Oil and Gasoline 101
Petroleum production and prices matter, but not for the reasons many people think.
When reporters call an energy economist during a presidential election year, it’s probably about oil and gasoline prices. Gasoline alone makes up 2%-3% of US GDP, so it is indeed important to the country. In light of its economic and political salience, it’s surprising that many commentators, reporters and policymakers are a bit fuzzy on the basics. So, in an attempt to help elevate the debate, here’s a very brief primer.
Oil in the US economy
There will be plenty of talk this year about the impact of oil prices on the economy. The country consumes about 20 million barrels (or 840 million gallons, because there are 42 gallons in a barrel) of crude oil and petroleum products per day, slightly less than half of which is in the form of gasoline. The price of crude oil has fluctuated dramatically in recent years, spiking to over $100 per barrel in 2022, more than triple the level of just a couple years earlier. At the current price of around $80 per barrel, US annual oil consumption costs around $500 billion. And that’s just the crude oil. Refining, distribution, retailing, taxes and environmental fees adds at least another $500 billion.
As anyone in Texas – or Oklahoma or North Dakota or Alaska, or even parts of California – will tell you, the $500 billion spent on crude is not a loss to the US economy. In fact, with the country now producing about as much oil as we consume, an increase in the price of oil benefits some people in the US by about as much as it hurts other people. That wasn’t true a couple of decades ago, when the US imported over 60% of its oil, but these days a rise in the price of crude isn’t likely to be a macro-economic jolt to the country as a whole.
The impact of crude prices illustrates that US production doesn’t protect consumers from price spikes. Roughly speaking, a $10/barrel price rise moves about $70 billion of income from consumers to producers over a year, or about $800 for a family of four.
Most of that is not showing up at the gas pump, but rather in all of the other things we buy that require transportation or other petroleum inputs. Oil-producing areas see economic booms, while the opposite happens to oil-vulnerable areas, such as towns dependent on auto production or areas of the country that use a lot of heating oil to keep their homes warm or diesel to run their production.
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Oil prices are determined by the worldwide balance of supply and demand, which oil executives will quickly remind you when they explain why their companies are not responsible for high prices. That’s true, but that also means that local crude production is no protection at all against high oil and gasoline prices, contrary to industry claims. The California oil industry doesn’t seem to get the internal inconsistency of claiming that they aren’t the ones driving high oil prices and claiming that California oil production helps hold down California pump prices.
From oil to gasoline prices
Consumers, and many policymakers, are often hazy about the relationship between the price of crude oil and what we pay at our local station. Although refining is a very complex process, on average it takes about a gallon of crude oil to make a gallon of gasoline. So, when the price of crude oil falls by 10 cents per gallon ($4.20 per barrel), for instance, the price of gasoline goes down by nearly as much…eventually.1
I say “eventually” because retail gasoline prices adjust with a lag and that lag is longer for decreases than for increases. The common perception that refiners raise the price of gasoline when crude goes up, but don’t lower it when crude falls, is not correct. But it is true that stations hold onto their high prices longer when crude is dropping.
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There is some great work on the cause of this “up like a rocket, down like a feather” phenomenon, much of it by Matthew Lewis at Clemson (a former graduate student at the Energy Institute). He has shown that consumers search for the best price most intensely when prices are rising, but don’t pay as much attention when prices are falling. That makes the market less competitive when oil prices are coming down, so stations are able to keep prices elevated for longer.
Some stations do adjust more quickly than others when crude oil prices are dropping, which creates greater price dispersion across stations at those times. Two stations a block apart are more likely to be charging drastically different prices when prices are falling, so that’s the best time to shop around. If more drivers flocked to the low-price station, those expensive retailers would not hold on long.
Oil prices and travel
Fuel prices also get highlighted in discussions of the travel and tourism economy. They clearly play a role, but probably not the role the media suggest.
Airline prices do change with the cost of fuel, but it takes many months. The reason is that once a flight is scheduled, the cost of running it is pretty much independent of how many people are on the plane. In economic jargon, fuel is a fixed cost per flight. It’s not easy to make capacity adjustments on a weekly or even monthly basis, so airlines are stuck with the seats they have for a few months. Pricing is driven by the number of seats they have compared to the demand they face. In the longer run, airlines reduce capacity when fuel prices rise and add capacity when they fall. It’s that change in their supply of seats that drives prices. So don’t be surprised when oil prices fall and it takes months to see it in airfares.
