSC). Unless you strip out the non-energy fixed costs associated with refining, distributing, and pumping the gas, a comparison of the two commodities' prices tells us nothing.

2008 Aug 24 10:12 AM

[GDS:]

Charts are interesting, however most any data can be presented to support one's basic premise. You have failed to include the rack-to-retail (wholesale price paid versus the retail price it was sold for) spread of gasoline. Actually the EIA data is very limited to the rack-to-retail areas covered. A source like OPIS is much more detailed and accurate for the rack-to-retail spread. If you would have included a rack-to-retail study, you would find a margin squeeze when crude spikes and a spread as crude declines.

I would imagine you could show the crude prices were the inverse to the financial sector during these same periods as players moved their money from one sector to the other, which I might suggest is more accurate. Just look at last week’s crude price spike. Using the EIA’s data would have indicated a big price drop, however the financials outlook outweighed crude inventories hence a short lived crude spike. That is not to say that crude won’t rise over the long run.

One final point, the Big Oil Companies are not the largest retailers of gasoline in the USA. Branded as well as unbranded wholesalers have a much larger market share. Most branded i.e., Exxon-Mobile, Shell, Chevron, etc., retail units are owned and operated by independent wholesalers. Virtually all home heating oil is supplied by independent wholesalers. Very few of these companies are publicly traded.

2008 Aug 24 12:32 PM

[fatcat:]

User 249878 is spot on in his last point....in my local area,5% difference in the general gas price is not unusual just driving 15 miles in any direction..

2008 Aug 24 02:56 PM

[The Saved S...:]

Since a good chunk of the price of a gallon of gas is fixed due to federal, state, and local taxes, it is natural that the percentage change at the pump will be lower (imagine if taxes were $10/gallon, whether oil were $200/barrel and thus gas were ~$15/gallon or if oil/gas were free buit still had the $10 in taxes, the percentage change would only 33% [1-10/15] despite the massive/infinite change in oil price). Remove the taxes from your charts above and let's see what that shows.

2008 Aug 25 08:37 AM

[Angelo:]

Sweet crude oil price It will go down to $20 Dollars a Barrel..Very Soon.

2008 Oct 18 12:07 AM