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Debunking Myths on Crude Oil and Gasoline Prices

It is not uncommon to read articles or hear of claims that international oil companies somehow “set” the price of crude oil and use this power to drive profits. But a new report from the U.S. Energy Information Administration (EIA) would, I hope, convince readers otherwise. This online report, called “What Drives Crude Oil Prices?” shows that there are a multitude of factors that influence the price of oil and gasoline – and demonstrates that oil companies simply aren’t able to set prices.

It’s a well-written report that would be useful for anyone interested in learning more about today’s oil markets. But I’ll summarize here.


EIA Report: What Drives Crude Oil Prices
EIA Report: What Drives Crude Oil Prices

As the EIA notes, crude is a globally traded commodity. Like any commodity, its price is influenced by changes in supply and demand in both producing and consuming nations, and many of these factors intertwine. For example, EIA points out that higher oil prices might prompt some consumers to buy more fuel-efficient vehicles or use public transportation, which in turn would reduce energy demand.

In its report, EIA organizes crude oil’s influences into several big categories: production (from OPEC and non-OPEC countries), demand (in OECD and non-OECD countries), existing inventories of crude, and financial markets. For example, on the demand side, EIA notes that while oil consumption in the OECD countries declined between 2000 and 2010, non-OECD oil consumption increased more than 40 percent.

These major categories are further detailed in the chart below. While still not exhaustive, it outlines the range of factors — from investments in new supplies to weather to geopolitics to swings in economic activity — that can influence crude prices on a given day, month or year:

Factors Contributing to Oil and Energy PricesThere are two points that I’d like to highlight about this graphic:

1.  Like other commodities, the price of crude is influenced not only by today’s market conditions, but also expectations for the future — on everything from economic growth to transportation demand to development of new resources. This point often gets overlooked, and it explains why sometimes, although a market might be well-supplied, prices might still rise — and vice versa.

2.  Financial-market factors — such as a weak U.S. dollar and the rising popularity of commodities as an alternative to traditional asset classes like stocks and bonds — can also exert significant influence on crude prices as supply-and-demand changes. EIA examines this subject in more detail in its “Energy and Financial Markets” slideshow, where it notes that the number of open contracts in crude futures has risen fourfold over the past 10 years.

Now some might ask: But what about gasoline prices? Gasoline is just one of the products that can be made from crude, but it is a regular expenditure in most U.S. households. And it is an expense that becomes more significant during difficult economic times as we are seeing now.

As you’ll see in the EIA’s chart below, the main driver of U.S. gasoline prices is the price of crude. In fact, in most cases, the price of gasoline very closely mirrors the price that refiner pay for crude oil.

Much of this is simple economics. Just as bread costs more when grain prices rise, when refiners pay more to buy crude oil, the cost of gasoline goes up. (As the chart shows, sometimes gasoline prices rise faster than crude prices; this is usually at times of temporary bottlenecks in refining, such as after Hurricane Katrina in 2005.)

There’s a lot more information in the report, and throughout the EIA’s website.

As the United States continues to debate its options for addressing its energy and economic challenges, it’s important that citizens and policymakers have the facts they need. For example, if our goal is to keep U.S. energy prices affordable, arbitrarily singling out oil companies for punitive taxes on so-called “excessive” profits would be counterproductive – it will do nothing to reduce pump prices, but would reduce funds available for investment in developing additional the supplies that could put downward pressures on prices. The EIA’s report clarifies important facts that should inform policymaking and dispel the myth that oil companies control gasoline prices.  

  • Worth a deeper look...