GAS PRICES | Why Rising While Crude Falls?

Feb. 21, 2009–I was wondering why gas prices have not fallen in line with the drop in the price of crude oil. It's a deepening global recession. Demand is dropping continuously, and crude oil prices have behaved as we expected. Why haven't retail prices dropped correspondingly? Instead, they have been rising. Is this perverse situation going to continue?

To answer the last question first, the Oil Price Information Service says that a disconnect between crude prices and gasoline prices will continue well into this year, with an average price of gas at the pump rising to $2.50 a gallon by early Spring. Prices are not expected to get back to the $4 per gallon level--at least not soon--but don't expect the price of gas to follow the decline in crude oil prices.

What's going on here? Price-gouging? An answer has been provided by the HEAT Zone blog on February 16, 2009 and I pass it on.

1. Refining activity has been cut back

Demand for gasoline in the U.S. began to drop at the end of 2008, as penny-pinching Americans drove less. Plummeting demand for gasoline, usually the most profitable petroleum product, led to refiners actually losing money as the wholesale price of crude purchased to manufacture gasoline actually cost more than the wholesale gasoline refiners were selling. When raw materials used to make a product cost more than that product, producers lose money. Wanting to minimize their losses, refiners cut back on gasoline production substantially, putting activity levels at their lowest point in 17 years, according to the Energy Information Administration. This supply reduction has succeeded in driving prices up 22 percent since December 30, 2008.

2. Different crude prices, different delivery systems

Oil prices are commonly reported as the price of West Texas International crude oil sold on the NYMEX (NY Mercantile Exchange). West Texas is a high quality crude that in the past has drawn a higher price than crude from the Middle East or Latin America. However, plummeting demand for petroleum products worldwide means huge supplies of West Texas oil are available, pushing the price of West Texas crude below other crude oils from around the world (such as North Sea Brent crude from the UK and light, sweet crude from Saudi Arabia). Because international crude has usually been cheaper than West Texas crude, American refineries are set up to receive crude by tanker and no domestic transport systems exist. Therefore refineries can’t easily switch to West Texas crude while it’s cheaper.

So now you know why gas prices at the pump are rising even though the price of crude oil we produce in West Texas is falling.