Since the beginning of Russia’s attack on Ukraine on February 24, the spot price of oil has been like a jumping jack. On February 18, the WTI (West Texas Intermediate) price was $91.07, and it was the highest on March 8, at $123.70. It went down on to a low of $95.04 on March 16, and on March 18 it was $ 104.70. I am using February 18 since it was a Friday, and the government survey of gas prices, which comes out on Monday, lists the average price for the prior week.
The average price of gas in New York State shot up in a flash from $3.69 on February 21 to $4.37 on March 14. Although the price of oil has gone down by $19 from its high on March 8, the price of gas has been falling slower than a rolling stone. It went down this past week from $4.37 to $4.28 a gallon.
The excuse for the rise in gas prices is the increase in spot crude prices. If that were accurate, then the prices at the pump should go in tandem with the spot oil price on the way up and on the way down. Yet it’s not so. That on its face shows that this reason is bogus. The most extreme example was on April 20, 2020, when the spot price was negative $37.63. I don’t remember gas stations giving away gas for free or just charging the taxes.
Nevertheless, I will give two examples to show the fallacy of this claim.
Much of the gas that comes from oil is based on a fixed price. Corporations that drill for oil and natural gas (upstream companies) have to expend a large amount of cash. These companies need enough cash flow not only to support a level of capital expenditures and exploration activity to ensure that oil and gas continues to flow, but also to make debt payments, comply with debt covenants, and support the general and administrative costs. In order to try meet these needs, companies have a hedging program. Twenty-seven out of the top thirty largest oil and natural gas companies use hedges. Hedging is selling the community at a fix price. With a hedging program, there is almost a certainty of what is going to be the cash flow for the year. Many companies have the set price for more than one year. Twenty-four out of twenty-seven largest oil and gas companies had an average price for crude was $44.69/bbl for 2021 and $43.88/bbl for 2022 and natural gas was $2.69/MMBtu for 2021 and $2.58/MMBtu for 2022.
There are risks when the price shoots up and the oil and gas producer is stuck with a low contract, like what is happening now. However, they would be protected if the price crashes, as it did a couple of years ago when COVID hit.
Another important factor is that only about one half of the price of gas is based on the price of oil. The remainder is distributing, marketing, refining costs, and taxes, none of which are directly affected by the price of oil.
As a result, the increase price of WTI on the commodity market has limited effect on the price of gas. It does not justify the extreme price increases since the beginning of the war.
So why are gas prices allowed to remain high? One answer is that they will charge these prices as long as people are willing to pay them. It is called capitalism - supply, and demand.
There has been little pressure on the energy industry to lower the prices. There are several reasons. Firstly, we have been trained to accept immediate increase in gas prices when spot oil rises and slow reduction in prices when the spot oil drops. Secondly, it is politically beneficial for prices to remain high. The Republicans are happy with the soaring prices so they can use it as a weapon against the administration and the Democratic Party in the mid-term elections next November. The progressives are happy because it accelerates the pace for the country to invest in clean energy. One of the arguments against clean energy is the cost in relationship to fossil fuel.
The fossil fuel industry is happy because they are making tons of money and can blame the government for the situation. There are many levels in the chain from the drillers to the refiners to the wholesalers to the retailers, who are benefitting from the higher prices. The oil companies have no incentive to drill more. It will only lower prices. What they are looking for are tax breaks or loosening of other regulations that make it more profitable to them to drill the oil they were planning to drill.
There have been suggestions such as a gas tax holiday. All that will do is legitimatize the price gouging at the expense of the public welfare.
A better approach is to put pressure on the fossil fuel industry. The president has tried his bully pulpit to chastise the industry for the price increases. The government can threaten to change the law to limit incentives and other tax benefits that are given to the industry. Americans can drive less. If the dangers of COVID are receding, there is no excuse not to go back to the prior routine of using mass transit. Now that the weather is getting better, there are healthy alternatives, such as walking or riding a bike.
Once we put the squeeze on the fossil fuel industry and they back down, we can say, “It’s all right now. In fact, it’s a gas.”