The Economics of Gasoline
What Determines Gasoline Prices?
Learn how Price, Taxes, Inflation, The Supply & Demand impact gasoline prices.
Gasoline Economics
The determination of what causes changes in gas prices is a complicated area of economics. Because of the tremendous demand for gas, consumers are highly conscious of pricing and often leap to conclusions concerning what is causing rises in gas prices. In reality, there are a variety of factors that determine the price of retail gas in the United States, including Price, Taxes, Inflation, and Supply & Demand. In this article, I will analyze how each of these factors affects the gas prices in the US and provide some suggestions for consumers and policymakers to cope with the fluctuations. According to the US Energy Information Administration (EIA), the average retail price of regular gasoline in the US was $3.19 per gallon as of November 29, 2023, which is $1.13 higher than the same week in 2022. The US has the sixth-lowest gas prices among the 37 member countries of the Organization for Economic Cooperation and Development (OECD), but they are still higher than the global average of $2.77 per gallon. The changes in gas prices have significant impacts on the US economy, as they affect the consumer spending, the inflation rate, the trade balance, and the greenhouse gas emissions.
Price
One of the largest factors determining gas prices is the price of crude oil. The average cost of crude oil in the US was $66.02 per barrel as of November 2021, which accounted for 54% of the retail price of regular gasoline. The demand for crude oil was affected by the COVID-19 pandemic, which reduced the global oil consumption by 9% in 2020. The supply of crude oil was also influenced by the Organization of the Petroleum Exporting Countries and its allies (OPEC+) agreement, which aimed to balance the oil market by cutting the production by 9.7 million barrels per day in 2020 and gradually restoring it in 2021. The US shale production, which contributed to the US becoming the world’s largest oil producer in 2018, also faced challenges due to the low oil prices and the environmental regulations.
Taxation of Gasoline
Taxes are a major component of gasoline prices. According to the US Energy Information Administration (EIA), the average retail price of regular gasoline in the US was $3.40 per gallon as of November 29, 2021. Of this amount, about 19% ($0.64) was federal and state taxes, while the rest was crude oil ($1.85), refining ($0.49), distribution and marketing ($0.42).
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The federal tax on gasoline is 18.4 cents per gallon, and it has not changed since 1993. However, state taxes vary widely, from 8.95 cents per gallon in Alaska to 66.98 cents per gallon in California. Some states also impose additional fees, such as environmental or inspection fees, on top of the state tax.
As of July 1, 2021, the EIA shows the highest taxed states are California, Illinois, Pennsylvania, New York, and Hawaii, while the lowest taxed states are Alaska, Missouri, Mississippi, Texas, and Arizona. Despite what many perceive as high cost of fuel, the US has lower taxes and prices than most other countries, especially in Europe. According to the International Energy Agency (IEA), the average retail price of gasoline in OECD countries was $5.77 per gallon as of October 2021. Of this amount, about 56% ($3.22) was taxes, while the rest was crude oil ($1.85), refining ($0.35), distribution and marketing ($0.35). The highest taxed countries are Norway, Netherlands, Italy, France, and Germany, where taxes account for more than 60% of the price. The lowest taxed countries are Mexico, Canada, Chile, Australia, and the US, where taxes account for less than 30% of the price.
Inflation
Taxation is a major factor affecting fuel prices at the macro level but coupled with this factor is inflation. Inflation erodes the purchasing power of money and makes everything more expensive. When inflation is high, consumers have to pay more for the same amount of gasoline. According to the US Bureau of Labor Statistics (BLS), the average price of gasoline (unleaded regular) in October 2023 was $3.48 per gallon, up 57% from a year ago. This was partly due to the surge in inflation, which reached 6.2% in October 2023, the highest level since 1990.
Gasoline prices have fluctuated significantly over time, depending on various factors. However, inflation has generally increased the nominal price of gasoline over the long term. The inflation-adjusted price of gasoline, on the other hand, has been more stable and reflects the real value of gasoline. Inflation is one of the factors that makes gasoline more expensive in nominal terms, but not necessarily in real terms. To understand how much gasoline really costs, we need to look at the inflation-adjusted price, which accounts for the changes in the purchasing power of money over time.
Supply & Demand
Taxes and inflation both affect price of fuel dramatically but supply and demand also play a large part in the pricing equation. Supply and demand are the main factors that determine the price of gasoline. When the demand for gasoline is high, such as during peak travel seasons, the price tends to increase. When the supply of gasoline is low, such as when there is a disruption in production or distribution, the price also tends to increase. Conversely, when the demand for gasoline is low, such as during a recession or a pandemic, the price tends to decrease. When the supply of gasoline is high, such as when there is an oversupply of crude oil or a technological innovation, the price also tends to decrease. Examples of supply and demand impacting gasoline prices have occurred many times.
- In 2008, the global financial crisis reduced the demand for gasoline, leading to a drop in prices from over $4 per gallon to under $2 per gallon in the US.
- In 2011, the Arab Spring and the Libyan civil war disrupted the supply of crude oil from the Middle East and North Africa, leading to a rise in prices to over $3.5 per gallon in the US.
- In 2014, the shale oil boom in the US increased the supply of crude oil, leading to a fall in prices to under $2 per gallon in the US.
- In 2020, the COVID-19 pandemic reduced the demand for gasoline, leading to a plunge in prices to under $1.8 per gallon in the US.
- In 2021, the Colonial Pipeline cyberattack disrupted the distribution of gasoline in the eastern US, leading to a spike in prices to over $3 per gallon in some states.
On the demand side of the relationship, there seems to be no lessening of demand despite prices. While demand does affect price of gas, the relationship is mostly inelastic. This is due to the critical dependency on oil and fuel due to lack of substitutes. The demand for gas is also directly proportional to the number of people and industries which utilize gas: the expansion of population, industry, and individual use. These factors continue to drive the demand for more gas.
While the relationship is somewhat inelastic prices do fluctuate with demand. Studies report a decrease in demand when prices increase but this decrease is relatively small. Also the decrease is not much different in the short term as it is in the long-term (greater than a year). This high demand is the reason that people will wait hours in gas lines as well as continue to pay high rates for fuel. The inelasticity is caused by the incredible dependence that Americans have on fuel. It is not a choice to go to not drive a car for many people due to the need to get to places. As a result of this high demand, fuel prices tend to increase or decrease more often due to other factors such as supply, taxes, and artificial inflation.
In the United States, there is little price regulation on the fuel industry but there are other regulations and policies which affect fuel price. Most obviously, taxes are a form of regulating gas prices. The large amount of taxes placed on fuel raise the amount retailers charge for fuel and keep the industry competitors mostly evenly priced. There are other policies such as safety and environmental regulations which also maintain control of retail fuel selling. These measures however, do not eliminate the dependency or the issues concerning price of fuel. The current demand for fuel in the United States continues to drive oil dependency and this allows for a great deal of seller pricing control. Still, more often than not, the changes in price are caused by shortages and rising costs associated with taxes or other normal supply and demand issues.
