Wednesday, February 18, 2009

Just what we need: rising gas prices in the middle of a deep recession

Gas prices are on the rise again; and with the unemployment rate accelerating, already-strapped consumers will pull back even more. Not good. Eventually, though, the rising unemployment rate and slackening demand for gasoline will pass through to lower gas prices.
The chart illustrates monthly gasoline prices through the February 2009. National gas prices have declined precipitously since July 2008 amid the global recession. However, gas prices have been creeping upward since early January. According to Aysegul Sahin (hat tip, Mark Thoma), this recession is shaping up to be worse than the 1980's. Therefore, renewed pressure on gasoline prices will squeeze consumers and firms further, worsening an already-beaten economy.

The recent bump in gasoline prices seems counter-intuitive amid building crude inventories and falling crude prices, but it is simply a lagged supply effect. According to the Wall Street Journal:
Refiners saw profits sink as demand declined in mid-2008 and only began to curtail output after hopes for a rebound evaporated in the fall. In December, operators of large refining networks announced reductions in gasoline production and, as a whole, the U.S. is processing well below full capacity. The rise in prices, following a slump that began in July, when gasoline prices were above $4 a gallon, reflects refiners' success in catching up with slackened demand.
This analysis suggests refiners can only maintain the squeeze as long as demand suffices, and eventually, the rising unemployment rate will drag down gas prices later this year. But until then, consumers are likely to cut back on non-energy goods and services in order to accomodate the higher gasoline prices. Furthermore, rising energy prices will put upward pressure on the headline Consumer Price Index - the index used to measure inflation.

Rebecca Wilder


  1. One aspect mentioned recently in relation to gas prices is the fact that the price per barrel most quoted daily is that of West Texas Crude which is not the gas processed by a majority of refineries. So, the bbl price has not much to do with our price at the pump. The pipeline capacity is also a concern in some states.

  2. Retail gasoline prices hinge on the "crack price", which ranges between $0.0425 and $0.0475.

    To maintain that range, refiners shall cut output, cut buying crude to refine and shut refining plants until getting the crack price within the range.

    As unemployment rises, refiners shall adjust, bringing prices to where they need them.

    Unlike producers of other products, refiners hold almost all of the cards in gasoline production.

    Gasoline production happens relatively locally and always within the borders of the U.S.A.

    A fixed number of plants exist.

    Refiners are not under obligation to run them all at the same time.

    No law exists to force refiners to run all refineries to capacity.

    No contracts exist to force refiners to keep workers employed to capacity.

    The notion that rising unemployment shall make gasoline prices fall does not hold, certainly not for long.

    Prices rise and fall to maintain a crack price that supports earning profits.

  3. Well, the crack as expressed by the Mar contract for RBOB - CL (on a barrel basis) is actually pretty healthy at $11.77/b. Given that most big US refiners have term contracts for oil at prices at a discount to NYMEX, their spreads are probably healthier. (Even contracts for heavier crudes--some of which just now are selling at a premium to NYMEX--are at a discount to market prices.)

    If you want to use the Apr contract, the crack is an even healthier $11.83/b (at yesterday's closing for all the above.)

    IF the situation persists, it might be reasonable to expect crude to chase the price of gasoline up even as you see destocking--as in the period between July 2007 - July 2008 (though crude then chased the price of diesel up.)

    But ... and this is a big but ... the demand destruction in Europe should leave a fair amount of their gasoline cut without buyers domestically--and real cheap tanker rates would make that arbitrage trade a possibility that much faster.

    The WTI controversy going on just now is just a bit overblown ... up until recently everyone had been complaining about the potential to manipulate the price of Brent--but then most international term contracts are priced a BWAVE even so. I think some in industry want the controls lifted on crude exports from the US--not that that would keep the price of oil cheap here.

  4. Oil, one of only 2 contracts that I've ever lost money trading (the other is the Deutsche Mark)

    Money is easy. It's being created at a blistering pace. So aside from production, the price of gasoline should be rising. But the price will soon be tested.

    The "administered" prices of the world's oil producing countries would not be the "asked" prices were they not “validated” by monetary flows or validated by the volume of money times it's rate of turnover(MVt),i.e.,validated by the world's Central Banks.

    As Friedman maintained "inflation is always and everywhere a monetary phenomenon".

  5. What Friedman should have said is this --

    Always and everywhere, inflation arises from central bank action.