Gasoline price affects every sphere of society, whether through inflation or geopolitics. Crude oil, one of the most widely traded commodities, makes up 61% of the gas price and is what determines gas prices in large part. Crude is also one of the most volatile commodities. Its prices plummeted into an anomaly, hitting negative prices during the COVID-19 pandemic, and then broke its previous high of $147.50 in 2022 due to the Russia-Ukraine conflict. The price of gasoline touched record highs in May 2022. So, why are gas prices going up? And, what determines the gas price? Let's find out.
What Determines Gas Price?
You may ask, "how are gas prices determined" but it is a complicated answer. The price of gas depends on several domestic and international factors. For a more straightforward understanding, you can break down the cost of gas into four major components:
- Price of Crude - Crude oil is a significant supply for global energy demand. Since it is used in every economic sector, oil demand rises during an economic boom and decreases during a recession. Major oil-producing nations can also influence the price of global crude by increasing or decreasing production (supply). Even though most oil-producing and exporting countries are bound by international organizations like the Organization of the Petroleum Exporting Countries (OPEC) and the International Energy Agency (IEA), regional conflicts in the Middle East, and recently in East Europe, often create oil crises. The price of crude, on average, determines 50-60% of gas prices in the US.
- Price of US Dollar - The final price that the US pays for crude oil also depends on the price of the US dollar with respect to the currencies of crude exporting countries. If the USD grows stronger than other currencies, the US can buy more oil for the same amount. The US Energy Information Administration (EIA) publishes inflation-adjusted gas prices for different states to reflect any changes in the US Dollar.
- Refining Costs - Crude oil is refined to create different petroleum products like diesel, gasoline, jet fuel, kerosene, paraffin, etc. According to EIA, refining costs 14% (as of 2021) of gas prices in the US. The domestic refining capacity was damaged during COVID lockdowns when companies were forced to shut down shops. Currently, there is a shortage of refining capacity in the US, pushing up gas prices. Refining costs can decrease with the development of refining infrastructure and cheaper refining technology.
- Distribution and Marketing Cost - Distribution costs are a major gas price determinant. It includes the shipping, storing, and distribution of gas from refineries to the final consumer. The supply chain may consist of multiple companies providing different services to make gas available to the end-user. Distribution and marketing cost $0.12 for every $1 worth of gas you buy at the pump. The shutdown of the Keystone XL pipeline project from Canada by the US government in June 2021 has hurt the gas distribution network for some states. The pipeline would have transported 830,000 barrels of oil per day to Nebraska, cutting down a major portion of the distribution costs. The same oil is now being imported through rail.
- State and Federal Taxes - Almost 17% of gas prices are made up of federal and state taxes. As of January 2022, the federal gasoline tax was 18.40 cents per gallon, and the average state tax was 31.02 cents per gallon. New carbon-taxation policies may increase tax on crude imports and hurt gas prices in the near future.
Apart from these four components of gas price, the price you pay to fill up your tank can also depend on the following factors:
- Market Conditions - Global crude price depends on many other external factors that can shock interconnected oil markets. Oil futures traders in Texas sold WTI (West Texas Intermediate) crude at a negative price during the 2020 pandemic because they could not physically ship the oil due for delivery during global lockdowns. Similarly, traders had to discount Ural oil during the 2022 Russia-Ukraine conflict due to west-led sanctions on Russia.
- Domestic Shale Gas Production - The US Shale Revolution has helped stabilize the energy supply in the country, reducing oil imports and foreign dependency on oil. According to the Energy Information Administration, shale production in the US rose by 0.72 bpd in 2022 to 11.91 bpd. Increasing domestic production can decrease oil imports and strengthen the US dollar.
Why Are Gas Prices Going Up?
Gas price is primarily determined by the supply and demand for global crude oil. Other costs in procuring, refining, marketing, distribution, and taxes usually don't change drastically. The demand for global crude comes from growing economies, but it can also stop during a slowdown or recession. Here's why gas prices are going up in the US.
- Russia-Ukraine Conflict: The recent hike in gas prices is primarily due to the supply side breakdown caused by the Russia-Ukraine conflict. A major oil exporter, Russia was hit by sanctions from the West, cutting off huge oil supplies to Europe. Many oil companies like Exxon Mobil, British Petroleum, Shell, Equinor, and Total Energies have exited Russia, and this may have a long-term effect on the global oil supply. The sudden supply vacuum forced the price of global crude oil to break its 14-year high in the summer of 2008. The EIA predicts gas prices to remain above $100 a barrel until the Russia-Ukraine conflict settles. Refinery capacity across the globe is also at an inflection point which may reduce capacity and supply.
- Increasing Demand in Asian Markets: Another reason for rising gas prices is China's easing COVID lockdowns. China is one of the biggest consumers of petroleum products, and an increasing demand can further push up the prices. Similarly, most economies of Asia are rising after the temporary COVID-induced recession. This can put further upside pressure on crude prices.
