Explaining the oil-gasoline price disconnect

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For obvious reasons, I’ve been getting a lot more reader e-mail than I used to. Which is great, except that I’m now way behind in answering. So here’s a good one one from a week ago that has only gotten more relevant with the passage of time:

One of the economic issues that really disturbs me is the movement in gasoline prices. Over the last 18 months oil prices rocketed upwards, and then fell sharply. … You would expect gasoline prices to show the same pattern. However this has not been the case.

In Q4 of 2007, oil prices were around $90 per barrel. Today’s oil price is about the same. In Q4 of 2007, gasoline prices were in about $3 per gallon. Today we pay an average of $3.50 per gallon.

In simple terms, it appears that we are paying $.50 too much for each gallon of gas. Yet I do not hear/see anyone talking/writing about this. Are we simply being robbed by the industry that provides our gasoline? Is there a legitimate reason that gas pricing has remained higher than you might expect?

There’s an extensive academic literature (pdf!) demonstrating that the relationship between oil and gas prices is asymmetric–when the price of crude rises, gas follows quickly; when it falls, the reaction is slower. As for why this happens, the most popular explanation is that refiners and retailers have a certain amount of market power, and tacitly collude to keep gas prices from falling too far and too fast. I’m willing to believe that’s a factor, although I don’t know of any conclusive evidence for it. But it could also have something to do with consumer behavior–people sometimes hoard gas when prices are rising fast, but generally don’t hold off on buying it when prices are falling. Similarly asymmetric behavior by refiners might play a role, too.

For the current disconnect between gas and oil prices, though, there may be a simpler explanation: Hurricanes that temporarily knocked out a lot of refining capacity along the Gulf Coast. And that’s not going to be a lasting condition, as my colleague Bill Powell reported a couple of days ago:

Oil was trading at $78.63 per bbl. Tuesday, while the average price of a gallon of gasoline in the U.S. has fallen to $3.15 and will likely fall further in the coming weeks. That’s because, along with falling global crude-oil prices, the refining capacity of the U.S.’s Gulf Coast that was lost as a result of Hurricanes Ike and Gustav is coming back onstream, which will mean a significant increase in gas supply next month.

So gas should be below $3 a gallon soon, if it isn’t already (as a Manhattan-dwelling subway rider, I’m not up on the latest developments). Until then, think of any extra you pay as a charitable donation to the nation’s refiners and gas-station owners.