Why is Gas so Expensive?!

Mar 7, 2022

We have all experienced that dreadful feeling watching the digital price meter at the pump going higher by the second. Why is gas suddenly so expensive? How does the price increase Hoosiers are experiencing compare to other states?

What determines gas prices?

Many factors influence the price of gasoline. According to the U.S. Energy Information Administration, as of January 2022, crude oil comprised 56% of the average retail cost of gasoline. The next highest cost factors are 16% for distribution and marketing, 15% taxes, and 14% refining. By far, the greatest impact is the price of crude oil.

Why is crude oil so expensive?

Many experts point to two main reasons for the recent increase in crude oil prices.

Reason #1:  Supply and Demand. When the COVID-19 pandemic started, lockdowns followed. During this time, hardly anyone was driving to work or flying to a vacation destination. As a result, the demand for oil consumption dropped significantly.

On April 20, 2020, the price per barrel of oil for May 2020 WTI crude oil even finished the day negative at -$37.63 a barrel! This is the first time a contract has closed with a negative value and reflected the difficulty associated with finding a storage place for the physical delivery of a barrel of oil. The average price in the U.S. for regular retail gasoline was $1.69 per gallon! As demand came to a halt, oil producers began scaling back their production.

However, the swift recovery of the U.S. economy from the COVID pandemic took many by surprise. People were itching to travel and get back on the road again, which resulted in a dramatic increase in demand for oil and gasoline. In the face of this demand spike, producers have been slow to increase output, leading to a rise in oil prices.

Reason #2:  Russia’s War with Ukraine. Russia is a key oil exporter, and the invasion is sparking fears of supply disruptions. Many companies are also disassociating themselves from their business ties with Russia, exacerbating supply chain issues. Prices were already increasing due to supply and demand issues. Now, prices have skyrocketed with this uncertainty around production because of the war.

Will it go higher or lower from here?

WTI crude oil is already trading over $100 per barrel - around $108 as of March 2, 2022. There is potential for it to increase or stay at this level for a while. If the Russian war with Ukraine continues, uncertainty will remain high, keeping the price inflated. In addition, the largest supplier of global oil - the Organization of the Petroleum Exporting Countries (OPEC) - has not yet signaled their intentions to increase oil supply anytime soon.

On the other hand, there is hope that oil could be reaching its peak. If the Russian war can somehow end soon, it would ease uncertainty. OPEC could also begin increasing production to help ease supply strains. Further, the U.S. could start opening more oil rigs to boost supply; however, this would be a longer-term solution as it is not easy to open a rig and start pumping oil overnight.

Where does Indiana stand?

Before we keep complaining about the price of gas, Hoosiers should count their blessings that it has not reached $4 per gallon, as it has in five other states. According to data from AAA - as of March 2, 2022 - the national average retail price for a gallon of gas is $3.66. Indiana has an average price of $3.61, ranking as the 21st most expensive state for gas. California is the most expensive at a whopping $4.87/gallon. Arkansas is the cheapest at $3.27/gallon.

One thing to keep in mind is our ability to become anchored to a low gas price. As mentioned before, we have to look back to 2014 since we have seen prices this high. When we think about gas being $3.61 today, that is not the same as $3.61 in 2014 because of inflation. Using a simple inflation calculator, that $3.61 per gallon of gas in 2014 is the equivalent of $4.29 in today’s dollars.

Summary

The oil and gas market is a complex global market impacted by many factors. Unknown variables (both economic and political) are sure to play a role in pricing and economists continuously debate their relative importance. Therefore, where the price of gasoline goes from here is uncertain. Hoosiers should be thankful we haven’t hit $4 per gallon just yet!

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