Gas Prices Summer 2012: Why the Price of Gas is Lower Than Usual

Rising gasoline prices seem to be as much of a summer tradition in the United States as baseball games and fireworks, but this year is different: gas prices have actually been falling, and projections are that we will likely get through the summer of 2012 without sky-high gas prices. “We’ve already seen the peak gasoline price for 2012, unless there is some geopolitical event,” said Guy Caruso, a senior adviser for energy and national security at the Center for Strategic and International Studies (CSIS) in an interview with Bloomberg. Nationally, prices for regular gasoline have dropped from $3.67 in late May to $3.36 the first week in July, according to the US Energy Information Administration.

So why the break in this annual pattern? It comes down to three factors: supply, demand and capacity – the ability of refineries to turn crude oil into gasoline and other petroleum products.

Crude oil is the single biggest cost input in the price of gasoline. It is Economics 101 that when the supply of a commodity is plentiful, its price typically declines, and currently the crude oil market is well-supplied. As we discussed earlier, domestic crude oil production in the United States is increasing; earlier this year Saudi Arabia increased their production as well, putting more oil onto the global market. Just as important to oil traders, there is a perception that the market will continue to be well-supplied, with Iraq working towards increasing the amount of oil they export and with new crude oil fields from Africa to the waters off Brazil coming online in the next few years. At the same time, fears over a war with Iran – and the negative impact this could have on global crude oil exports – have diminished, at least among the oil traders. Earlier in the year, the market was building a risk premium, an additional amount traders were willing to pay on futures contracts to guarantee they would have a supply of oil in case of a shortage, into the oil price, which led to a spike in prices in March and April when conflict with Iran seemed the most imminent. As fears of a conflict have diminished, the risk premium has come off and the oil price has fallen, helping to bring down gasoline prices.

Demand is typically the other factor that shapes prices, and demand for crude oil products, gasoline included, has been dropping. Often falling demand for petroleum products is seen as a bad sign for the economy since it is an indication of a lack of economic activity. An achingly slow recovery from the Great Recession in the United States, paired with the economic upheaval in the Euro zone and signs of an economic slowdown in China and other Asian markets have all paired back demand for petroleum products, and as demand drops, typically so do prices. Even though demand hasn't fallen dramatically in the United States, since crude oil is a global commodity, we are receiving the benefits of falling demand in Europe and Asia in the form of lower gasoline prices (remember, crude oil is the biggest single chunk of your gasoline price). Cathleen Lewis, spokeswoman for AAA New Jersey noted this fact, stating in an interview with NJ.com stating that “gas prices today are driven by things that we here in the United States have little control over.”

Finally there is capacity. Earlier in the year, there were a number of unplanned oil refinery outages, which helped gasoline prices to spike in March. In addition, a few months ago it looked like two refineries on the East Coast were headed towards a permanent shutdown, which would have reduced refining capacity in this part of the country by more than a half-million barrels per day. But in a first of its kind deal, Delta Airlines bought one refinery to supply its passenger jet fleet. While the refinery will be optimized to produce jet fuel, it will also produce gasoline that will be sold to the market. The other refinery was purchased by the Carlyle Group, which is rebranding the facility as an “energy hub” that will produce gasoline using domestic sources of crude oil and natural gas. Together the deals have eased fears of a gasoline shortage on the east coast and relaxed upward pressure on prices.

A number of factors go into establishing the price of gasoline; this year they are all working together to bring Americans some unexpected relief at the pump.