What We Should Know About Gas Prices

Big Falls, Minnesota

August 29, 2024

This topic is a pet peeve of mine. I get soooo frustrated when people blame or applaud the freaking president for the price of gasoline. In low moments I think the root of the decline of the US will be (or is) how lazy we’ve become in understanding the issues.

Off my soapbox.

I searched the internet for “what everyone should know about the price of gasoline.” That “one pager” that provide everything you need to know on the issue. Alas, I could not find it! What I did find was the following two articles that were the most useful. I’ll continue my search as I think there are still issues we need to understand such as WTI crude versus Breton crude, more explicit understanding of OPEC+’s role is setting supply (and price) and the cost of producing a barrel of oil.

From Gasbuddy.com:

There are many complex factors that impact gas prices, regardless of what you may hear from your friends or read on social media. Although presidents don’t control the actual price of gas, their policies and positions can definitely affect what happens.

Gas prices have historically been a hot—and polarizing—topic in everyday conversations, online, and in the media. Especially during a US Presidential election year, we can expect to encounter unique perspectives on what’s really driving the price of fuel.

We all could benefit from some basic facts about the elements and decisions that determine what US consumers pay for a gallon of gas. The following FAQs are designed to shed some light on the myths and reality about how gas prices are set.

DISPELLING 4 MYTHS ABOUT GAS PRICES

Myth: The US president controls gas prices.

Reality: Presidents and their administrations typically have very little short-term impact on gas prices. Policies at a state level have more impact than the Federal level.

Myth: Gas prices are higher in summer because more people are driving.

Reality: The gas formula mandated to reduce smog in warmer summer months is more expensive to produce—leading to higher seasonal pricing.

Myth: Gas prices are higher because of the reliance on imported oil.

Reality: The US has been the world’s leading oil producer since 2018 and is now a net-exporter of oil.

Myth: Gas prices have been historically much higher since 2008

Reality: In terms of today’s dollars, gas prices have remained relatively flat since 2008. As of June 2024, the inflation-adjusted price is about 35 cents below the 10-year June average.

CAN WE EVER EXPECT TO SEE A RETURN TO “NORMAL” GAS PRICES IN THE US?

“Normal” is often another word for “familiar” or “predictable.” Although various factors significantly impact the price of gas, some are predictable (historically repeatable), and some are unpredictable. Items in the unpredictable category might include natural disasters, rapidly shifting consumer behaviors, and military conflicts in certain regions of the globe.

After multiple years that included unexpected but long-term events such as the COVID-19 pandemic and the Russian invasion of Ukraine, we’re finally seeing a return to “normal.” According to the latest “Tracking Convenience Report” from GasBuddy and PDI Technologies, gas prices began to stabilize into more traditional and predictable patterns in 2023—and that trend has continued in 2024.

HOW MUCH DOES THE US PRESIDENT—OR ADMINISTRATION—CONTROL GAS PRICES?

As much as the occupant of the White House is blamed or lauded for gas prices, the president has little influence, based on a historical understanding of gas prices.

Yes, the president can control certain factors, such as increasing domestic energy output, changing fuel import/export guidance, or adjusting policies on how to manage the nation’s oil reserves. Over an extended period of time, macro-level policies can impact gas prices. In the short term, however, presidential actions have a limited effect on current gas prices.

WHAT ARE THE KEY FACTORS THAT DO INFLUENCE GAS PRICES?

In general, gas prices are influenced by crude oil prices, refining process costs, distribution expenses, station operation charges, and a variety of taxes.

Crude oil prices are the biggest factor. As oil prices rise, gas gets more expensive. As oil prices fall, gas gets cheaper. When global demand is high or supply tightens, the price per barrel rises.

After oil is extracted and traded on energy markets, it needs to be refined into gas. Operational expenses, equipment upkeep, and transportation all factor into the price consumers pay at the pump.

Distribution, logistics, and marketing also add to retail fuel prices. Lastly, fuel taxes, credit card transaction fees, the costs of running gas stations, branding royalties, and regional environmental fees all contribute to the gas prices that consumers see.

IS THERE A STRONG CORRELATION BETWEEN INFLATION AND GAS PRICES?

Although there’s currently a lot of discussion about inflation, from a historical context, gas prices haven’t risen dramatically since 2008 in terms of today’s dollars. Going back a decade, the average price of gas to start summer has averaged an inflation-adjusted $3.99 per gallon.

Current average prices are below that, so while the price may still feel above average, it’s taking the average American less time working to buy a gallon of gas (gas prices peaked in 2008).

Since that time, various changes such as OPEC production levels, Russia’s invasion of Ukraine, and the post-COVID US economy reopening led to a “super surge” in gas prices. However, that surge pricing has dissipated in 2023 and 2024.

WHY DO WE SEE SUCH DISPARITY BETWEEN GAS PRICES IN ANY GIVEN LOCALITY?

The prevailing trend this century has been the transfer of ownership over gas prices from refineries and larger oil companies to public and private retailers or distributors.

