You might have noticed a spike in gas prices over the last couple of weeks. Neil Shah of Wall Street Journal’s Real Time Economics reports that crude oil prices are at a 52-week high. Specifically, crude oil prices have risen to $108.05 a barrel. When looking at the market for gasoline, the price of gas is affected by the market forces of supply and demand.
Neil Shah mentions two factors: a rise in crude oil prices and an improving economy. Crude oil prices affects supply, while a stronger economy boosts demand.
There are four factors that affect supply.
- Change in input prices (any process or resource that goes into making a good)
- Change in technology
- Change in the number of sellers
- Change in the expectations of sellers
In this case, we want to focus on input prices. Regarding inputs to providing gasoline, think about labor, land, and capital. In this case, crude oil is considered land, which refers to any natural resource. Without crude oil, it is impossible to produce retail gasoline. Crude oil is accessed by refineries, who are then able to convert it into retail gasoline used by cars.
There are five factors that impact demand.
- Change in taste (activity is more or less attractive)
- Change in income
- Change in the price of related goods
- Change in number of buyers
- Change in the expectations of buyers
When Shah stated that greater economic optimism is causing prices to rise, this relates to the first and second factors of demand. When an economy is improving, that means incomes are rising and consumers are more likely to drive and travel because they have more money to spend on shopping. Even though the unemployment rate remain elevated, consumer spending has been trending up.
It was a little confusing when Shah referred to a boom in American oil production. That typically results in an increase in supply and drives prices down. However, that would explain previous dips in prices. What is happening now is that the utilization of refineries are near full capacity at 90.7% as of the week ending on June 28. In fact, U.S. refineries are operating at the highest level since 2007. That indicates that driving activity is on the rise and that would place upward movement on prices due to the first factor of demand again. If the utilization of refineries start to fall due to refineries expanding capacity through improved technology, then that would be an example of an increase in supply that would drive prices down due to the second factor.
Speculation also plays a role in gas prices and we can look to uncertainty with Egypt. Even though Egypt is not a major source of our gasoline supply, political turmoil there could impact global supply. This scenario would be consistent with the first factor dealing with supply. In this case, prices are driven up not by current market forces of demand and supply, but potential future disruptions in oil supply if the Middle East experiences more political instability. If disruptions are severe enough, then that would drive the price of crude oil up, which is an example of an input price.
When wondering why gas prices change, one can often look to the market forces of supply and demand. However, we must also realize the role of market speculation in influencing gas price movements.