Saturday, May 10, 2008

Gasoline Price Level vs Volatility

Gas tax hikes may not affect lower and middle class people so much if gas tax revenue is used for tax rebates. But another question is: would raising gasoline tax to $1, $3 or even $7 cause a lot of suffering among businesses?

The answer is no. Here's why: business will always try to pass the gas price hikes to consumers, whether that price hike is due to OPEC's manipulation, speculator's bidding frenzy or government taxation. What business really care about is not the level of gas price, but the volatility of gas price.

If a business has an Oracle that tells him, that gas price will stay at $10 +/- 10% in the next year, he will devise a strategy based on this number, decide how much product to manufacture, how much inventory to carry, how many delivery trucks to deploy, how many people to hire, and ultimately, the price he's going to charge. He has certainty at least about one thing, gas price, and it's valuable.

If on the other hand, a business has no such Oracle, the price of gas can double or half in a year. Then he'd have to guess: if he guess too low, he ends up charging too little, losing money if gas prices skyrockets; if he guess too high, he may charge too much and then lose customers to competitors who may have guessed better or may have just lucked out. Look at GM and Ford with huge inventories of SUV and other gas guzzlers sitting unmoved in the lot. Gas prices moved on , so Americans passed them by.

So when untaxed gasoline prices in America moved from $1.5 to $3.7, the heavily taxed gasline prices in Europe only moved from $6 to $8/gallon. In absolute terms, European businesses are paying more. But in relative terms, their businesses are better positioned strategically and can better absorb this hike.

No comments: