How Oil and Gasoline Prices Actually Work

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Credit: Bloomberg / Contributor

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Gas prices—and therefore oil prices—wield a tight grip on the American consumer psyche. No other commodity’s prices are tracked so closely, advertised so prominently, and hold such significance in the minds of the American people as gas prices. It is also a market few people understand. 

When gas prices are low, people are pleased, or at the very least do not complain about gas prices. But when gas prices are high—which everyone immediately knows because they’re posted in giant signs at hundreds of thousands of public locations across the country—people get mad, politicians react to that anger, and lots of hemming and hawing is done.

Recently, President Biden has taken to blaming oil companies for “padding their profits” by artificially increasing prices. The main point Biden and other folks calling out the oil companies make is that at the peak of the 2008 oil shock, a barrel of oil was going for about $132 a barrel and gas prices hit a high of $4.15 in the U.S., but now oil has peaked at around $103 a barrel—about $30 less than in 2008—but gas is going for $4.41 per gallon, almost 30 cents more than in 2008. Sen. Elizabeth Warren is reviving the idea of a new tax targeting oil profits. A CBS/YouGov poll showed most Americans are willing to accept higher gas prices for the time being, but a vocal minority is blaming Biden. 

“Politicians getting upset about rising gasoline prices are about as predictable as the sun rising in the east,” R. Tyler Priest, an energy history professor at the University of Iowa, told Motherboard. So too, he added, are consumers getting upset at politicians for rising gasoline prices.

What this cycle, repeated decade after decade since the 1970s, typically omits is any kind of rational discussion about how oil prices actually work. Motherboard spoke to two energy policy experts and one energy historian to figure that out. And while they disagreed on some matters, there were a few common threads they found frustrating about popular discourse around gas prices. Mainly, all the finger-pointing is completely disconnected from how oil markets work, what can be done to ease the pain at the pump, and how to prevent such shocks from happening in the future.

Kenneth Medlock, the senior director at the Center for Energy Studies at the Baker Institute at Rice University, put it bluntly: “Blaming each other for sudden, unexpected movements in price, especially on the heels of a pandemic recovery and now a war in Ukraine, is just patently false.”

Who controls oil prices?

At some point in their lives, most people learn some version, no matter how rudimentary, of the supply and demand curve. At some later point in their lives, nearly all of those people conclude none of that applies to oil markets, which are, they claim, manipulated by politicians, or a cartel of Western oil companies, or OPEC, the Organization of the Petroleum Exporting Countries, with 13 members mostly from the Middle East and Africa.

But that is a mistake, Clark Williams-Derry, an energy analyst for the Institute for Energy Economics and Financial Analysis, told Motherboard. He said oil markets are much closer to the classic version of Economics 101 with the supply and demand curves than, say, iPhone prices, where Apple decides what an iPhone costs and then sells it for that price. 

In contrast, “Oil prices are set, basically, by a bunch of buyers and a bunch of sellers who are engaged in a nonstop auction for oil,” Williams-Derry said. And the market is volatile and fickle. “Small imbalances between supply and demand, even just a percent or two, can push prices all over the place, because nobody wants to be the refiner that doesn’t have enough oil.”

It is true that OPEC, for example, can still manipulate prices in the oil markets by choosing not to release spare production capacity, Medlock said, which is often, but not always, a matter of diplomacy between OPEC members and the U.S. But this type of dynamic—in which a single or small group of companies have some ability to manipulate prices in their market due to their size—is hardly unique to oil markets, as researcher Matt Stoller has extensively documented in his newsletter about monopoly power in global markets. But the oil market is still sufficiently competitive that “padding profits” in the traditional sense, Medlock said, would be difficult to do.

The upshot, Williams-Derry said, is that “people I think have this idea that oil is the same way [as the iPhone], that there’s some company out there, like some person like in Saudi Arabia, or in Venezuela or in like some office in Houston is saying the price is ‘x.’ But when you look at how it actually works, the price is set surprisingly like in a free market.”

