The Price of Gas: Why It Goes Up and Down

History and Factors Impacting Gas Prices

why are gas prices so high? supply and demand, commodities trading and decline of a dollar's value

The Balance / Theresa Chiechi

Gas prices in 2020 and 2021 have been on a rollercoaster ride. The price for a gallon of regular gas was $2.58 on January 6, 2020. It plummeted 31% to $1.77 by the end of April 2020 and then rose 24% to $2.20 a gallon on July 13, 2020.

The cost of gas remained relatively stable through the beginning of 2021, starting the year at $2.24, though prices were on an upward trajectory. By the beginning of August 2021, the price was up to $3.16.

A combination of factors, including the response to the coronavirus pandemic, created this extreme volatility.

Key Takeaways

  • Oil costs account for 43% of gas costs, so when the price of crude oil goes up, so does the price of gas.
  • Many factors affect oil and gas prices, including seasonal demand, commodities speculation, and the value of the U.S. dollar.
  • To potentially lower gas prices over time, consumers and governments could prioritize fuel efficiency, alternative fuels, and public transit.

What Impacts Gas Prices?

High gas prices are created, in large part, by high crude oil prices. Oil costs account for 43% of the price of regular gasoline. The remaining 57% comes from distribution and marketing, refining, and taxes. These inputs don't change as frequently as oil prices do.

Important

Two grades of oil are benchmarks for other oil prices. West Texas Intermediate (WTI) is the benchmark for U.S. oil prices. Brent North Sea oil is the benchmark for global oil prices.

When oil prices rise, you can also expect to see the price of gas eventually rise at the pump. A $10 rise in oil prices (per barrel) translates to a $0.25 increase in gas prices (per gallon) over the long term.

Gas prices and underlying oil prices are determined by three factors: supply and demand, commodities traders, and the value of the dollar.

Supply and Demand

Like most of the things you buy, supply and demand affect both gas and oil prices. When demand is greater than supply, prices rise. For example, the exploration of new U.S. shale oil reserves increased the oil supply in 2014, and gas prices fell, but that boom reversed when low prices put many producers out of business.

Seasonal demand also affects oil and gas prices. Normally, gas prices rise every spring. The demand for gas increases in the summer as families hit the road to go on vacation. Regulations also require a shift to summer-grade gasoline, which is more expensive to produce.

Commodities Traders

Traders of commodities, such as gasoline, wheat, and gold, also cause high gas prices. They buy oil and gasoline on the commodities futures markets. Those markets allow companies to buy contracts of gasoline for future delivery at an agreed-upon price. But most traders have no intention of taking ownership. Instead, they plan to sell the contract for a profit. 

Both gas and oil prices are affected by the ups and downs in these futures contracts. The price depends on what buyers think the price of gas or oil will be in the future.

Note

When traders think that gas or oil prices will be high, they often bid them up even higher. Normally, that occurs in the spring as traders start buying oil futures contracts in anticipation of the summer price rise.

In this way, commodities traders create a self-fulfilling prophecy, which leads to an asset bubble. Unfortunately, the one who pays for this bubble is you, at the gas pump.

The Value of the Dollar

Gas and oil prices also rise when the value of the U.S. dollar declines. Oil prices rose between 2002 and 2008 because the dollar depreciated significantly during that time.

Note

Oil contracts are all denominated in dollars. 

Oil prices fell between late 2014 and 2016, partly for this reason.strong dollar allowed the members of the Organization of Petroleum Exporting Countries (OPEC) to make more money while keeping supply constant. 

History of Gas Prices

Here's how different situations—from conflict on the world stage to engineering mishaps—have affected the price of gasoline.

2011

In May, fears about unrest in Libya and Egypt sent oil prices up to nearly $127 per barrel. Even after oil prices dropped, the price at the pump stayed high. Why? Commodities traders were concerned about refinery closures due to the record Mississippi River floods.

2012

In February, concerns about potential military action against Iran—by either Israel or the U.S.—caused high oil prices. At the same time, some U.S. oil refineries were closing. Additionally, oil and gas prices tend to rise every spring, in anticipation of increased demand during the summer.

As a result, the price for a gallon of gasoline was above $3.50 by February 13, several weeks earlier than in 2011. By late March, the national average had jumped to $3.91 per gallon. The price of WTI oil exceeded $100 per barrel.

Prices were high in August as a result of Hurricane Isaac, which hit the U.S. Gulf Coast region on August 28, 2012. In anticipation of the Category 1 hurricane, refineries in the area shut down production. As a result, crude oil production lost nearly 1.3 million barrels per day, which caused the national average price of gas to increase.

2013

Iran started making threats regarding the Strait of Hormuz in March 2013. Almost 20% of the world's oil flows through that narrow checkpoint bordering Iran and Oman.

In anticipation of such a crisis, oil traders bid up the price, which reached $118.90 per barrel on February 8. Gas prices soon followed, rising to $3.78 per gallon by February 25. Prices rose again in August as oil prices hit a 15-month high that summer. That spike was created by political unrest in Egypt.

2014

Gas prices rose in April because the price for WTI oil rose to $104 per barrel. New pipelines from the Cushing, Oklahoma, storage hub pushed inventories to the lowest levels since November 2009.

