The Fundamentals Are Basically the Same: A Reprise of Last August’s High Gas Price Posth

Lynne Kiesling

We leave on an intermountain West camping trip Saturday morning, so will be beyond the reach of communication technology for a fair chunk of the next week. But given that the underlying fundamentals have not changed substantially in the past year, even though the prices have, I am re-posting this post, this post, and this post from August, 2005, about gasoline prices. The comments on the original posts were good and plentiful, and I recommend them to you as well.

Aggregate post is below the break. Have a great week!


In KP’s three years of life there’s been a lot of coverage of oil and gasoline markets, and some dominant themes have persisted:

  • The unintended consequences of price caps are usually pernicious.
  • Environmental regulation, in this case in the form of the EPA federal fuel oxygenate requirement, causes balkanization of regional gasoline markets, causes price differentials across regions, and exacerbates seasonal price spikes.
  • The price of oil is one among many factors influencing gasoline prices; environmental regulation is another, as are taxes. Regulation and taxes vary by jurisdiction, causing prices to vary.
  • Gasoline prices, like most other retail prices, follow a “rockets and feathers” pattern of response to oil prices. However, just because retail prices are slow to fall when oil prices do, that does not mean that retail gasoline markets are uncompetitive. It’s more a reflection of the inelastic demand for gasoline.
  • Part of the reason why the demand for gasoline is inelastic is what I mentioned this morning; fuel is a smaller share of household budgets for most US households.
  • Every spring like clockwork, gasoline prices rise for a combination of complex reasons (winter-to-summer fuel switchover, summer driving increase, etc.).
  • Every spring like clockwork, Illinois Senator Dick Durbin whinges about “greedy, price-gouging” oil refiners who are sticking it to consumers.
  • Every spring like clockwork, the Federal Trade Commission spends a lot of time and effort to investigate the competitive conditions in retail gasoline markets. Every spring like clockwork, they find no evidence of oil refiners’ abilities to influence retail prices in an anticompetitive fashion.
  • Right now, high oil prices are being driven by China’s (distorted and subsidized) demand and by risk premia due to uncertainty in the Middle East, Venezuela, and Africa.
  • OPEC and its shaky ability to sustain a successful cartel (because of hard-to-detect cheating from smaller members) does not determine world oil prices. OPEC’s decisions influence world oil prices, but they are only one part of a much more complex story, and that complexity is beneficial because it dilutes their ability to withold and raise prices.
  • [I saved this for last because it’s the important long-run point] Petroleum is scarce, perhaps even finite, in its supply. Technological change has helped us locate more of it, and pull it out of the ground where we might otherwise not be able to or where it would otherwise have been too costly. That’s the primary reason why prices fell in the 1990s. OPEC’s inability to sustain a cartel exacerbated that price decline. Price increases reflect expectations of future scarcity relative to demand and risk. That is the most powerful mechanism by which we learn both to conserve and to innovate.

[Leaves professor mode, goes downstairs to make herself a well-deserved Manhattan]

OK, here’s the data to show that relative to median household income, gasoline prices have fallen:

gasinchist

Data used to create figure:

  • Median household income data for 1980-2000 from Table H-11 of Census historical statistics, in current dollars
  • Median household income data for 2001-2003 from Table H-8 of Census statistics from the Current Population Survey, in current dollars.
  • Average price of regular unleaded gasoline, 1980-2003, from Table 5.24 of the DOE Annual Energy Review 2004, in current dollars.

GINORMOUS ASSUMPTION MADE: The above graph assumes that the quantity of gasoline consumed per household has been constant over the past 25 years. This is a heroic assumption, but the BLS website was not sufficiently user-friendly to enable me to find data on household spending on gasoline in a useful form, and I desperately want to go downstairs and make that Manhattan!

OK, Manhattan in hand … here’s an analysis that improves on the first one. I’ve taken the ratio of [gasoline price x gasoline quantity] to median household income. The gasoline quantity data are from Table 5.13a of the DOE’s Annual Energy Review 2004, in thousands of barrels.

Table 5.13a reports “estimated petroleum consumption, residential and commercial”. That means that I am overstating the amount of residential petroleum consumption, which at least will bias the results in the direction I want; if I’m overstating residential consumption, I’m overstating residential expenditure, so if it declines, then we know that in truth the decline is even larger than depicted. The analysis would be more precise if I could break them out. But here it is anyway:

gasspendinc

If anything, this decline is larger than just the ratio of gas price to median household income. Interesting.


