About The Price At The Pump

More on Gasoline Prices - 2 November

Updated 10.30 am Pacific
Gasoline prices at the pump have dropped a record 27 percent since 11 August. This drop cannot fully be accounted for by the decline in crude oil prices, even though the steep decline in crude prices seen since August are also a departure from historical trends.

On 13 August, CNN reported that Lundberg Survey pegged national gasoline prices at an all-time high* of $3.03 gallon for self-serve regular.

This week, Lundberg says the average price is $2.20 -- a drop of 82 cents, a 27 percent drop. This is a 50-cent drop from a year ago, according to the Department of Energy (DOE).

Is this normal market behavior?

Gas Pricing Explained
Prices, according to DOE, normally "dip" in the early fall, ostensibly linked to a decline in the amount of time Americans spend in cars post-summer vacation. Prices historically rise again in late fall, ostensibly due to an increase in the demand for that crude to be converted to fuel oil to heat northern homes.

There are four components to the price of gasoline at the pump: crude oil price, refining costs, distribution costs (that includes marketing and ads), and taxes. According to DOE, in August 2006, 55 percent of that price was crude. (For diesel, it's 54 percent). (See a chart)

Taxes are fixed, at least in the short term. Refining costs don't vary widely from month-to-month, although they may go up at an individual refinery, on a per gallon basis, if the volume of incoming crude declines. Distribution costs are nominally affected by the cost of diesel (the trucks that deliver to the gasoline station). Advertising/marketing are discretionary sums that can vary according to executive whim.

But the largest -- and most volatile -- portion of the price is crude.

Calculating What's Happened Here
If we round down to 50 percent the share of the pump price attributed to crude (it makes the math easier), then crude prices would have had to deline 54 percent (2x27) to effect a 27 percent change at the pump. All other things being equal, of course.

Crude oil prices have fluctuated wildly (in real, 2006 dollars) only twice since 1947: 1973-85 (the energy crisis resulted a six-fold increase over a five year period) and 1998-2005 (almost a six-fold increase in a seven year period).

What has happened to the price of crude since August 2006? Did it decrease 50 percent? No.

According to DOE, on 13 October, the US crude oil price was $53.72. On 11 August, it was $69.52. This is a drop of $15.80 or only 23 percent.

The drop in crude price should translate to an average national pump price of about $2.65, not $2.20 .... based strictly on the price of the primary ingredient, crude oil.

Crude Price Drop Not Typical
This DOE chart of crude oil prices shows that the steep drop in crude oil prices from August to October is not typical.

So, what has happened to cause the markets to devalue crude oil? Is world demand down? No. Is US demand down? No.

The demand for oil continues to rise, according to DOE: "oil demand increased slightly last year, even as the near-month futures price for West Texas Intermediate crude oil rose from the low $40s early in 2005 to above $60 per barrel later in the year."

DOE: It's Increased Inventory
DOE explains away the sudden and dramatic price drop by asserting that inventories are up. In other words, DOE says oil companies are stockpiling crude. The reason, according to DOE, is that current prices for crude are significantly different enough from futures prices for companies to buy today and sit on the stock.

Thus, the DOE says that inventory (supply) is "up" so that depresses prices -- which would be true for the price of crude if inventories meant oil companies were buying less crude.

But DOE also says that they are buying more crude. And DOE data do show demand is higher today than a year ago. This demand pressure should raise, not lower, the price of crude.

Update:
DOE data from February through July do not support the contention that energy firms stocks are on the rise. July ending stocks were lower than February -- and strategic reserve stocks (those mandated by the government) peaked in May.

However, for the six-year period 2000-2005, stocks rose steadily year-to-year. So even with Katrina and shutdown of the Gulf, ending stocks -- even the strategic petroleum reserve -- increased in 2005 compared to 2004.

Add to this equation: the world supply of oil for the first seven months of 2006 averaged 84,219,000 barrels per day. This is less than the 2005 average: 84,338,000 barrels. But prices today are lower than a year ago, which is backwards (according to basic supply-demand theory).

What about world demand? For 2005, the average was 83,840,000 barrels a day. The first six months of 2006, demand was up: 84,166,000 barrels a day. Increased demand means increased prices, according to standard economic theory.

Argue, if you like, whether these numbers show crude prices should be moving up or down. I've pondered this for days and can't make any sense of it.

Aruge, if you like, but doesn't matter: Only about half of the decline in US gasoline prices since August can be explained by crude oil prices. Is the other half the fact that mid-term elections are around the corner?

Your answer to that question probably reflects the degree of your cynicism in today's polarized -- and financially exorbitant -- campaign season.

Added: Reuters reported last week that consumer confidence -- and retail sales -- were up due in no small part to falling gasoline prices. Happy consumers less likely to throw the incumbents out? What do you think?

One reader thinks Goldman Sachs had something to do with this. Read her comment.

^{* The August price comes in second to March 1981, when gas was $3.16 in inflation-adjusted dollars.}

Related:

• Gas Gouging? - 15 March 2006
• Gasoline $4 a Gallon? Reserves Released - 31 August 2005
• National Gas Price Map

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