- Increasing Demand in Western Markets: Thirdly, the demand for gas in the US markets remains high despite inflation, depleting the domestic inventory. The US hurricane season (June to November) is expected to put more pressure on domestic energy demands. The oil demand for the EU, a major importer of Russian natural gas, is also likely to increase during winter.
- Domestic Gas Demand and Supply: Despite rising prices, domestic gas consumption increased YOY by 3% in 2022. Residential consumption is expected to grow during colder months. Industrial consumption is also high due to rising economic activity and power sectors not switching to coal from natural gas, despite high prices. On the supply side, crude production and oil imports from the Gulf are in full swing. The US gas imports have risen to a record high of 9.8 mil/barrels per day despite sanctions on Ural oil.
- Decreasing Domestic and Global Inventory: Inventory levels of petroleum products in the US are alarmingly low, nearing April 2020 levels when oil supply chains broke down. At 2 trillion cubic feet, the current US gas reserve is 15% lower than the 5-year average. Moreover, the Strategic Petroleum Reserve held by OPEC is also decreasing steadily to multi-year lows.
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Can the Government Control Gas Price?
The government may bring in new policies or change the fuel tax rate, but it has limited capacity to control crude prices directly. Every country develops a strategic oil reserve, procured during low oil prices, and uses them during hard times. The amount of oil a country stores depends on its inventory capacity. The US began releasing 1 million barrels/day from its strategic reserves on 31st March 2022 at the height of the Russia-Ukraine conflict. This release will increase supply and decrease the price in the short term. Similarly, OPEC also maintains its strategic reserves, which it may use to bring down oil prices.
When are Gas Prices Expected to Go Down
The rise of gas prices in itself is a driving force for the price to come down. When the price of crude increases, oil companies ramp up production to earn higher revenue. This increases supply in the market, which may bring down the cost. The price of crude oil will also come down when it hits a point of demand destruction, i.e., when there are no takers for gas at that price. The US is also looking to reduce its oil dependency on foreign countries for long-term energy security. Shale gas production is expected to double by 2030, which may stabilize the domestic market. While there may not be any crystal ball projections on gas prices, many have wondered when the next recession in the economy will hit. With inflation at multi-decade highs and central banks around the world hiking interest rates to slow the economy, we may be on the precipice of one sooner than we think. In a recession, demand for gas falls significantly as consumers spend less, drive less, travel less, and generally have fewer funds overall. That demand reduction would indeed reduce gas prices significantly.
Long Term Outlook
Global analysts like IEA, Deloitte, EIA, Goldman Sachs, Mc Kinsey, and Petronas predict global crude prices to remain above $100/barrel until 2023. According to IEA, global oil demand will likely reach new highs in 2023, even as Chinese oil demand may decrease in 2022 due to rising COVID cases. Domestic gas consumption will remain high for the next few quarters, which may nullify any increase in supply.
However, analysts believe oil prices will remain below $150/barrel long term. This will cap the gas price to below $6/gallon in US markets if other costs remain the same. This is the worst-case scenario for consumers, at which price is expected to reach a point of demand destruction. Once crude has plateaued near the $150/barrel level, it may start to come down. This could happen after global oil supply chains are reestablished post the Russia-Ukraine conflict. Oil prices may only decrease from mid-2023 as the effects of global rate hikes slow demand. The EU-Iran oil deal can also be a major game-changer in providing an alternate oil supply.
Short Term Outlook
The short-term outlook is bleak, and US gas prices may remain above the $5/gallon mark for the coming months. It may consolidate in the $4-5/gallon range and stay there for the next few quarters. As gas prices touch new highs, both the government and private players have taken several reactionary measures that can reduce gas prices. In June 2022, the FED made its sharpest rate hike of 75 bps since 1994 to counter inflation. Many more rate hikes are being planned throughout this year which may cool down inflation and gas prices. However, the effects of monetary policy can take several months to reflect in prices. Easing of Russia-Ukraine tensions, fresh oil exports from Iran to the EU, improving refining capacity, increased domestic shale production, and rising COVID cases across the world may also reduce global oil prices.
Rising gas prices hurt consumers the most. Since fuel is a universal raw material for all kinds of products, your everyday expenses may increase along with your fuel bill - go fill up your tank of gas this week and see how much cash you have left over compared to 2020 or even 2021. Analysts predict oil prices to remain high for 2022 and peak out at $5.5-6/gallon by 2023 - it may come down if demand cools off and new sources strengthen supply. An increased refining and storage capacity may help bring down gas prices, but rising gas prices may force many consumers to cut down on luxury spending and travel. Rising carbon-based fuel costs can also help in the development of renewable energy sources. Developing clean energy infrastructure can be expensive, but renewables can provide energy security in the long term. A particular date on which gas prices will fall significantly is not something anyone can predict with any accuracy, but what we do know is there are a lot of correlated factors at play. Eventually, there will be a gas price that the consumer simply cannot afford, and the best cure for higher prices is, in fact, higher prices.