“U.S. gasoline prices have fallen to their lowest level in nearly 33 months amid a boom in domestic oil drilling”, the Wall Street Journal declared last week. That’s a true statement, but there’s more to the story.
Americans are indeed facing the lowest gasoline prices in almost three years, but not by much. The price of gasoline last December was almost as low as it is now, as it also had been in December 2011. The fact is, U.S. gasoline prices are usually lower in the fall and winter than they are in the spring and summer due to seasonal variation in gasoline demand and fuel formulations.
Average U.S. price of retail gasoline, all formulations, in dollars per gallon, weekly Jan 10, 2000 to Nov 11, 2013 (data source: EIA).
The long-run determinant of the price of gasoline is the price of crude oil, which does not change much between summer and winter. The price of West Texas Intermediate has fallen from its high in September, but is still above the values we saw most of last year.
Price of West Texas Intermediate, in dollars per barrel, weekly Jan 7, 2000 to Nov 8, 2013. Data source: EIA.
Limits to U.S. pipeline capacity for crude oil cause the price of WTI in the central U.S. to differ from the world price of similar crudes such as North Sea Brent. Because we have adequate facilities to transport refined products, gasoline sold in the U.S. tends to track the world price and follows Brent more closely than it does WTI. Brent is down more modestly from its September high.
Price of Brent crude oil, in dollars per barrel, weekly Jan 7, 2000 to Nov 8, 2013. Data source: EIA.
I’ve often used a simple summary of the long-run relation (described by academics as a “cointegrating relation”) between the U.S. retail price of gasoline and the price of crude oil, according to which a $1 decrease in the price of Brent is typically associated with a 2.5 cents decrease in the price of gasoline. The drop in the price of Brent from around $108 at the end of September to $104 the week ended November 8 (the last week shown in the graph below) could explain a drop in the price of gasoline of about 10 cents a gallon. Over that same period, the actual price of gasoline fell about 30 cents. So the long-run relation would attribute most of the decline in gasoline prices this fall to seasonal factors.
Average retail price of U.S. gasoline (black) and price predicted on the basis of price of Brent crude oil (blue). Black: average U.S. price of retail gasoline, all formulations, in dollars per gallon, weekly Jan 10, 2000 to Nov 11, 2013 (data source: EIA). Blue: 0.84 plus 0.025 times price of Brent, in dollars per barrel, weekly Jan 7, 2000 to Nov 8, 2013 (data source: EIA).
Here’s a little calculator courtesy of Political Calculations that you can use to get the predicted gasoline price plotted in blue in the graph above. Just enter the current price of Brent to see the predicted gasoline price.
Here’s a self-updating reference to the current Brent price, where you can see the bad news. As of the end of last week, Brent was back above $108, wiping out most of the relief in crude prices since September.
Brent Crude Oil
And here is a self-updating plot of the average U.S. retail gasoline price.
So why hasn’t the surge in U.S. production of crude oil brought any real decrease in the price of oil and gasoline? The answer is pretty simple. If you leave out the growth in shale oil production from the U.S. and oil sands production from Canada, total field production of crude oil from the rest of the world combined actually decreased between 2005 and 2012. Given the increase from the U.S. and Canada, global production managed to increase by 2 million barrels a day over the period, but that’s less than the growth in consumption from the emerging economies and oil-producing countries over those same years. That’s why the world price of oil went up, not down, despite the growth in production from the U.S. and Canada.
The boom in domestic drilling is bringing some real benefits to the U.S. economy. But a lower gasoline price for U.S. consumers isn’t one of them.
This piece is cross-posted from Econbrowser with permission.