Are Oil Companies Ripping us off with Gas Prices?
Recently Gasoline at the pump have fallen while crude oil prices have stabilized. I often get the question ... are they really correlated?
The chart to the right shows the correlation between the average annual price of gasoline and the average annual price of crude oil. By using the average annual price we eliminate brief spikes and get a better picture of what we really pay over the long term. If we see a brief spike many of us will put off buying gas as long as possible hoping to miss the spike so over the long term we will pay closer to the average price.
But as we can see from the chart gas and oil prices are fairly closely related. They tend to rise and fall in tandem but at some extremes oil rose faster while at others gas seems to rise faster. Up until 1972 prices of crude and gasoline tracked very closely but since then there has been quite a divergence.
There is a simple explanation for this. Typically the oil price remained below the gas price with the major exception being during the price spike in 1979 -80. If you will notice it also appears that Oil prices are more volatile and erratic while gas prices don't fluctuate quite as much. This is partly because the oil companies tend to even out the fluctuations in gasoline prices making more money when oil is cheap and possibly even losing money when oil is expensive. They are primarily concerned with their average profit over the year and don't want to create too much of an uproar among their customers so they tend to hold prices as steady as possible.
Over the 10 years from 1980 - 1990 even though oil prices fell lower and lower gas prices remained relatively flat. Why? Is it some collusion by the oil companies? No actually it is much less sinister than that. It is actually just supply and demand. Over the last almost 30 years (since 1976) there have been no new refineries built in the US due to tight regulations (although some have been expanded, over 100 obsolete refineries have been closed or merged), environmental restrictions combined with low prices making the oil business less profitable.
According to BP U.S. refinery capacity in 1980 was 17,890,000 BPD and in 2011 it was 17,730,000 BPD
North American refinery capacity (including Canada and Mexico) in 1980 was 21,982,000 BPD and in 2011 it was 21,382,000 BPD so refinery capacity was less in 2011 than in 1980.
So supply has gotten tighter and tighter with it culminating around 2007 with only one or two percent excess capacity at the refineries.
When supply gets that tight several things happen, first of all, it goes from being a buyer's market to a seller's market and secondly any slight disruption causes all kinds of havoc. And that is exactly what has happened every time a minor storm shut down a refinery for a day we would see a new spike in gas prices at the pump. But then along came hurricane Katrina and it has shut down a dozen refineries for as much as six weeks. Reducing supply by as much as one fifth. In some cases not because of problems at the refineries but also because of transportation issues.
But then in 2007 the recession hit and demand for oil and gasoline began falling as people cut back on driving, factories shut down etc. Plus speculators were scared away from oil as margin requirements were raised by the exchanges. Thus the price of oil fell from 2008 through 2011 but has recently popped back up.
If as T.Boone Pickens suggests we switch our truck fleets to run on natural gas we could see demand for gasoline drop and prices with it.