Is there anything weird about why oil prices are high now?

Not really! Demand surged over the last half of 2021 as a result of COVID broadly easing (Omicron wave excepted). And a tremendous uncertainty hit the market when Russia, a major oil-producing nation, spent months signposting it was gearing up to invade another sovereign nation, an act which would surely generate repercussions in the global markets. It was the oil market equivalent of a weather forecast of a snowstorm coming and suppliers responded similarly: They stocked up. 

In times like these, oil companies can start producing more oil in response to the higher demand if they think the rising demand will persist. But they may think it won’t, or the uncertainty will fade, in which case they don’t want to risk overproducing oil and losing money on future sales. These decisions may look like profiteering from the outside, or they may be guesses humans are making about the future that are sometimes right and sometimes wrong. 

Either way, producing more oil, should they choose to do so, takes time—six months at least, according to Williams-Derry—and in between there is a period where prices go up. We are in that period now.

Don’t we produce more oil than we use? Can’t we just stop exporting?

All three experts were adamant that there’s no such thing as a “U.S.” oil market. The U.S. is part of the international oil market, which is the only one that exists. What happens in the world matters to the U.S. because it is all part of the same oil market. Whether the U.S. exports or imports more oil than it uses is not, at the end of the day, a serious policy issue.

Often, politicians or armchair tweeters say something to the effect of the U.S. produces more oil than we use, so we’re energy independent. This is nonsense for many reasons, but the most obvious is that there are many different kinds of oil. Much of the increased U.S. oil capacity over the last decade is from fracking, a process that also produces natural gas. The oil from fracking is lighter and thinner, so it has to go through a different refining process than crude or heavy crude oil, the kind that comes out of the Gulf of Mexico or Saudi Arabia. Most of the U.S.’s refinery system is meant for heavier crude oil. So the U.S. exports a lot of oil—but on net imports more than it exports—and imports a lot of gasoline—but on net exports more than it imports—and none of that has anything to do with “energy independence” because lots of oil and gasoline gets both imported and exported.

This is part of the reason why, even though the U.S. doesn’t actually import all that much Russian oil, the Russian-Ukraine War can have such a dramatic impact on U.S. prices. “We are not ‘energy independent’ nor is that even a relevant metric,” Medlock said. “We are connected to the global market, so what happens with Russian crude (or any crude) impacts markets in the U.S.”

What can presidents and other politicians do to lower gasoline prices?

Essentially nothing. Releasing reserves—about 582 million barrels as of February 22—is a tiny drop in the proverbial bucket that the oil market will barely register, considering global oil demand is about 100 million barrels per day. Leasing more federal land for drilling has the same issue and also suffers from the lag problem; it takes time to start drilling a place that previously was not being drilled, and by the time that is done, the drilling may not even be needed anymore, a risk oil companies know and will therefore be hesitant to buy the lease for in the first place. The vast majority of drilling in the U.S., Williams-Derry said, is done on private land oil companies already own.

“Politicians take too much credit and are assigned too much blame for things that are happening in oil markets,” Williams-Derry said. 

Medlock agreed, saying the “false accusations” that oil prices are somehow directly related to short-term political decisions lead to “blame-shifting,” but that at the end of the day “it is really all about supply and demand, but that is a boring, apolitical story.”

What should we be talking about instead?

Experts broadly agree there are two relevant policy discussions to have at times of high oil prices. One is regarding short-term measures to get money to people who need it so they can afford heating and gasoline bills.

The second is either accepting that being a part of the fossil fuel economy means being reliant on a commodity whose price we cannot control, or getting the U.S. off the “roller-coaster ride” of the fossil fuel economy, as Williams-Derry put it, by transitioning to locally-produced energy sources such as wind, solar, and other energy sources not a part of an international bidding war.

In the meantime, coping with the present might require the one thing Americans tend to struggle with: humility.

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