Posted April 2, 2018
The summer driving season is arriving, so it’s a good time to take stock of recent market dynamics that have raised per-barrel costs for crude oil and consequently gasoline and diesel fuel.
Nationwide, the American Automobile Association (AAA) reports that average prices currently are $2.64 per gallon for gasoline (up from $2.54 a month ago) and $2.95 per gallon for diesel fuel (unchanged from last month). While there is nothing particularly special about these figures from an economic perspective, consumers take notice when fuel prices have risen. Let’s look at the factors that have affected pump prices in recent years.
Seasonal variation historically has led to higher fuel demand and prices during the summer driving season, which the Energy Information Administration (EIA) defines as April through September. It also has cost more to manufacture summer specification fuels.
The U.S. energy renaissance has helped to mute these impacts. Before the upswing in domestic oil production, gasoline prices rose by 22 cents per gallon on average during the summer driving season. The past three years, prices still rose during the summer driving season but only by 13 cents per gallon.
As of March 2018, another positive consideration is that gasoline and diesel prices are on par with their average levels since 1995, when adjusted for price inflation. This is a great benefit for consumers, made possible largely because of the abundance of domestic crude oil, which makes up more than half of the cost to produce gasoline.
Oil market fundamentals have been supportive and spurred record increases in U.S. production – to 10.3 million barrels per day (mbd) in February and another 4.1 mbd of natural gas liquids. With solid global economic growth, however, coupled with supply cuts by OPEC and Russia, demand recently has outpaced supply, and inventories therefore have fallen. The following chart is a heat map for the first quarter of 2018 (relative to Q4 2017) of factors that affect oil prices:
This tightening of global oil market conditions, coupled with the U.S. dollar depreciating by 3.8 percent versus currencies of its trading partners in Q1 2018, corresponded with oil prices having risen by more than $7 per barrel or about 13 percent in Q1 2018, compared with Q4 2017.
The exchange value of the dollar matters because oil is priced globally in U.S. dollars. When the U.S. dollar depreciates versus other currencies, the oil price generally falls among all countries where their currency appreciated versus the U.S dollar. Economics tells us that demand goes up when prices go down, so for the market supply and demand to re-equilibrate the global oil price consequently generally rises when the dollar falls, and vice versa. The linkages between domestic and international petroleum prices also have been strengthened by rising U.S. exports, but market fundamentals are the primary drivers.
Let’s zoom in on the fundamentals of supply, demand and inventories. The chart below provides a snapshot of West Texas Intermediate (WTI) crude oil prices compared with the market’s supply/demand balance (positive implies a surplus, where supply exceeds demand), measured in million barrels per day. When supply has exceeded demand, as it did from Q3 2014 through Q2 2016, prices fell as expected. However, since OPEC and Russia together cut 1.6 MBD of oil supply beginning in Q3 2016, the EIA has estimated that global oil demand has outpaced supply for six of the past seven quarters. This is why petroleum inventories have fallen and WTI crude oil prices firmed recently to around $65 per barrel.
The prices of crude oil, gasoline and diesel fuel generally have moved in tandem, as the next chart shows. The dotted lines represent average prices (1995 to 2017) of $2.57 per gallon for gasoline and $2.94 per gallon for diesel fuel, adjusted for price inflation.
Currently, five states have gasoline prices above $3 per gallon, and 16 states have diesel fuel prices above $3 per gallon, according to AAA.
The proverbial silver lining is that gasoline and diesel prices in March 2018 remain on par with their average levels since 1995, when adjusted for price inflation. By remaining flat in real terms, gasoline and diesel prices have failed to keep pace with overall U.S. price inflation, which is a great deal for consumers and made possible largely because of the U.S. energy renaissance and the abundance of domestic crude oil, which makes up more than half of the cost to produce gasoline.
So exactly what are consumers are paying for at the pump? By EIA estimates, as shown in the final chart below, crude oil accounts for 57 percent of every dollar spent on gasoline. The industry’s costs to refine, distribute and market fuels all together are only 25 percent. And taxes currently are the remaining 18 percent of the price at the pump.
Fostering U.S. oil and natural gas production has helped put downward pressure on the cost of crude and then fuel costs. Just four years ago, many people thought it was impossible for oil prices to fall back below $100 per barrel, unless there was an economic recession. But the United States added more than 2.2 MBD of new crude oil production in just 4 years – meeting more than half of global oil demand growth over the period. U.S. oil production appears to be poised for even more growth. From energy policies, to international trade and taxation, the U.S. needs a cogent approach that continues to support the energy renaissance, benefit consumers and enhance U.S. energy security.
ABOUT THE AUTHOR
Dr. R. Dean Foreman is API’s chief economist, specializing in energy and global business. With a Ph.D. in economics from the University of Florida, he came to API from Saudi Aramco Strategy & Market Analysis in Dhahran, where he managed short-term market monitoring and the long-term oil demand outlook. Foreman has more than 20 years of industry experience in corporate strategic planning, forecasting, finance / risk management and regulatory policy at ExxonMobil, Talisman Energy and Sasol North America.