Refinery Capacity and Gasoline Prices - Follow-up

Wednesday, October 14, 2009

In response to the comments posted by Corey, gasoline demand does impact retail prices but not as strongly as crude oil prices. So while both variables are important, changes in crude oil prices explain the majority of fluctuations in pump prices.

Unfortunately, it takes a significant reduction in demand to lower pump prices. So pump prices are lowered by decreasing demand.

Another aspect of this issue is the effect that higher oil prices have on the world economy. Lower economic growth means less demand for refined products (gasoline, diesel fuel, jet fuel, etc.) which translates into lower oil demand.

Consumers Rejoice - The lower demand can create a surplus and force producers to engage in price cutting to maintain market share (maintain production levels). This in turn can force more oil on the market as producers try to achieve revenue targets. The additional oil depresses prices more and leads to a collapse in prices.

OPEC Maintains Control - As demand drops, OPEC reduces production to maintain price levels. This is dependent on cohesion within OPEC as well as the speed at which they can meet to agree on lower production quotas.

This same process can occur with gasoline prices.

Consumers Rejoice - Lower demand leads to reduced prices. Oil companies engage in price wars to maintain market share. Gasoline inventories increase to capacity and prices drop further.

Oil Companies Maintain Control - Oil companies anticipate lower demand and reduce refinery operations to control the amount of gasoline on the market. This does not require a conspiracy on the part of oil companies, merely market analysis and inventory management. This action reduces the supply of gasoline to meet demand and prices are maintained.

Gasoline demand has not doubled since 2003 but crude oil prices have gone from $27.56/B to over $90/B. Gasoline prices have gone from $1.50/gal. to $3.65/gal. Gasoline demand has risen from 8,935 thousand B/D to 9,290 thousand B/D in 2007 (4% increase). These numbers support our comment that oil prices have a greater impact on gasoline pump prices than changes in demand.

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