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why do gas prices fall slowly when oil prices drop?

by Brian Shrader
Published Jul 18, 2008
Views: 675

As the price of crude oil plummeted $15 in three days this week (it seems to be bouncing back a little this morning, as investors speculate that it fell too quickly this week), a lot of people are wondering why gas prices have not dropped as quickly at the retail level.

It's a fine question, and one that the Associated Press answered this week.  Here's the answer:

 

"The cost of oil does indeed affect what we pay at the pump, but the process of getting it from the well to your gas tank takes time. Prices take a while to catch up.

"Oil future contracts being traded now — the ones that hit new records last week but have since seen big drops — are for oil that won't be delivered until next month. That oil still has to travel to a refinery, be broken down into gasoline and other products, and then get shipped again before it reaches your local filling station.

"Another factor: Because of high oil prices, fuel refiners and retailers are making far less on a gallon of gasoline than they used to, and some are even losing money.

"As much as gasoline prices have climbed, the refiners and retailers would like to have raised them even more to cover their costs — but falling U.S. demand has made that impossible. And so, with an eye on their bottom line, they're not likely to lower their prices all that quickly — even with oil prices declining sharply."

A Ph. D candidate at U.C. Berkeley offered another possible explanation in a 2003 paper.  Economist and blogger Andrew Chamberlain has a good summary:

"...consumers don’t search much for better prices when they’re falling, but search a lot when they’re rising.  When consumers search, markets are more efficient. And when they don’t, markets are less efficient. So when wholesale gas prices fall, gas stations drop prices just enough to keep people from searching much. That makes markets sloppy, and retail prices get pushed down more slowly than up."

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Filed under: Transportation




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None of the arguments about falling oil prices "taking time to catch up" to affect refined gas prices hold water. Immediate news of increasing oil prices sends retail gas up in price, sometimes several times in a single day. The oil to refine THAT gas had nothing to do with today's price per barrel. The way I calculate it gas should be down at least .49 if it fell the same way it rises with oil. It happens this way because the refiners can do so. Why wouldn't they? They control the supply ans set set (fix) prices. Why isn't gasoline treated as a utility?

Greed on the part of the oil companies, the refineries, and the retailers are the reasons that prices at the pump go up faster when oil prices go up. Greed is also the reason that prices go down slower when oil prices go down. Retailers will tell that they are trying to recoup some of their losses by not lowering prices when oil prices go down.

"Another factor: Because of high oil prices, fuel refiners and retailers are making far less on a gallon of gasoline than they used to, and some are even losing money."

Check the profit margin on any company that refines oil from the middle east...tell me that they aren't making any money...gas isn't the only product that comes from that oil and I am sure by the time its all refined into everything they can squeeze out of it they have made a profit. Those who refine oil aren't in it to lose money, they make theirs and the consumer is the one who pays for it. Isn't it funny how when the stock price goes up we see and feel it within days, but when it does go down like the last few days we hardly see any change...thats where some of that money is made by the refinery and anyone who pays attention should have figured it out by now. I am sure ratailers don't make a fortune because I have friends in the business, its the store that brings in the money from snacks, cigs, and beer.

They fall slowly mostly because of psychology.

As prices rise, people get used to paying a certain amount so they are willing to keep paying more. And, retailers have to make back their money on the higher priced gas.

If oil prices would rise sharply today, the cost would be transferred to the customer tomorrow. But the opposite is not true. This is the problem.

"Matthew Lewis, the guy from Berkeley to studied gas prices, found no evidence of collusion."

---

He wasn't looking in the right place. The individual retail stations selling refined gasoline are not the problem.

It might appear so when you can drive down the main street in Lillington and see every station at 3.999 as I did yesterday but what's happening there is a decision to remove price as a factor in the consumer deciding where to stop and maybe go into the store where the food and pop are the true cash cows of the operation.

The real problems here are the big oil companies (who are pumping and refining the oil) and the distributors of the gasoline who are making sky-high profits due to speculation in oil because the value of the dollar is in the toilet.

Were it not for those two factors, I'd be hard-pressed to believe that it truly costs nearly half again to move basically the same oil from the well to the gas pump as it did 6-8 months ago.

Matthew Lewis, the guy from Berkeley to studied gas prices, found no evidence of collusion. He apparently is now an economics professor at Ohio State, and their news service summarized his findings: --- If stations were colluding to keep prices high, Lewis said some stations would hold on to high prices for as long as they could, but there would nearly always be one or more stations that would drop prices to try to get a competitive advantage. Then, nearby competitors would drop prices to match. The result is that prices would drop at different rates in different areas in the city.

But that is not what Lewis found.

“One of the things I documented is that the spread of prices in the city didn't change much. The lowest prices in the city fall just as slowly as the highest prices do. So there isn't the breakdown in collusion that you would expect to see.”

"I think the answer about why prices rise so quickly is probably the same for any retail situation: The seller will charge what the market will bear."

---

One thing to keep in mind is that whilst basic greed cannot be discounted as the real reason behind meteoric price rises and glacial price falls, in this particular case...the convenience store operator often has no pricing power for the gasoline in the tanks.

The price is more often than not mandated by the refiner/distributor who owns the pumps at the station as was seen during the spikes after Katrina when a Burlington owner tried to refuse a forced price change only to find his pumps locked the next day (this was subsequently ruled as illegal behaviour but the damage was already done).

I'm thinking the original article is not very well thought out...there's not much point in "searching" the best price when pretty much everyone is at the same price (collusion!) and searching would waste more money than it ultimately saves.

The gas you pump today is made from oil that was pulled out of the ground +/- 6 months ago.

"But even at those high retail prices, the service stations are making tiny profit margins, at best."

That is so true! We used to own a gas station and if we depended on the profits off of gas, we would have starved to death. It's only like pennies on a gallon or it was back then.........

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