The Gasoline Price Conundrum

If one takes the time to read this article, he or she might gain an understanding on an ongoing anomaly regarding the price of gasoline. Usually, gasoline prices are tied to the price of oil, rising or falling in accordance with the market price of the raw commodity. This is the way things have worked in the energy markets for decades.

In recent years, however, a strange new mechanism has imposed itself upon the pricing picture. It was understandable that gasoline was pricing at the pump for around $4 a gallon when oil was trending at over $140 per barrel. What has observers confused and consumers boiling is that there are $4/gal. prices at the pumps with oil pricing at only $113 per barrel. Gasoline’s “natural” price at this point should have been only $2.83 per gallon.

Gasoline prices are determined not only by the oil prices but by gasoline futures trading. This defines the Reformulated Blendstock for Oxygenate Blending (RBOB) price standard in the gasoline markets. Where things began to go “tilt” was when an increasing spread between the prices for oil traded on the West Texas Intermediate index and the Brent (London) index began to increase. This in turn triggered off spikes in the RBOB standard and rising gasoline prices despite falls in the oil prices. At its highest, RBOB was at 9 cents per gallon of gasoline instead of its traditional 2.3 – 2.5 cents per gallon standard. The differential eventually settled down to a lower 4.4 cents per gallon and has remained more or less at that level ever since.

Usually, the WTI priced higher than the Brent index. This was because the grade of oil traded on the WTI is slightly higher than that of Brent oil, and therefore garnered the premium price. However, from August 16th of 2010 the balance shifted. Brent crude began trading higher thanks to an oil glut in Oklahoma. This pushed an artificial spike in imports of refined petroleum products from abroad. Taken together, this made crude oil and gasoline pricing an international mechanism not tied to local cost/profit margins. Profit margins from total refinery usage now constitutes the predominant driving factor along with drawdowns in gasoline inventories worldwide. And thus is explained the driver for higher pump prices experienced by American drivers today.

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