26 thoughts on “The Fundamentals Are Basically the Same: A Reprise of Last August’s High Gas Price Posth

  1. Table 2.3.5. Personal Consumption Expenditures by Major Type of Product

    at BEA.gov will provide you with detailed data on personal consumption on gasoline and other energy that you can use to make exact calculations of your points.

  2. I suppose my problem is that my income is substantially below that of the median household.

    Makes me wish that I had a household.

  3. Dear Prof Kiesling:

    As a traveling salesman with an economics degree, one of the hardest thing to listen to (and keep the ole trap shut) on the rental-car shuttle bus is the price of gas…what people pay for self-service, and what they have to pay the greedy Hertz-Avis-National monopoly (ok, oligopoly, but that’s lost on them). Folks DO have choices in price; look at $3.19 for self-serve in Wisconsin, vs $6.00 if Hertz fills the tank for you. This would seem to be the easiest examples of how competition could drive pricing down…but NOOOOOO. It’s all about greed on the part of Pick-a-Rental, right?

    In fact, people make a conscious choice to be LAZY and/or let the employer pick up the price differential in the gas from the rental-car company. “What do I care? It’s not coming out of MY pocket.” Here is where the old example of employer-paid health insurance comes into play. If your company pays the insurance premium, and you only have a small deductible, what incentive do you have to ask about the price of the MRI when you’ve only strained your knee? Similarly, what incentives are there for rental companies to lower the price of gas if people pay the going rate, and the employer gets stuck with the bill? I would argue that it is not the oil companies or the rental firms that are being uncompetitive; it’s the CFO and Sales VP that approve of the expense who are the real enemies of competition.

    Oh well, have to run to turn in the rental car and catch a flight. $6.35 here…but, not my problem…

    Meanwhile, back at Camp Inelastic…

    Regards,

    Texan in Wisconsin
    http://texan-in-wisconsin.blogspot.com/

    PS. May I link to and quote this article on my blog?

  4. The limitation of this analysis is that it only covers data up to 2003. Thus, it’s not clear that it really applies to the situation today. Maybe the relevant data aren’t available, and that’s fine–you can’t analyze data that don’t exist. But it’s still important to clarify what this analysis does and does not cover.

  5. “Petroleum is scarce, perhaps even finite, in its supply. ”

    Sort of true- but energy is not, and petroleum substitutes are certainly not scarce at all. I’d like to see a rule that requires that every time anyone refers to oil the modifier “cheap” is added.

    We have known how to make light crude from various hydrocarbon biomasses for at least 25 years, how to extract oil from shale for 75 years, how to crack coal into usable liquid hydrocarbons since long enough before Hitler that he could use that source to run his tanks in WWII.

    The real problem of supply is 100% an investment risk dilemma- no big company CEO with a bonus package is going to bet a few billion on a commodity for which the market pricing has been as volatile as that for oil ($10 a barrel much less than 10 years ago) until s/he is absolutely convinced that the >$60 price is with us for the long term, and won’t go away as soon as the new sources come on line. Classic chicken-and-egg, like every new technology introduction.

    However, the major car company that bought up the Tesla electric distribution rights or a cheap 150 mpg 2 seat commuter hybrid just to get its CAFE number way down would do well. But, as with IBM vs the PC, you won’t see any GM execs willing to risk the existing product lines that desperately need to be creatively destroyed.

  6. Petroleum can be said to be finite only in a theoretical sense, since the two largest astronomical bodies within several light-years, Jupiter and Saturn, are made up of mostly hydrocarbon, not to mention Sol herself. It is merely the cost of useful energy that should concern sentient beings. Of course, sentience is not a characteristic of politicians, and ideology is the antonym of logic.

  7. I resized them so they’re slightly larger, hope that helps! When I get back I will update the data, unless one of you enterprising folks does it while I’m gone, in which case I’ll link to you.

    TTFN.

  8. About image size: In Firefox, right-click the image and choose “View Image,” and a larger, more readable version will open in the same tab. In Internet Explorer 6, hover the cursor over the image. A set of icons will appear, including a zoom tool, a magnifying glass with an x in it. Click the magnifying glass. A slider will appear. Move the slider to the right to enlarge the image.

  9. Interesting post. However, what I’ve yet to see is how many gallons of gasoline can be distilled from a barrel of oil and its calculated price per gallon for such production. Seems then we’d have a better “gauge of the gouge.”

