Tuesday, October 21, 2008, 9:20 AM: The following question has been posed to me several times the past month: On July 15, oil was at $145 a barrel, and gasoline cost $4.25 a gallon at the pump in Grand Rapids. Last week, oil was $72 a barrel, and gasoline cost $2.96 a gallon. If the price of oil has been cut in half, why hasn’t the price of gas followed suit?
There are a few reasons for this, that I will try to explain.
1. NYMEX. Oil and gasoline futures are traded on the NYMEX, a public market with prices available for all to see. The price of these future contracts helps set what is called the “spot” price, which is what is actually charged when real oil or gasoline changes hands at the wholesale level. Sales and other taxes are not included in the NYMEX prices. Looking at these futures prices, both oil and gasoline has dropped approximately 50%, so at least at the NYMEX level, these prices are correlated.
2. Taxes. There are three taxes applied to the wholesale price: the federal gas tax of 18.4 cents per gallon, the state gas tax of 19 cents per gallon, and the sales tax of 6%. So, that’s at least 50 cents of the retail price that is taxes, regardless of the wholesale price (except for the sales tax, of course). In the past three months, those taxes have not been cut in half, so it would be hard for the retail price to drop 50%.
3. Chicago Summer Premium. I coined this term a few years ago to describe how, during the summer months, the wholesale price in the Midwest is usually higher than the price based on NYMEX. The reasons for this have to do with reformulated gasoline, variations in supply and demand, and some other mysteries I’ve never solved. A way to monitor this premium is to look at the wholesale numbers for selected Midwest cities that are posted on AXXIS. The NYMEX/AXXIS difference was 20 cents on July 15, over a dollar in mid-September when Hurricane Ike struck, and is currently still 41 cents. The AXXIS price has not dropped in half the past three months, and this may still be a hangover from the hurricanes. It is also the first place I would look for gas gouging if I was the Attorney General.
4. The Dynamics of the Retail Market. As a journalist said to me last week, “Up like a rocket, down like a feather.” We’ve documented time and again on this site how this works, with the big price hikes followed by the gentle day-to-day drops, while the wholesale price fluctuates in the background. Our last price hike was during the September 12-14 weekend, when prices got up to $4.29 on 28th street. Since then, the drops have been slow but sure — some days one or two cents, other days seven or eight cents. In an area where there are several stations, one station decides to drop their prices a few cents because a cheaper shipment came in that day, and the other stations follow suit. The point is that the retailers aren’t setting their prices based on trading on NYMEX. They are setting it based on their costs, what their competitors are doing, and what sort of business they are getting. Are the retailers making extra money right now? I doubt it, as our monitoring indicates they are still dealing with high wholesale prices in the Midwest, and some of the gas in their tanks cost them $2.95 a gallon last week. But prices continue to fall, slowly but surely.
All this leads to my latest prediction: It looks to me like the chaos on Wall Street is dissipating, so energy prices are starting to stabilize. I expect Speedway and friends will decide it is time to straighten up their prices, with a reset by the end of the week to $2.89.
