Gas Goes Up, Oil Goes Down: What’s Up With That?

Ahh, the bitter irony.  Just last week, oil prices hit $34 per barrel, a low for the year.  On that very same day, however, the national average gas price rose to $1.95, its highest level so far in 2009.  How could it be that gas prices could reach a high on the same day oil prices fell to new lows?  It must be a conspiracy!  Aren’t gas prices supposed to follow oil prices, after all?  Well, no.

What’s Going On?

According to this article on MainStreet.com, there is a very good reason for this discrepancy and it doesn’t involve oil speculators, hedge funds, or scheming politicians.  So what’s going on?  As it turns out, crude prices as quoted on the New York Mercantile Exchange are based on the price of West Texas Intermediate crude which is drilled, you guessed it, in West Texas.  The problem is that due to over-supply caused by freaky market conditions, West Texas crude is actually selling at prices below inferior-grade foreign oil.

This is an unusual condition, to say the least.  West Texas crude, being the high-grade oil that it is, practically always commands a premium price.  So unexpected is this turn of events, in fact, that no pipelines were ever built to transfer the stuff from West Texas to refineries in other parts of the country, which have traditionally relied on far more abundant, less-expensive imported oil sources.

The side effect of this, of course, is that refineries outside of West Texas are forced to continue buying lower-grade but more expensive foreign oil to refine into gasoline, oil that costs more than $10 per barrel over the quoted price.  So yes, the “price” of oil is currently around $34, but as it turns out, the quoted price is based on a benchmark that really isn’t a very good measure of what the stuff is actually selling for on the market, especially not under current market conditions.

So Why Not Just Build More Pipelines?

The primary reason pipelines aren’t being built right now to transport West Texas crude is the same reason none were built to begin with:  West Texas Intermediate crude is practically always more expensive and thus less economical to refine than importing from abroad.  Companies are understandably wary of investing the billions necessary in response to what is in all likelihood a temporary situation.  Eventually, markets will revert to the mean and West Texas crude will once again command a premium price.  If that happens, and it almost certainly will, any money spent on building new pipelines out of the area will prove to have been a massive waste of money.

So no, there is no conspiracy.  There is a very simple and logical economic explanation for why the price of gas continues to rise even as the “price” of oil continues to fall (remember, the real price of oil is much higher than the quoted price).  You can take off your tin foil hats now.