The world cannot do without gasoline – as of today, at least. Yes, it’s bad for the environment. But, let’s face it, the economy would suffer without it. The fact that it’s very important to the economy makes its price sensitive to quite a lot of factors. Its pricing structure, in reality, depends more on day-to-day events, as opposed to supply and demand – although they also play a part. Its sensitivity to events is a big reason people trade futures to mitigate risk. In other to get the best futures deal, a proper understanding of the factors affecting the price of gasoline is imperative.
The crude oil effect
Just as it is with most products of crude oil, the price of gasoline is heavily dependent on situations in the crude oil market. And when we say the crude oil market, we mean the global market – and not just the domestic market. In general, whatever moves the price of crude oil would most certainly move the price of gasoline too. Take the current crises in Iraq for example. While many have blamed the rising price of ethanol – which constitutes about 10% of the gasoline at the pump – as a major reason for the spike in the price of oil, you need to admit that the uncertainties around the Middle East play a bigger role. What has happened is that the crisis have helped financial speculators big up oil prices, which would naturally affect the price of every of its product.
The truth is critics of the ethanol industry are always on the lookout for opportunities to price ethanol out of the oil industry. However, as a savvy investor, you want to note that the effect of the ethanol market (more on this below) can hardly contribute more than the 10% to the price of ethanol – at least at current levels. As the chart below shows, the price of gasoline moves very closely relative the price of crude oil.
Moreover, According to the U.S. Department of Energy, crude oil prices make up 65% of the cost of a gallon of gas, on average. So you whenever you are considering the price of gasoline, the first place you want to look is the (global) crude oil market. However, the rest of the price can be traced to other factors that would be discussed below.
The ethanol market
As stated above, today, ethanol makes up about 10% of the total volume of gasoline sold at the pump. This means that, no matter how little, the price of ethanol affects the price of gasoline – especially when the price of crude oil is stable. But when the crude oil market is turbulent, the effect of the price of gasoline might be hard to spot – but it’s there.
In addition, many ethanol proponents have argued that the ethanol market has actually brought down the price of gasoline – and they have a genuine point, although the media is fueled to make you believe otherwise. Here is how. If you look at the chart above closely, you’d find that the movement of the price of gasoline in early to mid 2000s is more like the movement of crude oil than during the latter half of the decade.
Note that, as of year 2000, the ethanol market share in the U.S. gasoline supply was just over 1%. By 2006, its market share had risen to 3%. And by 2011, that figure had risen to 10%. The point here is that, during the latter half of the decade, ethanol made the price of gasoline less sensitive to the occurrences in the crude oil market. In many cases, when there is a spike in the price of crude oil, the price gasoline doesn’t rise as much. This is, partly, because the vision of the ethanol market is to overtake the crude oil market. So any turbulence in the crude oil market strengthens the belief of the market that ethanol owns the future. And since ethanol is already a component of gasoline, that belief is able to reduce the impact of crude oil on the price of gasoline.
The production environment
What happens at refineries also affect the price of gasoline, albeit on a short-term. We can divide this into several classes. But to make things simple, we’ll divide it into three.
- OPEC production
- Non-OPEC production
- Domestic production
That OPEC holds a large portion of the energy market makes its decisions affect the price of gasoline a great deal. For instance, whenever OPEC’s surplus production drops, you can expect that that the price gasoline would go up, as it causes fears that, if any event stalls the production of oil, supplies might be affected.
The reason for which Non-OPEC production have huge effect on the price of gasoline in the US is that US imports about half of its crude from Non-OPEC countries, as can be made out of the chart above. Therefore, if, for some reason, production in Non-OPEC countries dips, you can expect a higher price of gasoline.
The domestic aspect is driven by the activities of domestic refineries. For instance, GasBuddy.com predicted in February 2014 that the price of gasoline could rise by between 15 and 40 cents by April 20, 2014, pointing to refiners’ annual maintenance activities as a factor. This turned out to be the case, as the chart above shows. While, this couldn’t have been the only factor, it’s hard to deny its impact. So in general, whatever producers decide to do, in some way, influences the price of gasoline. In addition, whatever affects their production also influences the price of gasoline.
Economic and foreign exchange factors
As stated above, gasoline is important to the economy. As such, most factors that affect the economy also bear weight on the price of gasoline. According to the EIA, by the fall of 2008, crude oil prices began to fall due to the weakening economy and a contraction of global petroleum demand. These factors helped gasoline prices to drop below $2 per gallon of regular gasoline in late 2008 and early 2009. The gradual improvement in the U.S. and world economies in 2010 and the political events in the Middle East and North Africa in early 2011, the source of about one third of world oil production, contributed to increases in crude oil and gasoline prices in 2010 and 2011.
As for the foreign exchange market, its effect can be considered artificial, since it doesn’t actually reflect the situation of the gasoline market. However, in general, countries with strong currencies do see minimal rise in the price of gasoline locally.
Again, you should note that the crude oil market affects the gasoline market the most. Every other factor’s effects are minimal and occur relatively on a shorter-term. Going into the future, though, the impact of ethanol could become bigger – if its importance to the gasoline market increases.