Do Oil Prices Really Predict Gasoline Prices?

At a Glance

  • OPEC’s production cuts will affect global crude oil. Could gasoline prices follow?

With the commencement of a new round of OPEC + Russia crude oil production cuts on January 1, many people are worried about a sudden and crippling rise in the price of gasoline at the pump.

The relationship between oil prices and gasoline prices is notoriously hard to track. WTI crude oil prices fell from the high of $76.90 reached on October 3, 2018 to the recent low of $42.36 on December 24, a 45 percent drop. Gasoline prices, however, fell only 17.3 percent in that same time period.

According to the Energy Information Administration (EIA), regular retail gasoline price averages dropped from $2.86 per gallon to $2.366 per gallon from the beginning of October to the end of December. Clearly the price of gasoline is not exactly correlated to the price of crude oil especially when price is falling quickly over a short span of time.

So what is the correlation? A much larger data set is needed to give a basic idea of the effect.

In mid-February 2016, WTI rallied over 190 percent from $26.05 to the highs mentioned above. In that same two-year stretch, regular retail gasoline prices rose approximately 64.3 percent. Going back to June 2014, there was a WTI price drop of 75.8 percent and a gasoline price drop of only 52.2 percent. Clearly the correlations are inconsistent and given the EIA data involves monthly averages instead of closing prices, it’s difficult to use simple inputs to figure it out. A simple base estimate of the correlation could be about 2 – 2.5 to 1.

Other Factors Influencing Price of Gasoline

Part of the reason there is no clear relationship between oil and retail gasoline prices, is there are other factors influencing the price. It’s obvious that the biggest single component of retail gasoline prices is the cost of the raw material used to produce the gasoline, but there is also the cost of refining, transporting, and selling the gasoline at retail outlets.

According to the EIA, crude prices make up approximately 57 percent of the price at the pump and it often takes six weeks for price changes in WTI crude oil to filter through to the pump. That is not the case with the other inputs. Transport and refining cost changes can take effect almost immediately. Some of those cost changes have been in the news lately, as in transport bottlenecks between U.S. shale basins and refiners.

The cost to move crude has risen and that may have had an influence on prices at the pump, which seemed to stay a touch more elevated. There are also taxes that vary from state to state, known as excise taxes, added into the final sale price and they can change from time to time. According to the Tax Foundation, the highest gas taxes in 2018 were in Pennsylvania and California at 58.7 and 55.22 cents per gallon respectively. Crude oil costs account for about 57 percent of what people are paying at the pump, excise taxes average 18 percent, which leaves just 25 percent for the refiners, distributors, and the retailers, according to EIA data.

The Bottom Line

According to The Wall Street Journal, Saudi Arabia is looking for prices to get back above $80 a barrel. If $48.50 was the mid-point for the month of December in WTI, then $80 represents about a 65 percent rally in price. If the average price of gasoline was $2.366 per gallon in December and 57 percent of the cost of that gasoline went up 65 percent, the input cost effect is about an 87 cents increase.

That’s about a 36 percent increase which fits our earlier approximation of about a 2 – 2.5 to 1 correlation between oil and regular gasoline. It’s not certain OPEC will get WTI prices where they want them, but if they do, expect gas prices to nearly double. All else being equal of course, which is rarely the case.

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