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A media favorite when gas prices are high is to claim that fewer people are hitting the road, because “families can’t afford to take a driving vacation.” This may be an appealing narrative to a reporter looking for a story, but the math doesn’t really add up. Even a long 2000-mile driving trip in a 20-MPG vehicle – which is pretty horrible mileage on a highway-dominated trip – uses only 100 gallons. A $40/barrel increase in oil prices – as big as anything we have seen in a decade outside the pandemic gyrations – raises gas prices by about $1/gallon. That increases the cost of that 2000-mile, multi-day, many-meal journey by $100. For a family staying in even the cheapest lodging and eating at even the cheapest restaurants, that seems unlikely to be a big share of the cost.
Oil news you can use
So if you are just a regular consumer and driver, what’s the take away?
First, shop around for lower gasoline prices. The gas is essentially the same (evidence that the proprietary additives extend the life of your car is pretty scant) and you can save a lot of money, particularly at times when prices are falling. Plus, when you buy from the lower-price station, you help pressure the high-price outlets to reduce their price.
Second, think about fuel economy if you are buying a gasoline-powered car. Choosing a car that gets 35 MPG instead of 20 MPG is the same as cutting your price of gasoline by 43%. Or, better yet, if you live in a place where electricity costs less than about $0.40 per kWh (i.e., outside much of California and Hawaii), you can probably save money on fueling with an electric car.
Third, oil production matters to a local economy, both because it creates high-wage jobs and wealth, and because it creates pollution and climate change. Those are the factors to weigh when discussing oil production in your area, not the misguided idea that it will protect local drivers from high gas prices.
Oil and gasoline prices are clearly not the most important policy issue that should be driving voters in November, but they will inevitably come up. So here is hoping that politicians across the spectrum will hew closer to reality when they talk about petroleum and the media will do some serious fact checking.
I am posting frequently these days on Bluesky @severinborenstein.bsky.social
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Suggested citation: Borenstein, Severin. “Oil and Gasoline 101” Energy Institute Blog, July 15, 2024, energyathaas.wordpress.com/2024/05/13/oil-and-gasoline-101/
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- “Nearly” because 10% of our gasoline is ethanol, made from corn.
Another geeky but important aside: because of this physical recipe for gasoline, the relationship between the price of oil and gasoline is additive, not proportional. A $1/barrel increase in crude oil prices raises gasoline prices by about 2.4 cents/gallon regardless of whether the price started at $30/barrel or $90/barrel. The common journalistic error comparing the percentage change in crude oil prices to the percentage change in retail prices is like fingernails on a chalkboard to an energy economist. ↩︎
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Severin Borenstein View All
Severin Borenstein is Professor of the Graduate School in the Economic Analysis and Policy Group at the Haas School of Business and Faculty Director of the Energy Institute at Haas. He received his A.B. from U.C. Berkeley and Ph.D. in Economics from M.I.T. His research focuses on the economics of renewable energy, economic policies for reducing greenhouse gases, and alternative models of retail electricity pricing. Borenstein is also a research associate of the National Bureau of Economic Research in Cambridge, MA. He served on the Board of Governors of the California Power Exchange from 1997 to 2003. During 1999-2000, he was a member of the California Attorney General's Gasoline Price Task Force. In 2012-13, he served on the Emissions Market Assessment Committee, which advised the California Air Resources Board on the operation of California’s Cap and Trade market for greenhouse gases. In 2014, he was appointed to the California Energy Commission’s Petroleum Market Advisory Committee, which he chaired from 2015 until the Committee was dissolved in 2017. From 2015-2020, he served on the Advisory Council of the Bay Area Air Quality Management District. Since 2019, he has been a member of the Governing Board of the California Independent System Operator.
Energy Institute Blog
The first part of this commentary is unremarkable. Gasoline prices do rise and fall with crude pries.
Gasoline prices also rise and fall with refining margins. In 2022 the United states and other nations added millions of barrels to the market from strategic stocks. Crude prices fell. Gasoline prices did not. Instead, refiners pocketed record margins through most of 2022. The increasingly concentrated intendent refining industry enjoyed record profits.
