Anyone who owns, rents or uses a car for business must face the realities of changing gasoline prices. But while shopping for the best price or cutting back on driving when gas prices are high may be easy for drivers to understand, the complexities of global supply and demand in the oil market are much more complex.
Supply and Demand Basics
As with any commodity, oil and gasoline are subject to the basic economic principle of supply and demand. When the demand for a commodity increases, suppliers will satisfy that demand at a higher price. When demand decreases, suppliers will need to lower prices to find an equilibrium. At the same time, a rising supply will lead to a higher volume of sales but at a lower price. When supply decreases, price increases to meet stable demand. Because there is a limited supply of oil in the world, and because access to that supply changes as countries and oil companies drill more wells or slow production, supply levels change over time. Demand comes from drivers and industries that need oil and gas to operate, and is also subject to fluctuation.
Supply and demand for crude oil, and the gasoline that refineries produce from it, occurs on a global level. Industrialized nations throughout the world rely on oil for industry and gasoline for cars, but oil reserves are located in certain geographic areas, far from the end users. This means that oil producers have a choice of where to send their oil, with oil consumers around the world bidding on the product and driving up prices. The principles of free trade allow consumers in any part of the world to buy oil from and seller, though tariffs, taxes and embargoes all play into the political side of global oil markets and affect prices for consumers.
Effects for Suppliers
When oil prices are high, oil producers have more of an incentive to explore new sources, drill new oil wells and exploit reserves. However, too much new supply will drive down or stabilize rising oil prices. This is why oil cartels, such as the Organization of Petroleum Exporting Countries, OPEC, limit the amount of oil they produce and sell abroad. The supply of gasoline depends not only on the supply of crude oil, but also the capacity of refineries to turn oil into gas. Investments in refineries are more reasonable business decisions when gas prices are high and a business can expect a greater profit from the new gasoline it produces in the future.
When gas prices are high, and supply remains the same, the natural economic consequence is a reduction in demand. However, according to the Federal Trade Commission, gas prices must rise and remain high for an extended period of time before drivers begin to significantly change their driving habits and reduce the amount of gasoline they buy. New technologies, such as hybrid-electric vehicles and an increased availability of bio-diesel engines, reduce demand regardless of supply, which contributes to a reduction of high gas prices.