Gasoline Prices As Related to Barrel Crude Oil Prices

An oil refinery for turning crude oil into refined petroleum products like gasoline and others

Theoretically at least, the relationship between the price for a barrel of crude oil and the price of a gallon of gasoline should be simple--since gasoline is refined from crude oil, higher crude prices should lead to higher gasoline prices, and lower crude prices should lead to relief at the pump. However, several studies suggest that gasoline prices and crude oil prices may be related but related asymmetrically-- that gasoline prices respond more robustly to crude price increases than decreases.

History of Crude Prices

Public sign protesting high gas prices.

Energy prices have always been a serious consideration in economic output, and the industry for petroleum products is the largest world industry by sales, due to the high demand for petroleum products such as gasoline, kerosene, diesel fuel, paraffin wax, chemicals for plastics, and other products.

Oil prices has fluctuated dramatically due to recent financial events; when corrected for inflation, the price of crude between 1985 and 2005 largely stayed between $20 and $45 (in terms of 2008 dollars) but spiked to almost $140 a barrel during the summer of 2008 before falling to roughly $60-70/barrel (as of October 2009).

Gasoline Prices and Public Opinion

Gas prices in the $3.50-$4.50 range frusterated American drivers and became a political issue

Since the major input for gasoline production is crude oil, crude oil price should affect gasoline prices. Gasoline prices are politically important to citizens, and the popular conception that gas prices rise quicker than they fall due to changes in crude prices. Public opinion was quickly established and cemented during the summer of 2003 and the summer of 2008, when gasoline prices spiked in response to crude oil price changes.

Measurements of Asymmetry

Historical crude prices. Notice the price surge in summer 2008.

Several economists have tackled the question of the supposed "asymmetry" between gasoline price responses. Researchers such as Borenstein et al, Kaufmann et al, and Du et al find that asymmetry does exist in gasoline prices. For example, Borenstein's team found that for an average gasoline consumer a $.05 per gallon increase in crude prices (a crude price increase of $2.10 per barrel) means that a consumer will pay $1.30 more over the price adjustment period than a $.05 per gallon decrease in prices would save her over that period.

Causes

Asymmetrical inventory adjustment might explain the price asymmetry

Economists are undecided on the reasoning behind this price asymmetry. Some suggest that this asymmetry comes from the asymmetry in costs of inventory adjustment for crude production facilities, while other economists suggest that this asymmetry may be evidence of market power by oil companies (defined as the ability to charge a price above the competitive free-market price). The study of the asymmetry of gasoline price changes in response to crude changes is complicated by several factors, such as the interconnected supply characteristics of petroleum products as well as seasonal problems, and economists have yet to reach a conclusion on this matter.

Understanding Recent Crude Trends

The emerging Chinese market probably helped lead to higher oil prices

The high price of crude oil in the summer of 2008 is an economic anomaly, and economists have sought to explain this rapid and unexpected price change in terms of commodity price speculation, strong world demand, OPEC monopoly pricing, and geological limits on increased production, as well as others. Although there is probably some truth to all of these, Hamilton highlights the low price elasticity of demand, strong growth in demand for petroleum products in China as well as other developing economies, and the lack of increase in global production as key factors.

References

• "Understanding Crude Oil Prices"; Hamilton, James D.; Working Paper, National Bureau of Econ REsearch; 2008
• "Do Gasoline Prices Respond Asymmetrically to Crude Oil Price Changes?"; Borenstein, Severin; Cameron, Colin A.; Gilbert, Richard; The Quarterly Journal of Economics, Feb 1997
• "Causes for an Asymmetric Relation between the Price of Crude OIl and Refined Petrolem Products"; Kaufmann, Robert K. and Laskowski, Cheryl; Energy Policy, Vol33, p.1587-1596; 2005

Resources

• "Interim Report on Crude Oil"; US Commodity Futures Trading Commission, July 2008