On the link between airline fares and oil prices Borenstein is just wrong because airlines hedge. It is not the issue that capacity adjustments are difficult but rather the fact that hedging immunizes most airlines from oil price fluctuations. The hedges can establish a fixed cost of fuel for up to a year for an airline eliminating the need to raise prices when crude prices rise. For example, one report indicated that Southwest and Air-France KLM had each saved more than a billion. Ryanair has hedged most fuel into 2025. https://simpleflying.com/what-is-fuel-hedging-and-why-do-airlines-do-it/
Southwest has lead the industry. An comment on the airline’s web page reports the airline’s success (it saved billions). The hedging allowed the airline to maintain a low fare strategy. https://southwest50.com/our-stories/the-southwest-jet-fuel-hedge-strategy/
According to the EIA, the price of Brent crude peaked in June 2022 at $123 and fell to $81 by December 2022, a decline of $42 per barrel. At a pass-through rate of 2.4 cents per gallon for every $1 per barrel of crude, that would imply a gasoline price decline of $1.01. According to the EIA, the U.S. price of gasoline declined from $4.93 in May 2022 to $3.21 in December 2022. (Over the same time period, the price of California gasoline declined from $6.20 to $4.32.) I’m not sure where you are getting your “fact” that the price of gasoline did not decline.
On your claim about hedging. A fixed quantity forward contract (such as in the futures market) does not alter a firm’s marginal cost of production. It is a sunk gain or loss. The marginal cost of burning fuel is still the market price. Airlines do make money when they are hedge goes in the right direction, but that doesn’t change their marginal cost.
As we know well from the 2000-01 electricity crisis, control of a large share of production capacity, production near the capacity level (as evidenced by market responses to refinery outages) and an inelastic near term demand gives market power to change prices to producers.
The impact of CARB increasing the renewable fuel blend from 10% to 15% of gasoline would be a 20 cent per gallon decrease fuel costs, saving consumers in California $2.7 billion per year, according to a study released this month by UC Berkeley professor.
With the federal EPA again approving E15 blend for 49 states (which has occurred every summer since 2020), California is the only state that mandates a 90% petroleum gasoline blend – a direct cause of higher fuel prices for disadvantaged communities and our poorest residents in the state.
Since the federal EPA has stated that a permanent approval of year-round E15 will be issued early next year, why is Gavin Newsom the only Governor in the U.S. that still mandates 90% petroleum gasoline? It is illegal to use more renewable fuel than 10%, enforced by Newsom’s CARB board of directors, which seems to be exactly opposite of Newsom’s political claims of “fighting for lower cost fuel to help California families”.
In Modesto, Aemetis produces 65 million gallons per year of ethanol, employing hundreds of people to sell ethanol for about $2 per gallon. Yet, we pay more than $5 per gallon nearly to fuel our gasoline vehicles. The 90% petroleum gasoline mandate is denying consumer access to low cost, renewable, 113 octane, 34% oxygen, clean-burning fuel that is produced right here in California.
Eric McAfee – Chairman/CEO, Aemetis, Inc.
The study referred to was paid for by the Renewable Fuels Association and, IMO, is deeply flawed. It suggests that the savings of this 5% substitution is greater than the entire cost of the gasoline displaced, not even counting the cost of the ethanol added. Increasing ethanol from 10% to 15% may not be a problem for cars, but it will do practically nothing to lower fuel costs for drivers.
As an economist, your reply is notable for its lack of facts. Since when does replacing a 84 octane fuel molecule (petroleum gasoline) that costs $1 more wholesale than a 113 octane, 34% oxygen “oxygenate” result in “no savings” for our poorest consumers in California?
You seem to be comfortable ignoring math when it is only 20 cents a gallon of savings for California consumers, since $2.7 billion per year does not matter much to well-paid oil industry consultants. Is oil industry consulting fees and grants causing your bias against renewable fuels that decrease the market for petroleum fuels in California?
And, as a petroleum industry economist, you would also know that the cancer-causing benzene, toluene and other components of the BTEX aromatics in gasoline are replaced by a renewable fuel (alcohol) that reduces cancer and the other harmful health impacts of petroleum gasoline when a 15% ethanol blend is allowed.
