Are gasoline prices too high? (Part 1)

Oh no, this question again. It is very convenient to blame the current administration. Or Opec.

Sometimes in polite company, it is bad to know too much. “I paid $40 to fill up my tank, so don’t you think it’s too much?” Ok, the correct answer is “yes, you poor dear,.” even though I know better. People compare what it cost to fill up a gas tank now verses a week ago. No one compares what it cost to fill up a tank now compared to 2013 or 2014. Or the price of gasoline in 1981.

A recent Facebook post compared economic measures from October 2020 to October 2021, and showed almost everything improving, such as higher salaries, lower unemployment, and higher stock market prices which for many Americans mean their retirement plans are gaining value.

No question about it- the price of gas at the pump has risen significantly from October 2020 to today. In October 2020, gasoline on average was $2.248/gallon and in October 2021, the cost was $3.384/gallon, a gain of 51%.

A 50% change in gasoline prices isn’t that unusual. Gas prices dropped in half during the economic crisis which began in 2008. What really drove the economic crisis was new forms of lending, which allowed people to buy homes, without adequate income or assets. Gasoline prices dropped nearly in half from around 2014 to 2016 as offshore drilling and fracking became commercially viable. Improved drilling technology allowed offshore gas and oil wells in the Gulf of Mexico to be drilled in much deeper water, and highly deviated or horizontal wells became common. Subsea completions allowed for more rapid development, and reduced the front end expense.

It took just 3 years following the 2008 housing crash for gasoline prices to get in the $3.80 to $4.00/gallon. The declining prices from 2012 to 2016 were due to increased oil prices due to fracking and deep water drilling Fracking really dried up in 2016 due to low oil prices. The companies involved in fracking can postpone the completion of wells to cut costs. This is a desperate measure because they don’t get the benefit of new production. Offshore developments are on a much longer timeframe, from discovery to initial production from 5 years or more, so they do not react as quickly to lower oil prices.

These boom to bust and back to boom cycles will continue. Nobody in 2016 was complaining that oil prices had dipped below $2.00/gallon except the oil industry, which needed to make large investments to maintain their supply of oil. It was the cheapest oil had been in 8 years, during a couple of months at the worst moments of the housing crash. Or the lowest gas had been since 2005.

We haven’t defeated Covid but travel and businesses are returning to normal. If I remove the 2007 to 2008 housing bubble, the 2008 to 2009 housing crash/recession, and the Covid-19 economic crash and early recovery, the trend become a bit clearer.

So, the first upward trendline goes from 2002 when gas cost about $1.20/gallon to 2014, when it hit about $4.00/gallon. From 2014 to 2016, technology increased production and the oil glut simply reset the trendline back to $2.00/gallon by 2016, then we were back on the same trendline.

In fact, it is very rational to believe oil prices should go up with time over the long run, because the worldwide supply of oil is limited. It is increasingly more expensive to find more oil. Economic turmoil seems to temporarily reverse the upward trend. I know world leaders are gathered in Glasgow to cut fossil fuels consumption. So, should alternative fuels become more popular, then oil prices should go down. At present, the electric vehicles account for 1.7% of all cars sold, so we have a long ways to go.

Oil prices will be influenced by many factors including the policies of OPEC and the global economy. It seems anything above about $60/barrel for crude oil, results in increased fracking for oil and gas. We are now around $83/barrel.

So, I understand the higher prices are painful. But, longer term prices will result in more production, and people choosing either buying EV’s or fuel efficient cars. This can, in the long term, reverse the trend.

The graph above starts at 1993. If I go back to 1981, gasoline cost $3.88/gallon after adjusting for inflation. So are gasoline prices too high? They are really pretty much on the same trend as pre-Covid. Will we hit a peak, then a decline as more production comes on line? Maybe not. Added production may lower the slope of the trendline, or in other words, slow the pace of increases.

In general, gasoline prices increase when oil prices go up, but it is not always in synch. I will discuss oil prices and production in the next blog.

Stay tuned,

Dave

Links:

EIA US Historical Gasoline Prices

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