SIOUX FALLS, S.D. (KELO) — Gas prices have risen considerably over the course of the past few months, with very little sign that they may soon fall. The price of oil, however, has fluctuated. But why, when oil drops in price, does gas not follow suit?
To get the answer, we must begin with a look at the supply chain. To get an idea of what this looks like, KELOLAND News spoke with Haresh Gurnani, Professor of Operations and Supply Chain Management at Wake Forest University.
“The supply chain,” said Gurnani, “is relatively easy to describe. It includes the oil exploration — then there is distribution of that to the refineries, and the refineries are the ones which are actually converting into the product that we end up using.”
The refining process, says Gurnani, also requires transportation and storage, not just at the refinery itself. Gurnani uses the example of the Colonial Gas Pipeline, which passes about 30 miles from where he teaches in North Carolina, and has huge storage facilities.
Gurnani lays out the supply chain: extraction, transportation to refineries, refinement, transportation and storage, and then finally, retail.
There’s a lot that goes into the price that you pay at the pump, says Gurnani. As of Tuesday morning, the average price for a 42-gallon barrel of crude oil was about $104.
“55-56% of the cost [at the pump] goes into the crude oil,” he explained. “Then you’re looking at distribution cost, which is around 15% — another 15% would be the taxes, both at the state and federal level, and another 14-15% is the refining cost.”
As the cost of crude oil makes up a bit over 50% of the cost that goes into gasoline, Gurnani points out that an increase in crude prices will affect the price at the pump.
“In some sense, I think that what we are experiencing at the moment is two-fold,” he explained. “The price of crude oil at the global level has gone up — second, which was pre-dating the current conflict [in Ukraine], which has also caused a spike, the transportation, or the distribution cost, was already on the higher side in the last 12-18 months, as we know about trucker shortages and so on, and the cost of labor.”
Of the invasion of Ukraine by Russia, Gurnani points out that the conflict raised the price of the oil itself, as much of the world has cut off purchases of oil from Russia, which holds huge reserves of it.
While the price of oil has recently begun to dip back down, do not expect gas to follow suit, at least not quickly.
“There are a number of factors that lead to a faster jump in the price [of gas] as the crude oil price increases, but a much slower reduction in the price we end up paying once those prices start to fall,” Gurnani said.
“It’s primarily driven by visibility into future prices,” said Gurnani, attempting to give a simple explanation of why gas prices fall so much slower than they rise.
“Think about a gas station that’s selling gas to the consumers,” he said. “Obviously they have to be mindful of what their cost is going to be for the next time that they are replenishing their own inventory.”
Basically, retailers need to make sure that they are not selling their gas for less than it will cost them to replace it once they need to refill their tanks. Since it is impossible to know for certain what the future holds, most station owners will be unlikely to lower their gas prices in response to a decrease in oil prices, for fear that those prices may shoot back up the next week.
“Unless they were to see a sizeable or predictable reduction in their own procurement cost, they are not likely to pass on any savings that we might see at the crude oil level to the consumers,” said Gurnani.
Of course, local competition also has a role to play in the price of gas. “Generally, these gas stations seem to have an implicit agreement that they are not going to reduce prices because then it becomes a losing proposition for them,” said Gurnani. “If one reduces the price in order to get more traffic, the other one is also going to lower their price.”
Due to the nature of competition and the current uncertainties in the realm of oil, prices at the pump will likely continue to stay elevated as long as oil prices fluctuate. If there is not enough time between a fall in crude prices and the next rise, most retailers will not lower their prices.
“We would still likely encounter small fluctuations in prices, maybe like 3-5 cents plus/minus,” said Gurnani. “But I believe those changes would largely be driven by the local competition rather than anything else.”
Don’t expect to see a local gas station dramatically drop its prices to undercut the competition either, said Gurnani. “I can’t imagine any gas station that will not be forced to raise their price beyond a short-term,” he said. “They can’t afford to be making losses, because there are sizeable costs involved in running a gas station.”
Gurnani says psychology also has an impact on the prices.
“Once prices start to go up, we as consumers — there’s a sense of helplessness — we have no option but to get used to the elevated prices. That psychology also helps them. We are willing to pay those higher prices, because we have no other option,” Gurnani said.
People need to drive to work, take kids to school or day care and get to the grocery store; for many of us, purchasing increasingly expensive gas is an inevitability.
Despite this, Gurnani suggests some ways people can minimize the amount they drive. “Many people I know have started reducing their driving, myself included,” he said. “I’m being a bit more careful and maybe combining trips, and making fewer longer trips than I used to.”
In terms of things that could lower gas prices, Gurnani first discussed stability in the crude oil market. Specifically, a downward sloping price curve, which sees prices fall consistently.
“That can happen if we are able to get a larger supply of oil into the market,” said Gurnani. “A larger supply will in some sense alleviate the current pressures we are experiencing where the gap between the supply and demand has reduced tremendously.”
As to where that increase in supply would come from, Gurnani says OPEC, the Organization of Petroleum Exporting Countries, is best suited to increase the supply.
OPEC is a group made up of 13 member states: Algeria, Angola, Congo, Equatorial Guinea, Gabon, Iran, Iraq, Kuwait, Libya, Nigeria, Saudi Arabia, UAE and Venezuela. Previous members include Ecuador, Indonesia and Qatar. The stated purposes of the organization include stabilization for the oil market and steady income for oil producers, among other things.
OPEC member countries account for nearly 80% of the world’s known crude oil reserves, giving them substantial control over the supply and demand of oil.
While a domestic increase in oil production in the U.S. could also improve prices, such increases are liable to take a large amount of time. In the shorter term, Gurnani says an end to the conflict in Ukraine would certainly lead to lower anxiety about the price of crude.
“A big part of the price escalation is because of uncertainty,” Gurnani said. “There is always that risk that due to conflict, certain supply lines might get disrupted.”
Gurnani also points to the Iran nuclear deal, which if re-established, would put 1-2 million barrels of oil per day back into the market, which he says would have a tremendous impact on the price of oil.
One important thing to keep in mind is that while high prices are generally bad for consumers, they are, for the most part, great for producers. “Higher prices are good for them, until it isn’t,” said Gurnani.
The game for oil producers such as OPEC is to keep oil prices as high as they can justify, without causing damage to the global economy. “It would not be good for them if there were to be a drop in the demand [for oil] because of a recession,” Gurnani explained.
The question for producers, or course, is how far can they push the prices before they hit that tipping point into a recession? At what point do they need to lower costs and release more oil onto the market?
At this point, Gurnani says increasing production would be beneficial for OPEC. “They would be able to enjoy relatively elevated prices for an extended period, as opposed to seeing really high prices for a short period,” he said, “which is what is currently happening.”
“In many ways, we cannot control the price that we pay,” said Gurnani, “but certainly, it would help if we were to shop around a little bit — I think changing our driving behavior can help a bit on the demand side.”
One specific tip Gurnani offers is to drive a bit slower.
“If you were to drive within 5 miles +/- of the speed limit that’s actually not too bad, but if you drive 10-15 miles over the speed limit, you’re looking at a good 10-20% increase in your fuel consumption,” Gurnani said.