Why do gas prices bounce up and down weekly, if not daily?
Gasoline prices change at the local level because the contracted price for delivery of gasoline changes between the gasoline retailer and wholesaler in response to the change in crude oil prices.
With only a few wholesalers in one city compared with another, the retail price in Bloomington-Normal can and does differ from Peoria, for example. Crude oil is refined into many different fuels—gasoline, heating oil, diesel fuel—and at some points during the year, refiners change the mix of fuels to take advantage of expected U.S. motorist driving patterns. If the mix is wrong relative to actual gasoline demand, prices change to balance demand and supply.
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The price of crude oil is set in an international marketplace. In the short term, the quantity of crude oil in the market is relatively fixed; an increase in price adds little to the available supply. Crude oil and its refined by-products are storable commodities after extraction, however. Unexpected drawdowns or buildups of oil and gasoline stockpiles can affect retail prices.
Since the early 1970s, the Organization of Petroleum Exporting Countries (OPEC), an oil production cartel, has sought to limit the amount of crude oil sold to international markets to raise prices and the value of their oil reserves. On March 25, 2017, OPEC and Russia, the largest non-OPEC oil producer, agreed to the extension of previous production cuts. Improvements in technology for extracting North American and Brazilian shale oil and oil-sands reserves mean that oil prices less than $50 per barrel are profitable. OPEC actions to limit production and raise prices create an incentive for non-OPEC producers to increase production, which holds prices down.
Because the quantity of crude oil in the market is relatively fixed in the short term, changes in demand, real or expected, can have a large effect on day-to-day prices. The price of oil, and to some extent the price of gasoline, reflects short-term changes in the world demand for oil. If the Chinese economy slows unexpectedly, for example, the news will cause oil traders to demand less oil and the price will fall.
An increasing price for oil and gasoline can reflect a strong and healthy economic picture in the short-term. It can be argued that because unexpected news is randomly revealed, markets that effectively balance demand and supply will reflect that randomness.
Volatility in prices reflects the speed at which markets react to news—the faster the better to prevent advantage by some decision-makers over others.
Gary Koppenhaver, chair and professor, Department of Finance, Insurance and Law
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