Today, gas prices primarily stem from the business strategy chosen by gas retailers and convenience stores, depending on how they want to derive their profits. For example, big-box retailers might be willing to sell gas at or near cost, hoping to attract consumers inside their stores to buy items with higher profit margins.

C-stores featuring private brands tend to establish street prices with just a few pennies of profit margin. They also hope to attract consumers inside their c-stores for higher-margin deli, soft drink, candy, and impulse purchases.

More traditional gas stations tend to rely on consumer brand loyalty or partnership programs with grocery chains or general retailers to help offset gas costs for participating consumers.

WHY ARE GAS PRICES HIGHER IN THE SUMMER?

Each year, consumers can anticipate gas prices rising in the summer months and then falling as colder weather arrives. There’s a simple explanation for this pattern.

During temperate or cold-weather months, gas can include cheaper hydrocarbon components that are volatile but do not violate Clean Air requirements. However, in the warmer months, it’s necessary to limit volatility so gas emissions won’t compromise ozone readings or contribute to smog.

In other words, the gas sold at stations in much of the US between June 1 and September 15 has to be “cleaner”—which makes it more expensive. For instance, when gas prices begin to fall in the run-up to the November 2024 election, it’s not by presidential decree—it’s an easily predictable historical pattern.

WHAT SHORT-TERM FACTORS CAN AFFECT GAS PRICE VOLATILITY?

Much of the US petroleum industry operates with “just-in-time” inventory practices, and there’s rarely a good backup plan if a major refinery shuts down. As a result, any unexpected disruption or even planned maintenance can significantly impact gas prices.

Areas that are particularly dependent on local refineries—including the upper Midwest, the Rocky Mountains, and the West Coast—can experience price spikes on very short notice. That’s why natural disasters such as Hurricane Katrina and cyberattacks such as the one that shut down the Colonial Pipeline can quickly lead to supply chain issues, increased demand, and surge pricing that results in panic buying from consumers.

WHAT HAPPENED TO THE STRATEGIC PETROLEUM RESERVE, WHICH IS NEARLY EMPTY?

In 2015, Congress voted to sell down the strategic petroleum reserve (SPR), highlighting the rise in US oil production and budget deficits. Congress mandated the sale of 360 million barrels between 2017 and 2031. In addition, President Biden authorized the release of 180 million barrels from the SPR in 2022 due to Russia’s invasion of Ukraine creating a surge in oil prices. However, many of the mandated sales have been cancelled, and the Department of Energy has been refilling the SPR virtually every week since mid-2023. Additional deliveries are scheduled to continue through at least November 2024.

From Investopia.com:

OPEC’s Influence on Global Oil Prices

Many of the largest oil-producing countries in the world are part of a cartel known as the Organization of the Petroleum Exporting Countries (OPEC). In 2016, OPEC allied with other top non-OPEC oil-exporting nations to form an even more powerful entity named OPEC+, or “OPEC Plus.”

The cartel’s goal is to exert control over the price of the precious fossil fuel known as crude oil.

OPEC controls about 40% of global oil supplies and more than 80% of proven oil reserves.

This dominant position ensures that the coalition has a significant influence on the price of oil, at least in the short term. Over the long term, its ability to influence the price of oil is diluted, primarily because individual nations have different incentives than does OPEC+ as a whole.

KEY TAKEAWAYS

The Organization of the Petroleum Exporting Countries Plus (OPEC+) is a loosely affiliated entity consisting of the 13 OPEC members and 10 of the world’s major non-OPEC oil-exporting nations.

OPEC+ aims to regulate the supply of oil to set the price on the world market.

OPEC+ came into existence, in part, to counteract other nations’ capacity to produce oil, which could limit OPEC’s ability to control supply and price.

In March 2020, OPEC+ initially failed to reach an agreement about cutting production to stabilize the price of oil as it plummeted during the COVID-19 pandemic.

OPEC+ announced production cuts in October 2022 aimed at bolstering oil prices as they slid on recession concerns.

Oil Price and Supply

As a cartel, the OPEC+ member countries collectively agree on how much oil to produce, which directly affects the ready supply of crude oil in the global market at any given time. OPEC+ subsequently exerts considerable influence over the global market price of oil and, understandably, tends to keep it relatively high to maximize profitability.

If OPEC+ countries are unsatisfied with the price of oil, it is in their interest to cut the supply of oil so that prices rise. However, no individual country actually wants to reduce supply, as this would mean reduced revenue. Ideally, they want the price of oil to rise while they increase supply so that revenue also rises.

However, that is not how market dynamics work. A pledge by OPEC+ to cut supply causes an immediate spike in the price of oil. Over time, the price reverts back to a level, usually lower, when supply is not meaningfully cut or demand adjusts.

Conversely, OPEC+ can decide to boost supply. For instance, on June 22, 2018, the cartel met in Vienna and announced that it would be increasing supply. A big reason for this was to offset the extremely low output by fellow OPEC+ member Venezuela.