The price of imported Brent oil rose to $111 per barrel in May. This spike was caused by the Ukraine crisis as well as unrest in Nigeria and Iraq, two significant oil producers.

2015

In 2015, California experienced the highest gas prices in the country for the first time, with an average annual price of $3.16. Midwest refinery problems sent California's oil elsewhere. Since it doesn't have major pipelines from other regions, California had to wait for tankers with imported oil to arrive. 

2016

Gas prices rose when OPEC cut production in November. Members agreed to reduce supply by 1.2 million barrels per day in January 2017. In response, traders bid up oil prices in December 2016. 

Gas prices rose for 14 consecutive days after the OPEC meeting. The national average of $2.23 per gallon was up 20 cents, compared to the same time period the previous year.

2017

On August 25, Hurricane Harvey attacked Texas, wiping out 5% of the nation's oil and gas production. Gas prices rose from $2.37 per gallon to $2.68 per gallon in a matter of weeks. By September, the U.S. Department of Energy had released 5.2 million barrels of oil from the Strategic Petroleum Reserve.

In November, OPEC agreed to keep production cuts through 2018. At a meeting of OPEC and non-OPEC oil-producing nations in December 2018, they again cut production.

2018

Thanks to increased shale oil drilling, the U.S. became the world’s largest oil producer.

In May, global oil prices reached $80 per barrel following the U.S. decision to pull out of the Iran nuclear agreement and reinstate sanctions. Production in Iran dropped from 3.84 million barrels per day (Mbpd) in January to 2.6 Mbpd in December 2018. In addition, Venezuela faced limited production. Gas prices reached $2.90 per gallon in October.

2019

Oil prices entered a bear market in 2019. The price of WTI oil peaked at $66.24 per barrel on April 23, 2019. It fell to $52.41 on October 3, 2019. One reason was that U.S. oil production had increased to a record of 12.8 Mbpd by late 2019. It was also the first time since at least 1948 that the U.S. exported more oil than it imported.

2020

In January 2020, governments began shutting down travel and businesses to stem the COVID-19 pandemic. By April, much of the world's population had been told to stay at home. Demand for oil fell by 5,600 barrels per day in the first quarter of 2020.

A drop in demand was worsened by a supply glut. On March 6, Russia announced that it would increase production to offset falling prices. To remain competitive, OPEC also increased production. As oil-storage facilities filled up, oil and gas prices plummeted.

On April 12, 2020, OPEC and Russia agreed to lower output in order to support prices. It wasn't enough, however. By April 20, 2020, the price for a barrel of oil had fallen to about minus $37. Traders were willing to pay someone else to take delivery of the oil, since they couldn't store it.

2021

In March 2021, a year into the pandemic, a decrease in lifestyle restrictions drove up demand for gas as more people began driving again. By the beginning of May, the price of $2.89 was the highest average price seen since April 2019.

As more people become vaccinated, it's likely that demand for gasoline will only continue to rise and therefore increase the price.

Factors That Force High Gas Prices To Drop

The April-to-September vacation-driving season often causes an increase in gas prices. Prices tend to fall in the winter because transportation needs and production costs are lower. This price decrease even offsets an increase in home heating oil usage for winter in northern areas of the U.S.

Gas prices usually drop when supply increases. There are a lot of ways that could happen; for example, OPEC could decide to release more oil, or shale oil producers could find another large deposit or adopt new technology.

Note

Prices also fall as the dollar's value rises. OPEC can allow supply to expand, since they'll remain profitable with a rising dollar.

Most important is the impact that all of these factors have on commodities traders. If they believe that oil and gas prices will fall, they won't bid up futures contracts. They may even find another investment, which would allow prices to decline further.

How Can We Reduce Gas Prices?

The most immediate thing we can do is to reduce our usage of gas by driving less or increasing fuel efficiency. One easy way to improve fuel efficiency is to keep tires inflated. Keeping the engine properly tuned can save $0.13 per gallon. Urban dwellers can use public transit. Others can move closer to work in order to reduce commuting time. 

For the long term, we can change our need for oil and gas by switching to alternative-fuel vehicles. Although gas prices are lower now, they will become lower still as demand drops.

Could these actions reduce the high price of gas? Maybe, if they are sustained over a long period of time.

Important

The best way for consumers to lower gas prices is to reduce demand for gas and oil for a sustained period.

The demand for gasoline and fuel isn't declining, and it's unclear whether the development of alternative forms of energy will help. The U.S. consumes 20% of the world's oil.

Frequently Asked Questions (FAQs)

Who controls gas prices?

Although many politicians would like to take credit for falling gas prices—and blame their rivals for rising prices—gas prices are mostly affected by market forces. Legislation and policy can have an effect on gas prices, but no one person or entity controls prices.

What state has the highest gas prices?

California, Hawaii, and Nevada usually have the highest average fuel price in the U.S., while Texas, Louisiana, and Mississippi have the cheapest prices.

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

Gas prices can have a significant impact on the economy. When consumers spend more or less on fuel, they have more or less to spend on other goods and services, so it can have effects on demand throughout the economy. Further, gasoline prices are based on the price of crude oil, and fluctuations in the price of crude oil can have effects on inflation. Increases in crude oil prices often precede recessions.