A separate point is that the decline of California crude oil production has now created a situation where 77% of California’s fuel is produced from imported crude oil – directly funding Saudi, Venezuelan and other OPEC countries with cash from California consumers.
By Newsome and CARB mandating a 90% petroleum gasoline blend and limiting biofuels to a 10% blend in California, our consumers are not provided a choice to purchase lower cost, renewable fuel at the pump to fund local jobs and U.S. farmers, instead of directly sending California cash to foreign dictators and terrorists.
I would like to see the facts supporting a $1 per gallon, more expensive, environmentally damaging, 77% imported gasoline instead of a lower cost, locally produced, renewable, high 113 octane, high 34% oxygen, clean-burning, BTEX aromatics replacement – ethanol.
Here is my math, anonymous person. Substituting 5% of fuel, i.e., 1/20th of a gallon from gasoline to ethanol could only lower the price of a gallon of fuel by $.20 if the price of ethanol were four dollars per gallon lower than the price of gasoline. That is, unless you are claiming that the substitution would drastically lower the price of gasoline as well by reducing demand for it. It certainly would not affect the world price of crude oil. It could lower refining margins, but likely only in the circumstances where refining is constrained. Given that the average spot gasoline price difference between California and gulf or NY has been declining over the last 20 years, it is not very plausible that refining scarcity is a major driver of California’s elevated gasoline prices. As I have blogged about earlier, the Mystery Gasoline Surcharge appears primarily downstream of the spot price, suggesting that the problem is not the supply of gasoline.
Navigating the impact of oil and gasoline prices is vital for meaningful discussions, yet it often remains misunderstood. In the US, daily oil consumption, mainly for gasoline, plays a pivotal role in our economy, influencing costs across goods and services. Understanding these dynamics helps consumers make informed choices and policymakers address economic and environmental challenges effectively.
A particular irony we see is that the anti-tax advocates (DeMaio/Reform California) cry foul and beat the drum when the tax on gasoline goes up 2¢/gal because of voter approved gasoline taxation yet when they are silent when the price is raised for other reasons.
Since gasoline is a significant contributor to climate change, I would suggest that it be taxed at a rate that the funds produced can make public transportation attractive both in price and convenience. Yes, I own a unicorn and a leprechaun rents my ADU.
“The California oil industry doesn’t seem to get the internal inconsistency of claiming that they aren’t the ones driving high oil prices and claiming that California oil production helps hold down California pump prices.”
The California oil industry has been making this conflicting claim for a long time. Internal inconsistencies notwithstanding, this erroneous juxtaposition seeks to establish alternative facts through dogged repetition, which the industry is very good at. Alas, it’s also a sign of the times.
I thikn this is a typo “A $10/barrel increase in crude oil prices raises gasoline prices by about 2.4 cents/gallon regardless of whether the price started at $30/barrel or $90/barrel.” Should be $1/barrel, correct?
Yes, thank you for catching that typo. Corrected now.
A query. Are the dollars used in the figure adjusted for inflation?
This post contains the germ of a far more important message than is discussed in detail.
The opening graphic shows crude prices for a decade. Bottoming out at $20/bbl during Covid, prices rapidly rose as Covid subsided, then surged some more with the Russian invasion of Ukraine, reaching $120/bbl in 2022.
THAT surge in crude prices is the most important source of the price inflation that has been a central political problem for the Biden administration. Oil price increases quickly become gasoline price increases, food price increases, and even health care price increases. Oil price increases drive a demand for wage increases, to keep up.
And, quite naturally, when oil prices have since declined from $120/bbl to $80/bbl, we should naturally expect to see some moderation of inflation, and perhaps even some deflation in energy-intensive price sectors.
THAT ISSUE is the one that we energy economists should talk with the press about in a Presidential election year. Inflationary pressure IS declining, and likely WILL continue to decline if oil prices remain stable or decline.
Jim Lazar, Olympia
From the oil crises of the 1970s to the 2010s, the average household energy costs declined from about 3% to 2.5% and now, with more produced in the US (and Canada) we could see changes.
https://www.eia.gov/todayinenergy/detail.php?id=10891