Every time gas prices start to go up, my essay “Why Are Gas Prices Rising?” gets a lot of hits from Google searches by people looking for an explanation. Because the supply/demand dynamics have changed, that essay needs dusting off, especially in light of stories like this:
Fuel industry pundits have been left scratching their heads at the recent jump in gas prices, which have increased despite plummeting crude prices.
“The nationwide average retail price of self-serve regular gasoline seems to be defying gravity this month,” according to American Automobile Association (AAA) Director of Public Relations, Geoff Sundtrom, “as it continued to rise in the face of sharply lower prices for crude oil and wholesale gasoline.”
Oil prices closed out at $34.78 per barrel last Friday, according to AAA, the lowest they’ve been since April 5, 2005, when the nationwide average retail gasoline price was $1.76 per gallon compared to Monday’s nationwide average of $1.842. Average nationwide prices jumped slightly to $1.848 on Wednesday. The statewide average is slightly higher at $1.851 per gallon. By this Friday, prices had risen to $46.47, according to The Associated Press.
First things first. Checking the EIA data, their numbers/trends don’t match up. Per the EIA, in April 2005 retail gas prices were $2.28 a gallon (Source) when West Texas Intermediate was trading at $52.98. In early 2009, retail gas prices (per the EIA) are at $1.84 with WTI hovering around $40. AAA is obviously using their own metrics, but a scan of the various EIA gas prices show a pretty consistent trend: Gas and oil prices both sharply down from 2005.
But, it shouldn’t surprise anyone that gas prices would be headed back up – even if oil prices are stagnant. Gasoline had over-corrected to the downside in relation to oil prices. In fact, crack spreads – a measure of the difference between the price of oil and the price of the products – did go negative in late 2008. That is unsustainable, and an indication that gas prices must correct to the upside (or refiners will start to cut production since they are losing money on every barrel). So why are gas prices rising? Because they fell too far. (Nobody ever seems to ask why gas prices fell so much in relation to crude oil; they only get excited when the opposite occurs).
There is another key factor to consider when comparing the behavior of gasoline and oil prices. I have seen them move in opposite directions on numerous occasions. Here is an example of when they might do that. Let’s presume that we have a glut of oil, but a refining bottleneck. In such a case, you would see little demand for oil, keeping the price low. But if refiners are having trouble keeping the gasoline market supplied, then gasoline prices will rise in relation to oil prices. This has taken place multiple times over the past few years, and can usually be understood if you watch the crude and finished product inventories reported each week in This Week in Petroleum.
Other factors that impact the price of gasoline include the strength of gasoline imports (primarily from Europe), and refinery utilization (both of which are reported weekly at the EIA). If gasoline demand is strong, and something happens to reduce the utilization number (e.g., hurricane), prices spike. If demand starts to slacken, you will see refiners start to dial back their utilization.