5 Things That Actually Determine the Price of Gasoline
Written by Brian Merchant
The price of gasoline is one of the most important variables in daily American life. The vast majority of Americans own cars—there are some 240 million of them on the road—and rely on them to commute to work and for general transportation. Whenever gas prices get too high, it can cause an economic shock for hundreds of millions of people. So whenever those prices show signs of heading towards the $4 a gallon mark, a mild panic ensues. Typically, it arises from the genuine concern of ordinary citizens, and then is promptly fanned into something resembling hysteria by opportunistic politicians and pundits.
Exhibit A: Drill, baby, drill.
Republicans take advantage of the gas anxiety to claim that a lack of domestic drilling and too-tough regulations that are causing prices to spike. Specifically, they allege that Obama’s tree-hugging energy policies are preventing oil companies from opening reserves and providing the markets with cheap, American-made oil. This is nonsense, but it plays well with voters. In reality, oil is traded as a commodity on the global marketplace, and its price is prone to wax and wane according to various market forces. In fact, domestic drilling policy is one of the least important factors in today’s price of oil. So let’s take a quick look at what actually determines how much you’re paying at the pump.
1. Global Supply and Demand
This is the biggie. Gasoline prices are tied to oil prices, and oil consumption is booming, especially in places like China, India, and Brazil. It’s not relenting in the U.S., either. But supply remains relatively fixed—new oil discoveries are fewer and far between in modern times, and that which we do find is often harder and more expensive to get. As the commodity grows scarcer on a global level, prices rise. That’s why many experts now believe that the era of cheap oil is over—and that we can expect it to continue to rise in the longterm. As for the short term, Reuters offers a look at how global demand can mess with prices;
Japan, for example, is replacing some of its nuclear energy with oil. Its oil imports appear to be running about twice pre-tsunami levels. In addition, there has been some pick-up in demand from Asia. Note that the IEA forecasts oil consumption to rise 830k this year after a 740k bpd increase last year. The unusually cold European winter is also thought to be boosting demand.
2. Instability in Oil-Producing Regions
As you’re likely aware, much of the world’s oil comes from nations in more volatile parts of the world. And when the market perceives a risk that political instability, diplomatic tensions, or regional violence might cut off the flow of oil, it reacts. That’s why we saw prices spike after tensions escalated with Iran. Marc Chandler at Brown Brothers Harriman told Reuters that the “Iranian confrontation and its response (to cut sales to the UK and France) has also taken supply out of the market. The bellicose rhetoric and fear of an escalation raises the risk premium as well.”
Additionally, civil wars or political uprisings can have similar effects. “Between Sudan, Yemen and Syria, nearly 750k barrels per day (bpd) have been taken out of production due to political instability,” Chandler said. “On top of this Libyan oil output is about 600k bpd below pre-civil war levels.”
Since political volatility racks many of the world’s largest oil exporters—Nigeria, Venezuela, Libya, Iran, Iraq, Sudan, etc—it plays a very real factor in influencing both global supply and the risk premium of the oil coming out of the region. Bankers who trade in oil futures will make bets that such volatility will increase the cost of oil, and they can raise the cost of the commodity as a result.
Photo from Maggie Osama via flickr
3. Financial Speculation
Financial speculators gamble on the oil futures market, effectively spurring the market price to rise and fall apart from the laws of supply and demand. Experts assert that net impact has typically been the overinflation of the price of oil. The U.S. Senator Bernie Sanders recently penned an op-ed in CNN describing the impact this process has on oil markets:
The CEO of Exxon-Mobil, Rex Tillerson, told a Senate hearing last year that speculation was driving up the price of a barrel of oil by as much as 40%. The general counsel of Delta Airlines, Ben Hirst, and the experts at Goldman Sachs also said excessive speculation is causing oil prices to spike by up to 40%. Even Saudi Arabia, the largest exporter of oil in the world, told the Bush administration back in 2008, during the last major spike in oil prices, that speculation was responsible for about $40 of a barrel of oil.
I won’t get into the details about how betting on oil futures works here, but see HowStuffWorks for an elementary introduction.
Photo from jcoterhals via flickr
4. Domestic Energy Policies
And here, way down near the bottom, we get to domestic energy policy. And that’s because there’s very little that a government can do to reduce the price of oil on the market. But governments can, of course, make gasoline cheaper by subsidizing its sale (nations like Venezuela do this in extreme measures to provide citizens with dirt cheap gas). And they can make it more expensive by taxing it. In fact, high gas taxes can have the longterm effect of buffering citizens from oil shocks— transportation planning evolves to accommodate higher petroleum costs, the market incentivizes more efficient cars, and folks aren’t as vulnerable when gas prices rise. In the United States, the gas tax is extremely low—it’s the lowest in the industrialized world. As such, citizens here remain quite vulnerable to the whims of the forces described above.
It’s also important to note that expanding domestic drilling would have almost no discernible impact on gas prices in the near-term, and a very small one in the longterm. It would take years before the sought after oil could be drilled, refined, transported, and taken to market, during which the market could care less about bombastic GOP rhetoric. But even opening every last remaining parcel of land in the U.S. to drilling would hardly yield a drop in the bucket in terms of the global marketplace—our proven reserves are minuscule by comparison. So it wouldn’t be enough volume to meaningfully beef up the supply level on the global scale.
Photo from conarcist via flickr
5. Seasonal Factors
It also needs to be mentioned that seasonal conditions can influence the price of gas. Gasoline typically gets around $0.20-0.50 more expensive in the summer for instance, because, as Brad Plumer explains in the Washington Post, “refiners stop blending gasoline with cheap butane and swap in more expensive ingredients that don’t evaporate as easily in the heat.”
Not Even the US President Can Control the Price of Gas
That’s the bottom line. Nothing Barack Obama—or the U.S. Congress—does will have much of an impact on the price of oil tomorrow. Globalized trade has created a web of various interlocking forces that instead determine the price of oil, much as has happened with other commodities. The president can tap the strategic reserve—as Obama’s fellow Democrats are leaning on him to do now—and he can lean on OPEC to release more oil supply into the market. He can approve the aforementioned drilling measures that would trickle into the market years down the road, but that wouldn’t impact today’s gas prices.
It’s also worth mentioning the myriad costs that don’t factor into the price we pay at the pump. Extracting, transporting, and burning gasoline creates all kinds of externalities that we pay for elsewhere—in health costs at the hospital, in wear and tear in roads, in environmental cleanup after disasters like the BP spill, and for the pollution that impacts society at large. Studies have shown that gasoline should be up to $11 more expensive because of these unaccounted-for costs. Of course, we’re actually already paying those costs—we just don’t notice it immediately as we fill up at the pump. So keep that in mind next time prices rise: if they reflected their true cost, you’d be paying some $150 to fill up your car. That $0.50 spike suddenly won’t seem as bad by comparison.
This post was originally published by TreeHugger.
Photo from brentdanley via flickr
Photo from taylor.a via flickr