What’s with the weird fluctuations in gas prices?

September 8, 2017

Dear Cecil:

Why are increases in gas prices often so abrupt and large, while decreases are small and incremental? Where I live, we've had two six- to ten-cent increases in the last two weeks, all happening on one day. But earlier this summer, I'd note one- to two-cent drops once every day or three at just about every local station. And why, during these increases, are the stations often in lockstep, yet when they’re falling they get pretty far out of whack with each other?

Cecil replies:

Here’s a question where the most obvious answer, and the most cynical, is pretty much the correct one. Say you’re a gas station operator, John. If you’re seeing crude oil costs rise, you’ll want to promptly adjust the prices you charge at the pump to make sure your margin is secure. Seeing crude fall? Hey, no need to be hasty; if your prices take a little while to float back down, well, that’s money in your pocket.

There’s actually an econ term for this — “rockets and feathers,” describing prices that shoot up rapidly but decline slowly — and a pretty robust body of economics thought surrounding it. The issue we’re looking at is what’s known as pass-through, which refers to how so-called upstream costs, in this case the price of crude, affect downstream prices at gas stations. Crude oil prices and refining costs tend to account for about 70 percent of what drivers wind up paying. So you’d expect there to be some proportionality to the oil-gas price relationship, and there generally is — crude rises, prices at the pump adjust upward; crude falls, pump prices decrease. When the numbers don’t track as closely, that’s called asymmetric pass-through.

(We stipulate that there’s some debate over whether price asymmetry in the gasoline market is really a big deal. The phenomenon you observe, John, obviously exists. Consider, though, the research of analyst J.D. Karrenbrock [back in the ’90s, but still]: If wholesale gasoline prices went up by ten cents one month, he found, average retail prices would jump up by about seven cents that month, then three cents more the next. If the wholesale price dropped ten cents, conversely, pump prices would go down just three cents that same month, but another seven in the month following. So retail prices did fall more slowly, but there wasn’t any meaningful asymmetry, Karrenbrock argued — after two months it was a wash.)

As I say, the easiest explanation is basically correct, but this being a complex market, there are other factors in play. The lag in price reduction may reflect gas station operators’ need to sell out of the more expensive stuff they’ve already bought before restocking with cheaper gas, only then passing along the lower price to consumers. Sellers aren’t acting in a vacuum, either; they do this because buyers will accept it. When gas prices head up, drivers will reliably seek out the cheapest gas around. When prices fall again, though, they do less comparison shopping, which keeps pressure off station operators to rush their pricing back down. As one expert put it to the Los Angeles Times, “If every consumer kept searching for the best price, this asymmetry would likely pretty much go away.”

It also depends on the station, which gets us to the second part of your question. The owner of the only gas station at a highway exit has less incentive to hurry up and lower her prices than the three competing stations at another exit 50 miles up the road, who are all trying to pull in the same customers. A 2008 study of gas prices in southern California found that having a rival nearby did in fact restrain stations’ tendency toward rockets-and-feathers behavior. Consider, too, the type of station. Is it also a convenience store? Those tend to make most of their money on non-gas items, meaning they can afford to be among the first to reduce prices when wholesale costs drop — they’ve got a cushion.

These are short-term fluctuations, of course — we're seeing a price spike now following Hurricane Harvey's disruption of Houston-centered gas production facilities — and there’s plenty more ink to be spilled about price variation over a longer timeframe. Prices rise in the summer, for instance, not just because road-trippers produce more demand but because we’re pumping a different product: the Environmental Protection Agency mandates what’s called summer blend gas, a pricier variety formulated to reduce evaporation into the ozone during warmer months. There’s geography, too: stations closer to refineries benefit from lower distribution costs, and thus can charge less; and of course taxes vary by state, which is why gas is a good deal cheaper in South Carolina, for instance, than in North Carolina.

The larger context here, though, is that current gas prices are historically low — for a number of reasons, including an increasing gulf between supply and demand, which has been dropping as fuel efficiency improves and electric cars gain ground. Remember the hubbub over peak oil? Supply anxiety seems almost retro at the moment; these days there may be more concern about peak oil demand — if you’re an oil company, that is. The rest of us should probably just enjoy it while it lasts.

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