Monday, June 09, 2008

Arbitrage, Gasoline, Diesel, and Mexico

A story was on the local news last night about people in the southwestern U.S. crossing into Mexico to buy gasoline and diesel. Apparently it is significantly cheaper there. The story did not go into why it might be cheaper, although I had some guesses.

My first thought was that gas would not stay cheaper in Mexico for long. This was clearly a kind of abritrage. With people buying less gasoline in the U.S., and more in Mexico, the price of gasoline in Mexico should rise, and the price in the southwestern U.S. should fall. If there were no transportation costs and no differences between the products, then the price should, in equilibrium, be the same in both countries.

Of course, as this article explains, the products are not the same, and clearly there are costs to driving to Mexico to get gasoline and diesel (including waiting in long lines). Also, Mexican gasoline and diesel do not have meet the same regulatory standards as U.S. gasoline and diesel, and there is apparently a possibility that they may be bad for American engines designed to run on cleaner fuels. We therefore should not expect the price to be the same in both countries; the price of Mexican fuel may go up, but it should remain cheaper than U.S. fuel, due to the costs of getting it and the poorer quality.

Mexico also subsidizes its gasoline and diesel to make it more affordable for consumers, but that should not prevent prices from rising if Americans drive over to buy a lot of fuel.

A similar phenomenon is going on in the U.S. between diesel and gasoline. Diesel fuel provides better fuel efficiency than gasoline. For a long time it was cheaper than gasoline, too, but people didn't use it because of the stigma of the poor diesel engines of the 1980s, and because gasoline was cheap enough. Diesel engines were also dirtier than gasoline engines until recently (new regulatory standards were imposed, and automakers have come up with several ways to reduce diesel emissions). As a result of these engine improvements and expensive gasoline, more people began switching to diesel. The price of diesel, of course, started to rise.

What should we expect in equilibrium? We should expect the price of diesel to rise just enough that the marginal consumer is indifferent between buying a car with a diesel engine and a car with a gasoline engine. There should be no significant savings in going with either route. (This could still vary for some drivers, depending on their driving habits.)

2 comments:

Andy said...

My boss drives a Jetta TDI that gets 45-50 mpg, mostly highway. The price of diesel is about $4.75/gal. So he's paying $10-11 every 100 miles. Considering a good fuel efficient gasoline-only car gets around 28-33 mpg highway, at $4/gal or $12-13 for 100 miles, he's still coming out ahead, just barely.

Of course, the transportation industry buys a lot more diesel so the higher prices are killing truckers.

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