    Sidebar:
    You can resize webpage images using FireFox. Install the browser, then the Image Zoom extension. Right-click, zoom to 200%. Easily readable for these 45 year old eyes. As an alternative, Opera has a built-in zoom function, but it zooms the entire page.

  10. RedLion – a bbl of crude oil is “cracked” into products of different qualities and values – mostly gasoline, heating oil, and the remainder heavy industrial fuel oil. The spread that refiners get between the cost of the crude and the value of the products varies (its known as the “crack spread”), and its value turns on its own economics – mostly by the total demand relative to refining capacity available, as adjusted by net imports and exports of refined products. If you go to http://www.nymex.com, you can get historical prices for crude, gasoline, and heating oil at the wholesale level, to see how the relative values change over time.

  11. RedLion – a bbl of crude oil is “cracked” into products of different qualities and values – mostly gasoline, heating oil, and the remainder heavy industrial fuel oil. The spread that refiners get between the cost of the crude and the value of the products varies (its known as the “crack spread”), and its value turns on its own economics – mostly by the total demand relative to refining capacity available, as adjusted by net imports and exports of refined products. If you go to http://www.nymex.com, you can get historical prices for crude, gasoline, and heating oil at the wholesale level, to see how the relative values change over time.

  12. RedLion – a bbl of crude oil is “cracked” into products of different qualities and values – mostly gasoline, heating oil, and the remainder heavy industrial fuel oil. The spread that refiners get between the cost of the crude and the value of the products varies (its known as the “crack spread”), and its value turns on its own economics – mostly by the total demand relative to refining capacity available, as adjusted by net imports and exports of refined products. If you go to http://www.nymex.com, you can get historical prices for crude, gasoline, and heating oil at the wholesale level, to see how the relative values change over time.

  13. Gasoline prices, like most other retail prices, follow a “rockets and feathers” pattern of response to oil prices….It’s more a reflection of the inelastic demand for gasoline.

    If I may offer an observation: Retail gasoline prices rise rapidally and fall slowly because the retailer use replacement pricing instead of cost+profit pricing. The price you pay at the pump for a particular gallon of gas does not reflect the cost to that the retailer paid for that particular gallon of gas. Instead it reflects the retailers assessment of the cost of the gallon of gas he must purchase to replace the one you just bought.

    As a consequence, retailers raise prices quickly out of fear that they won’t earn enough on their in-stock gas to buy more as prices rise. They lower prices slowly due to the fear that a sudden uptick in price will also leave them unable to buy replacement stock.

    I think this in one of those cases where it might be more prudent for the economist to set aside books and charts and instead wander down to the local mom&pop filling station and just ask them what they are doing.

  14. RedLion;

    The gallons of gasoline per barrel is variable and you can find statistics at the EIA. It is variable depending on the quality of crude (light or heavy, sweet or sour), the refiner, and what exactly it is that you mean by “gasoline”. There are a dozen or so varieties of gasoline, depending on what market you are blending for (see this post at Econbrowser). The average is about 19-20 gallons per 42 gallon barrel.

    Knowing the cost of production tells us almost nothing about gouging; we also have to know about aggregate demand. See this post for other considerations.

  15. RedLion;

    The gallons of gasoline per barrel is variable and you can find statistics at the EIA. It is variable depending on the quality of crude (light or heavy, sweet or sour), the refiner, and what exactly it is that you mean by “gasoline”. There are a dozen or so varieties of gasoline, depending on what market you are blending for (see this post at Econbrowser). The average is about 19-20 gallons per 42 gallon barrel.

    Knowing the cost of production tells us almost nothing about gouging; we also have to know about aggregate demand. See this post for other considerations.

  16. The 20 gallons of gasoline from 42 gallons of crude oil doesn’t tell the whole story, because there are another 24 gallons of petroleum product that are also made from that same barrel. The cost of the crude oil that went into the gallon of gasoline is not 1/20 of the price of a barrel of crude oil, but 1/44 of the price of the barrel.

    I addressed this and other points in the post that misattributed something Texan in Wisconsin said. The correction passed muster for the moderation, but not the original.

  17. The 20 gallons of gasoline from 42 gallons of crude oil doesn’t tell the whole story, because there are another 24 gallons of petroleum product that are also made from that same barrel. The cost of the crude oil that went into the gallon of gasoline is not 1/20 of the price of a barrel of crude oil, but 1/44 of the price of the barrel.

    I addressed this and other points in the post that misattributed something Texan in Wisconsin said. The correction passed muster for the moderation, but not the original.

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