Why Are Gas Prices Going Up and Down?
Oil prices, commodities traders, and supply and demand all affect gas prices
Gas prices in 2020 have been on a rollercoaster ride. The price for a gallon of regular gas was $2.58 on Jan. 6, 2020. It plummeted 31% to $1.77 a gallon on April 27. It then rose 24% to $2.20 a gallon on July 13. As of Aug. 17, 2020, the average price per gallon is $2.17. A combination of factors, including the response to the coronavirus pandemic, created this extreme volatility.
What Impacts Gas Prices?
High gas prices are created by high crude oil prices. Oil costs account for 54% of the price of regular gasoline. The remaining 46% comes from distribution and marketing, refining, and taxes. These inputs don't change as frequently as oil prices do.
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 expect to also see the price of gas eventually rise at the pump. A $10 rise in oil prices translates to a $0.25 increase in gas prices 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. Gas prices fell to their lowest levels in five years. But that shale oil 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 go on vacation and hit the road. Regulations also require a shift to summer-grade gasoline, which is more expensive to produce.
Traders of commodities like gasoline, wheat, and gold, also cause high gas prices. They buy oil and gasoline at 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.
Since 2008, both gas and oil prices are affected more 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.
When traders think gas or oil prices will be high, they often bid them up even higher.
Normally, that occurs in the spring. Traders start buying oil futures contracts in anticipation of the summer price rise.
In this way, commodities traders create a self-fulfilling prophecy. This 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 dollar declines. Oil prices rose between 2002 and 2008 because the dollar lost 26% of its value during that time.
Oil contracts are all denominated in dollars.
Oil prices fell between late 2014 and 2016 in part due to this reason. A strong dollar allowed the members of the Organization of the 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.
In May, fears about unrest in Libya and Egypt sent oil prices up to $127 a barrel. In April, when 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.
In February, concerns about potential military action against Iran, by either Israel or even the United States, caused high oil prices. Second, some U.S. oil refineries were closing. Third, 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 $3.50 by February 15, two weeks earlier than in 2011. By mid-March, the national average had jumped to $3.87 a gallon. The price of WTI oil exceeded $100 a barrel.
Prices were high in August as a result of Hurricane Isaac, which hit the U.S. Gulf Coast region on Aug. 28, 2012. In anticipation of the Category 1 hurricane, refineries in the area shut down production. As a result, crude oil production lost 1.3 million barrels per day. This caused the average national price of gas to jump in one week from $3.78 per gallon to $3.84 per gallon.
Iran started war games near the Strait of Hormuz in March 2013. Almost 20% of the world's oil flows through this narrow checkpoint bordering Iran and Oman.
If Iran threatened to close the Strait of Hormuz, it would have raised the fear of a dramatic decline in oil supply.
In anticipation of such a crisis, oil traders bid up the price, which reached $118.90 a barrel on February 8. Gas prices soon followed, rising to $3.78 a gallon by February 25. These rose again in August 2013 because oil prices hit a 15-month high that summer. That spike was created by political unrest in Egypt.
Gas prices rose in April because the price for WTI oil rose to $104 a barrel. New pipelines from the Cushing, Oklahoma, storage hub lowered inventories to the lowest level since November 2009.
The price of imported Brent oil rose to $110 per barrel in May. This was caused by the Ukraine crisis, as well as unrest in oil-producers Nigeria and Iraq.
California experienced a gas price surge to $3.29 a gallon in July. It was the first time the state had the highest price in the country. 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.
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 oil prices to $51.50 a barrel in December 2016. That was double the 13-year low of $26.55 a barrel in January 2016. Gas prices rose for 14 consecutive days after the meeting. The national average of $2.21 per gallon was up 20 cents compared to the same time period the previous year.
On August 25, Hurricane Harvey attacked Texas, wiping out 5% of the nation's oil and gas production. Gas prices rose from $2.36 a gallon to $2.69 gallon. By September, the 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 of 2018, they again cut production.
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 rose to $2.90 a gallon in October.
Oil prices entered a bear market, a 20% decline, in 2019. The price of WTI oil peaked at $66.24 on April 23, 2019. It fell to $52.41 on Oct. 3, 2019.
One reason is that U.S. oil production increased to a record of 12.8 mbpd in December 2019. It was also the first time since 1948 that the U.S. exported more oil than it imported.
At the same time, demand slowed in the fourth quarter, from 102.12 mbpd in the third quarter to 101.71 mbpd.
In January 2020, governments began shutting down travel and businesses to stem the pandemic. By April, 40% of the world's population had been told to stay at home. Demand for oil fell by 5.6% in the first quarter of 2020.
A drop in demand was worsened by a supply glut. On March 6, Russia announced it would increase production to offset falling prices. To remain competitive, OPEC also increased production. As oil storage facilities filled, oil and gas prices plummeted.
On April 12, 2020, OPEC and Russia agreed to lower output to support prices. It wasn't enough. By April 20, 2020, the price for a barrel of oil had fallen to about -$37. Traders were willing to pay someone else to take delivery of the oil since they couldn't store it.
Factors That Force High Gas Prices to Drop
The April to September vacation-driving season often causes an increase in gas prices. Prices fall in the winter since 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 United States.
Gas prices drop when supply increases. There are a lot of ways that could happen. OPEC could decide to release more oil. Shale oil producers could find another large deposit or create new technology.
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 all these factors have on commodities traders. If they believe oil and gas prices will fall, they won't bid up futures contracts. They may even find another investment, allowing prices to decline further.
How Can We Reduce Gas Prices?
The most immediate thing we can do is reduce our usage of gas by driving less or increasing fuel efficiency. An easy way to improve fuel efficiency is to keep tires inflated. Keeping the engine properly tuned can save $0.09/gallon.
Urban dwellers can use public transit. Others can move closer to work 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? They might if they were on a sustained basis over a long period of time.
The only real way for consumers to lower gas prices is to reduce demand for gas and oil for a sustained period.
But the demand for gasoline and fuel isn't declining, and it's unclear whether the development of alternative fuels will help. The U.S. consumes 20% of the world's oil. This has remained fairly stable over the last 20 years, at around 20 mbpd.