Pain at the Pump

By: Dr. M. Ray Perryman
Published in syndication June 29, 2022

The price of gasoline remains elevated, with the national average briefly surpassing $5 per gallon before retreating modestly. In parts of the country (particularly those distant from refineries), it's already well above that level. Unfortunately, I think that prices will generally stay relatively high through the summer driving season before abating to some extent.

One plan which has been put forth is to pause the federal gasoline tax. This approach would likely provide some modest relief in gasoline prices to the extent that the savings are passed along to consumers. However, the federal tax is only $0.18 (less than 4% of the current cost), so such a move is not a game changer. In California, where prices exceed $6 per gallon, the legislature has acted to send rebates. Whether federal or state, these types of actions may help consumers, but don't shift the underlying market dynamics. In fact, how much gets passed through relates to some arcane interactions of elasticities of supply and demand, which I will spare you at this point.

As with any product or service, supply and demand are clearly important. As prices rise, people tend to buy less while suppliers have an incentive to increase the amount they are producing. We are indeed seeing this phenomenon, with demand for gasoline lower this year than last even though the economy continues to add jobs and people are ready to get out and about after being restricted by the pandemic. During the summer, demand will likely remain strong as people take advantage of being able to travel more freely. With airlines dealing with challenges which are causing waves of flight cancellations and delays, road trips have even greater appeal. Once we get into the fall, consumption will decline. Longer-term trends, such as greater fuel efficiency and greater use of hybrid and electric vehicles, will gradually impact usage patterns.

As to supply, oil production is ramping up in the Permian Basin (by far the largest oil production region in the US), as well as the Eagle Ford, the Bakken, and even Saudi Arabia. That should help, as about 59% of the cost of gasoline is the underlying crude oil. However, refining capacity is constrained due to declines during the pandemic, the shutdown of a sizable Louisiana facility emanating from Hurricane Ida, and the transition of several plants into making biofuels. Nonetheless, facilities and expansions are coming online, non-critical maintenance is being postponed, and we're importing more refined products.

In short, the summer months will likely see high costs remain in effect. The good news is that there are factors of both supply and demand that are beginning to put downward pressure on gasoline prices. That's the power of markets. Stay safe.