As of Monday, March 24, EIA’s weekly survey of retail gasoline prices showed the U.S. average price for regular grade at $1.690 per gallon, down from $1.728 per gallon the previous week, the highest nominal (not inflation-adjusted) national average price on record. With prices this high, and months to go before the summer driving season (traditionally the time of highest gasoline demand and prices), many people are understandably concerned about the potential impact on gasoline prices of the war in Iraq. Some also note the wide variations in crude oil and wholesale gasoline prices from week to week, or even day to day, and wonder how quickly increases (or reductions) can be expected to show up at the pump.

The effect of the war on prices for crude oil and petroleum products, including gasoline, is likely to depend mostly on how events unfold, particularly in terms of the scope and duration of any interruption to world oil supplies. The commencement of military action has to date affected oil production only in and near the combat region. For the time being, EIA is assuming that the flow of legal Iraqi oil exports has been effectively stopped. Kuwait has reportedly reduced production at certain northern oil facilities, but offset this with increases elsewhere, yielding no net change. Iran has reportedly shut in production from its offshore Soroosh field in the Persian Gulf. In total, the gross Middle Eastern oil supply disruption is estimated at 1.8 million barrels per day (MMBD). (This estimate is prior to excess production capacity being brought online by other countries). At present, promises of increased supplies from OPEC, especially Saudi Arabia, appear to be perceived by markets as sufficient to offset the temporary loss of Iraqi (and some Kuwaiti and Iranian) production, as evidenced by price movements to date. In fact, after rising nearly 50 percent since mid-November 2002, reflecting both tight global supplies and uncertainty over the possibility of war, prices fell as much as $10 per barrel in just over a week leading up to, and including, the first few days of battle.

In addition to the war in Iraq, other events continue to have substantial impact on world oil markets. Oil exports from Venezuela, a major exporter and OPEC member, remain at reduced levels as that country continues to recover from a general strike that began in early December 2002. Though official and unofficial estimates vary, Venezuelan production continues to run as much as 600,000 barrels per day lower than pre-strike levels. More recently, civil unrest in portions of Nigeria has reduced crude oil production from that OPEC member country by about 900,000 barrels per day. Problems in both of these countries have disproportionate effects on the United States, because they are among the relatively “short-haul” Atlantic Basin crude oil sources favored by refiners on the U.S. East and Gulf Coasts.

Higher crude oil prices exert upward influence on gasoline prices in two ways: a direct pass-through to all petroleum products, because crude oil is the primary feedstock to refineries; and inflation of refinery margins, because of the secondary effects of crude oil prices on refinery economics. Increases or decreases in crude oil prices, which are dependent on global supply and demand, translate almost instantly into changes in wholesale petroleum product prices, particularly in the spot and futures markets. (Each $1-per-barrel change in crude oil prices equates to a change in product prices of about 2.4 cents per gallon).

The other major component of gasoline price changes impacted by crude oil is refining margins, the difference between product prices and crude oil prices. When the supply/demand balance for a product is tighter than that for crude oil, refining margins are pushed higher. The balance can tighten because of rising demand, reduced production or imports, or a combination of these. This has recently been the case due to low U.S. crude oil inventories, which have begun to constrain refinery runs, in addition to reduced gasoline imports related to the Venezuelan strike. Additionally, high crude oil prices are often accompanied by “backwardation” in futures markets, where prices for commodities to be delivered in later months are lower than those for immediate delivery. Such a situation provides a disincentive for refiners to purchase and refine high-priced crude oil now, to be delivered as lower-priced products later.

The two components discussed above, crude oil prices and refining margins, add up to the spot market price of gasoline.  Changes in spot prices are passed through to retail prices over a period of weeks, with about two-thirds of the impact of spot price changes arriving at the retail level within two weeks.  Thus, unless counteracted by other influences more specific to gasoline, changes in crude oil prices can be expected to show up in retail gasoline prices, at the rate of about 2½ cents per gallon of gasoline for each $1 per barrel in crude oil price, within a matter of weeks.  Because this “pass-through” of price changes from crude oil to wholesale and then retail gasoline markets is relatively consistent, EIA has found that near-term retail gasoline prices can be predicted with accuracy using recent spot price data.

When will last week’s $10-per-barrel drop in crude oil prices show up at the gasoline pump? The answer lies in the lagging nature of price pass-through, and is not as simple as it may sound. Because the impact of a sudden change in spot prices is passed through to retail markets over a period of weeks, there can often be conflicting influences being passed through at the same time, especially when wholesale prices have quickly reversed direction. The current situation is a perfect case in point: gasoline spot prices had only peaked two weeks ago, so a portion of last week’s sharp spot price decline, along with a lagging part of the previous increase, were both contributing to retail price movements this week. As a result, the downward movement was partially offset by the upward, yielding a net retail price decline of 3.8 cents per gallon for the week (note: this refers to the national average retail price for regular gasoline; prices can vary considerably on a regional basis because of differing logistical costs and product specifications).

Although it is impossible to predict spot market behavior over the coming weeks, it is likely that we will continue to see some conflicting influences on retail gasoline prices as the spring proceeds.

Archives of past Energy Situation Analysis Reports are now available.

Contact:
Doug Macintyre
douglas.macintyre@eia.doe.gov
Phone: Doug Macintyre (202) 586-1831
Fax: (202) 586-9753

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