May 7, 2011

Gasoline Prices: Why Are They Fast To Spike, But Slow to Fall? (Guest Post)

By Bob van der Valk

This year's Cinco de Mayo Mexican holiday may go down in US oil trading history as the day the oil prices spun down into their biggest free fall. Oil traders have already started calling it: "Jueves de Carniceria", which loosely translates to "Killer Thursday". However, motorists looking for lower pump prices were disappointed when the average price for unleaded regular gasoline dropped a mere penny from $3.99 to $3.98 a gallon.

The gasoline spot market prices are quick to react to any changes in the price of crude oil but there are a couple of steps in between those and the retail pump prices.

Understanding this complicated business requires some basic knowledge on how the spot market interrelates with the system of eventually pumping gasoline into the tank of your vehicle. My course is called: “Gasoline Marketing 101” and you will need to pay attention as there will be pop quiz after reading this article.  (42, 2.5)

Factoids in the oil market for this week:

On Friday, May 6, 2011 the June (WTI) West Texas Intermediate crude oil settled at $97.18 a barrel, down $16.75, the biggest ever drop for a week in dollars on the Nymex (New York Mercantile Exchange).

The June Brent crude oil price on the Intercontinental Exchange of London (ICE) ended up at $109.13 a barrel, falling $16.76, also a record one week loss.

Earlier in the week Goldman Sachs’ analysts David Greely and Jeffrey Currie, who in April predicted this downside crude oil price correction, reinforced their pricing forecast for 2012. They said crude oil could still surpass recent price highs with world crude oil demand catching back up to supply. The timing of their announcement coincided with the death of Osama Bin Laden on May 1, 2011.

Expressions of relief by Americans from the seemingly never-ending wars on terrorists caused this week’s selloff in the oil futures market. The “fear factor” of $15 to $20 a barrel has been taken out of the posted prices for crude oil on the ICE and Nymex.

After crude oil prices dropped about 20% this week gasoline prices are still hovering around the $4 per gallon mark. Why is it they are raised faster in the up market than they fall in the down market?

The question may be answered with basic gasoline economics--when the price of crude oil rises up, most of the increases at the pump take place within the first two weeks.

Furthermore, when oil prices sink down, it takes up to eight weeks for the savings to be passed along to consumers in the phenomenon known in the petroleum industry as "asymmetric price adjustment."   

Here is how it works in the real world of gas stations.

Branded station gasoline retailers receive deliveries on an almost daily basis, so there's some pressure to pass along price hikes without much delay.

Those stations cannot raise prices too fast or too furious because consumers tend to be extra-vigilant about shopping for bargains when oil prices are on the rise. When newspapers report gasoline prices are going up, drivers tend to comparison shop down to the last penny per gallon.

The asymmetry comes into play as soon as oil prices start to deflate. Freed from the constant reminders about rising fuel costs, drivers become less concerned in looking for the lowest price. Retailers don't have to worry as much by having to keep up with their competition.

As a result, station owners can keep drivers happy by knocking off just a few cents the "old" price as soon as they receive gasoline deliveries at the lower price.

The flow chart in this article explains how the California gasoline spot market works.

My pop quiz has two questions;

  1. How many gallons are there in a barrel of crude?
  2. How many cents per gallon of gasoline does the difference of $1 represent in the price for a barrel of crude?
Hint - The answers are hidden at the end of one of the paragraphs in this article.

About The Author - Bob van der Valk is a Petroleum Industry Analyst with over 50 years of experience. Bob's email - trademoil@aol.com.

The views and opinions expressed herein are the author's own and do not necessarily reflect those of EconMatters.

EconMatters, May 7, 2011 | Facebook Page | Post Alert | Kindle

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