As the national average price of gasoline tops $5 per gallon, there are few reasons for optimism that gas prices will decline any time soon.
President Joe Biden, despite his recent remarks, has no good solution at his disposal to temper the rise of gasoline prices.
There are many culprits, some economic and others political. Longstanding Democratic policies against the energy industry have crippled U.S. producers, while Western decisions to sanction Russia have created an acute supply crunch. And unless the Biden Administration undoes its entire energy policy, there are few levers available to the U.S. government within the current framework to mitigate gas prices.
In March, Washington decided to release 1 million barrels of oil per day from the U.S. Strategic Petroleum Reserve for the next six months. But the tactic hasn’t helped, with gasoline prices rising from the low $4 per gallon in March to $5 per gallon in June.
This has led the Biden administration to wave the proverbial “white flag.” Transportation Secretary Pete Buttigieg as well as Sen. Elizabeth Warren (D-Mass.) have instead blamed energy companies for “price gouging” consumers at the pump.
The reason for high gasoline prices is supply and demand. But several constraints were self-created. Let’s dive in.
According to the American Petroleum Institute, 50 to 60 percent of the price of gasoline is derived from the price of crude oil. That’s the biggest driver of gas prices.
Oil prices are set by the market. Anyone can look up what the spot oil is trading at on a given day. If we ignore long-term contracts locking in a price in advance, oil producers generally sell their oil at or near the spot rate. Oil producers also have a cost base, so the higher the price of the oil, the more money they make. They can also lose money if the market price of oil dips so low that they cannot cover their costs.
The argument that the oil producers are “price gouging” is overly simplistic. They can theoretically sell their oil below market price, but that’s an ill-advised decision that wouldn’t make a dent unless the entire industry—all oil producers—can be persuaded to do the same.
And experts are warning that oil prices will likely go up, not down. JPMorgan CEO Jamie Dimon said that oil prices could run up to $175 a barrel later this year. CEO of Commodity trading firm Trafigura, Jeremy Weir, said at a conference that “we have got a critical situation” with regards to the price of oil.
So what can be done to lower the price of oil? Economics 101 suggests that there are two ways to reduce the price of a product. Either supply has to increase, or demand has to decrease.
To increase supply, the United States has been releasing barrels of oil from the nation’s strategic reserves. It has an impact, but not enough of an impact to move the market. Nor does it solve the underlying issue; at some point, the strategic reserve will run out.
OPEC+, which includes Russia, recently agreed to boost crude oil output in July and August by 648,000 barrels per day, or 50 percent more than previously discussed.
That should also bring more oil to the market, and the price of oil temporarily decreased when the decision was announced. But it won’t be enough to offset the ban on Russian oil. Russia is the world’s No. 3 oil producer behind the United States and Saudi Arabia, accounting for around 10 percent of global production.
The recent invasion of Ukraine has led to much of the Western world sanctioning Russian oil. In 2021, 3 percent of all United States crude oil imports and 20 percent of petroleum products (including fuel oil and unrefined oil) came from Russia, according to EIA statistics. Supply increases OPEC+ plans to implement are still not nearly enough to rectify the market imbalance of removing Russian oil.
What about domestic producers? The Biden Administration, the United Nations, and prevailing anti-fossil fuel bias from banks and lenders over the last several years have limited the oil industry’s access to capital and financing.
The XL pipeline was canceled. The U.N.’s “Net-Zero Banking Alliance” effectively forced global banks to restrict lending to the oil and gas industry. Swiss bank UBS decreased lending to the traditional energy industry by 73 percent from 2016 to 2020 according to a CNBC analysis. And last year, Dutch lender ING Group vowed to stop lending to oil and gas companies altogether. These efforts have collectively, over time, made ramping up U.S. oil production difficult.
Lifting these longstanding “sanctions” on domestic oil industry can ultimately solve the issue. However, the Biden Administration as well as left-wing bias within the banking and business establishment are unlikely to suddenly undo years of policy evolution. Even in the unlikely scenario such policies are suddenly undone, it would still takes month if not years to bring new production online.
The other solution is to decrease demand.
Various factors have caused demand to increase recently. Employers have compelled workers to go back to the office, fueling demand for gas used in commuting. Across many major metropolitan areas, more commuters have eschewed public transit due to COVID and public safety concerns, increasing the number of cars on the roads and gasoline demand. The return of travel—especially jet travel—has increased demand for jet fuel, which takes up capacity at oil refineries that otherwise could be used to refine gasoline for cars.
Besides the price of crude oil, the next biggest price component of gasoline (at 15–20 percent) is the cost of refining. Refining costs don’t move much, but the cost of some refining inputs has also increased such as wages (labor) and the cost of ethanol (an additive made from corn, the price of which has also gone up).
Next, at 10-20 percent, is the cost of distribution such as pipelines and transportation. Transportation costs also went up due to higher wages and diesel prices (ironically, gas is needed to transport gas to local stations).
And lastly, also at 10–20 percent, are federal, state, and local taxes. Taxes vary depending on state and municipality. California has the highest state gas tax while Alaska has the lowest. Some states (such as New York) have implemented gas tax holidays to temporarily alleviate prices at the pump.
What would actually stem the demand for oil? An economic recession. A downturn will cause businesses to cut back on investing and spending, consumers to cut back on travel and purchases, and overall economic activity to slow.
So what would the U.S. government do to combat high gas prices–choosing to undo years of anti-energy industry policy to increase supply, or waiting for a recession to drive down demand?
It’s fairly clear the choice was the latter.
