I've explained this before, even to O'Reilly, but I suppose I have to explain it again. This is how the price of gasoline is set. It is set based on the cost of replacing each gallon of gas sold, pus 2 to 5 cents. This is how all retail businesses set their prices. Huge profits result because the replacement price is much higher than the product's original price. In other words, the replacement price of a gallon of gasoline sold today is based on a price of around $75.00 per barrel of oil. The original cost of the gallon of gas being sold today may have been around $50.00 per barrel of oil. This results in huge profits. Huge profits come from selling a product for a much higher price than you originally paid for the product.

Again, all retail businesses set their prices based on what it costs them to replace the item of inventory being sold. It doesn't matter what the product being sold is. If Wal-Mart sells toothpaste at a cost basis of $1.00 a tube for $1.10, and has 20,000,000 tubes of toothpaste in stock, and the cost to replace a tube of toothpaste sold goes from $1.00 to $1.10, then Wal-Mart raises its price from $1.10 to $1.20. Before, it was making 10 cents per tube of toothpaste sold. Now, it will make 20 cents per tube of its existing inventory sold. When the existing inventory is depleted, it will go back to making 10 cents per tube of toothpaste sold. The same principle holds true with oil and gasoline.

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"Victory at all costs, victory in spite of all terror, victory however long and hard the road may be; for without victory, there is no survival."
Winston Churchill

They *can* do that, but it's not a law of economics or anything. And doing so in extremes -- such as quadrupling the price of water and generators after a hurricane -- is usually considered price-gouging.

There is nothing stopping them from selling out their existing inventory with a reasonable markup on the price they actually paid, and then raising the price when their costs actually go up.

There are plenty of examples of retailers using a special, one-time, lower cost of goods to undercut the competition. And there is usually a lag between the time oil jumps on the spot markets and the time prices rise at the pump.

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Man up.

I think something important was left out. Companies, by and large, purchase their products on terms ranging from 30 days to over 100 days. So as long as their inventory is turning right (and if it's not they have other problems), they don't have to worry about pricing current products to buy replacements. They get a period to sell stuff they haven't paid for yet. The whole "replacement" issue only applies to all cash businesses.

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I wasn't born with enough middle fingers.

The fact that the oil company's profits are even making headlines goes to the stereotyping and demonization of "Big Oil." For some reason......their profits are a big issue with a lot of people.

The fact that the demand hasn't decreased tells me that people aren't having trouble purchasing it. Which means they are doing well financially. Which goes to the good economy that we have.

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"This is a time for a national imperative not to fail in Iraq." Condoleeza Rice, January 11, 2007

Actually all it says is that demand for gas is relatively inelastic, like it is for food. We're dependent on it, especially in the short-term.

And oil prices are determined by global demand, not strictly domestic U.S. demand.

To back up your assertion you'd have to look at domestic demand, and also examine what people are forgoing in order to buy the gas they need.

Or so I think. Stekim, do you ever feel like a counselor at a summer camp for Junior Economists?

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Man up.

No, you cannot sell your product for less than what it costs to replace that product. That is a rule of economics, and no one, but no one breaks that rule. Otherwise, you would see HUGE price fluctuations (upward), and gross inconsistencies in price, from region to region, caused by fluctuations in supplies of crude. No you base the price on its replacement cost, plus 2 to 5 cents per gallon, resulting in consistent prices throughout regions. As in the example of the Wal-Mart toothpaste, once inventories of "cheaper stock" is depleted and sold, profit margins return to where they have historically always been. Once depletion of "cheap" crude is consumed, and there is not such a large margin between original cost and future's prices, profit margins will return to where they have historically always been. There is absolutely zero price gauging going on in the oil business. Again, profits are high because of the large spread between original cost and the future cost of replacing the oil sold.

There is no charge for this brilliant lesson in econmics you have just received.

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"Victory at all costs, victory in spite of all terror, victory however long and hard the road may be; for without victory, there is no survival."
Winston Churchill

Please refer to Barney's post above.

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I wasn't born with enough middle fingers.

Very true. All should be required to read my brilliant analysis on how gasoline is priced, and why oil profits are so high.

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"Victory at all costs, victory in spite of all terror, victory however long and hard the road may be; for without victory, there is no survival."
Winston Churchill

The reverse also holds true, as it did in the 80's when oil companies lost money because of falling oil prices. The rule for setting the price of gasoline was the same--it was based on the future's market price of replacing the gallon of gas sold, plus 2 to 5 cents per gallon of gas. But in the 80's, with future prices falling, oil companies had a cost basis that was often higher than the future's price. Consequently, they lost money on the gasoline they sold.

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"Victory at all costs, victory in spite of all terror, victory however long and hard the road may be; for without victory, there is no survival."
Winston Churchill

Actually, all it's telling you is that people are buying it. It does not indicate whether they are having trouble doing so. For the most part people in this country are indeed working. So they have some amount of money. And those people, by and large, MUST buy gas. So they do. But every penny spent on gas is a penny not spent on something else. So what I would do if I were still working as economist is the look into the following (for starters):

1. What is happening to leisure spending across the low to middle range of the income scale?
2. What is happening at the low and medium range retailers? Which are doing well and which are not? Who is shopping there? If Wal Mart is seeing more middle class shoppers moving over to them and lower class shoppers are heading to thrift stores and Dollar General there's a problem brewing.
3. What is happening with consumer debt?
4. What cars are hot?
5. What's happening to the housing market?

If those trends looked good we're OK. If not we're not. But either way, at $3.00 people will still be buying gas.

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I wasn't born with enough middle fingers.