Friday, July 11, 2008

Why is Gas So Cheap?

Gasoline is amazingly cheap. I know this sounds stupid, but bear with me. If you drive a car the implications are important.

Gasoline is made from oil. At the current price of $147 a barrel, a gallon of crude costs $3.50. Historically gasoline has retailed between 1.5 to 2 times the cost of the oil it's made from. Today that ratio is 1.2. By historical norms gasoline should be well over five dollars a gallon, and probably closer to seven. This means that even if crude oil prices stabilize or drop a bit, gasoline prices could still soar.

But they probably won't.

Diesel prices will go up. So will heating oil, and jet fuel. But we got lucky on gasoline. Most of the world is switching to diesel engines, and for good reason. They're a lot more efficient than gasoline engines. But the result is that there's a relative glut of gasoline, forcing prices down compared to other oil products. Refineries can't quickly or easily change the mix of products they produce, so as worldwide demand increases for diesel fuel, they end up with lots of gasoline that they need to get rid of, so they're willing to sell it cheap.

Eventually refineries will fix this problem, and gasoline prices relative to crude oil will increase significantly. But this will take years, and until then we're getting a break compared to the rest of the world. Gasoline prices are still directly tied to the price of crude, so if crude oil prices go up so will gasoline, just less than other fuels. Of course, if we do something stupid, like attacking Iran, you can expect gas prices to go through the roof.

The big question is if we'll use our temporary cost advantage compared to the rest of the world to smooth the inevitable and expensive transition away from liquid fossil fuels, or just piss it away by continuing to drive big cars and SUV's. Given that this is America, it's pretty safe to bet on the latter.

For a good, if rather wonkish, discussion of gasoline prices relative to other fuels check out this post and discussion on The Oil Drum. It's a great site if you're into peak oil and energy policy.

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