Saudi Arabia and Russia, two of the largest oil exporters in the world that both have the ability to increase production, are big proponents of increasing supply, as that would increase their revenue.

However, other nations that cannot ramp up production, either because they are operating at full capacity or are otherwise not allowed to, would be opposed to this.

In the end, the forces of supply and demand determine the price equilibrium, although OPEC+ announcements can temporarily affect the price of oil by altering expectations. A case in point where the expectations of OPEC+ would be altered is when its share of world oil production declines, with new production coming from outside nations such as the United States and Canada.

While oil market developments have repercussions throughout the economy, changes in oil prices have a particular impact on inflation. However, oil’s capacity to drive inflation in the U.S. declined over recent decades as the economy became less oil-dependent.

Oil prices tend to have a greater effect on the Producer Price Index (PPI), which measures prices at the wholesale level, than the Consumer Price Index (CPI), which measures the prices that consumers pay.

OPEC+ Disagreed on Pandemic Production Move

In March 2020, Saudi Arabia, an original member of OPEC, the largest exporter of OPEC, and an extremely influential force in the global oil market, and Russia, the second-leading exporter and, arguably, the second most important player in the recently formed OPEC+, failed to reach an agreement about cutting production to stabilize the price of oil.

Saudi Arabia retaliated by ramping up production sharply.

This sudden increase in supply happened when global oil demand was slumping as the world was dealing with the 2020 global COVID-19 health crisis. As a result, the market, which is the final arbiter of the price, overrode OPEC+’s desire to stabilize the price of oil at a higher level than the laws of supply and demand dictated.

In the spring of 2020, oil prices collapsed amid the COVID-19-related economic slowdown. OPEC and its allies agreed to historic production cuts to stabilize prices, but they still dropped to nearly 20-year lows.

Aside from reaffirming that market forces are more powerful than any cartel, especially in free markets, this episode also gave credence to the premise that individual nations’ agendas will override the cartel’s. Brent crude oil in April 2020 sunk below $20 per barrel, a level not seen since 2001.

West Texas Intermediate (WTI) crude oil, meanwhile, slumped to about $17 per barrel, a level not seen since 2002.

OPEC+ Cuts Production on Recession Concerns

As pandemic restrictions eased around the world, oil prices began to recover along with demand. From lows of less than $17 per barrel in the spring of 2020, WTI prices recovered to more than $80 by October 2021. When Russia invaded Ukraine in February 2022, oil prices climbed even higher, with WTI prices jumping over $115 per barrel by June.

As the second-largest exporter in OPEC+ engaged in a violent conflict with its neighbor and inflamed tensions with the U.S. and Europe, the market showed its concerns about the stability of oil supplies.

Although the war raged on, with little to indicate a possible easing of geopolitical tensions, oil prices began to moderate in the second half of 2022. WTI slipped back down toward $100 per barrel by July.

As fears of a global recession raised questions about demand for oil around the world, OPEC+ sprang into action, announcing that it would cut production by 2 million barrels per day in an attempt to stabilize the recently sliding prices. The OPEC+ move came despite opposition from the U.S., with President Biden calling the production cuts “shortsighted.”

It remains to be seen how effective the OPEC+ production cuts will be in slowing or reversing oil price declines. Continued concerns about a global recession could overshadow the potential for a tighter supply implied by the coalition’s production cutbacks.

However, the recent turmoil in the oil markets is a great example of the mechanisms that OPEC+ uses to influence prices and their far-reaching impact on the global economy.

Which countries are part of OPEC+?

The Organization of the Petroleum Exporting Countries (OPEC) has 12 members: Algeria, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, the United Arab Emirates, and Venezuela.

In 2016, OPEC formed the alliance known as OPEC+ with 10 other top oil-producing nations: Azerbaijan, Bahrain, Brunei, Kazakhstan, Malaysia, Mexico, Oman, Russia, South Sudan, and Sudan.

How does OPEC+ control oil prices?

OPEC+ regulates the supply of oil to influence the price of the commodity on the world market. The group can achieve this by coordinating supply cuts when the price is deemed too low and supply increases when its members believe prices are too high.

How do oil prices affect the U.S. economy?

Oil prices have a multifaceted impact because of the diversity of industries operating within the U.S. economy.

Higher oil prices can help create jobs and drive investments as it begins to make economic sense for companies to develop high-cost shale oil projects. However, elevated oil prices affect consumers and businesses by increasing transportation and manufacturing costs.

Lower oil prices have the opposite impact—limiting unconventional oil activity but benefiting other sectors that are sensitive to fuel costs.

The Bottom Line

The Organization of the Petroleum Exporting Countries (OPEC) and the broader coalition known as OPEC+ leverage their countries’ dominant market position to exert a strong influence over global oil prices. However, divergent long-term goals for member countries and increased production from countries outside the group may limit the capacity of OPEC+ to control prices over the long term.