Crude oil is a mixture of naturally occurring hydrocarbons. Found under the earth’s surface, crude oil is extracted and separated into its simple components. The components of crude oil include kerosene, jet fuel and gasoline. As a product of crude oil, gasoline is used as engine fuel in automobiles.
In the United States, crude oil is majorly imported from foreign markets. After its importation, the crude oil is then separated into its components in refinery processes of fractional distillation. It is after this process that gasoline, like paraffin and jet fuel, is supplied to distributers and finally, to consumers.
This paper seeks to discuss the opinion that the “gasoline market in the United States and the market for crude oil are significantly independent”. The paper will look at factors that determine the supply, demand and the price of gasoline in the United States as well as the determinants of the demand, supply and prices of crude oil. The paper will then analyze the correlation between the two markets with the aim of identifying whether or not, there exists a relationship between the two markets.
Market of Gasoline in the United States
The gasoline prices in the United States’ economy are dependent on a lot of factors. Among these factors is the “unanticipated disruption of U.S. refinery output” (Killian 100). Events like fire that abruptly halts the operations of the refineries have been characterized with “significant increase in the real price of gasoline” (Killian 100).
These particular disruptions however have less significant effects in the prices of the imported crude oil. The phenomenon is expected to have the reverse effect of reducing the price of crude oil as a result of reduced demand which is insignificant in the world market.
The factors determining the demand for crude oil and the price of gasoline in the United States such as disruptions results in specified shocks in supply and demand are not easily predictable. It was also noted that the price of gasoline in the United States has some relation to the global market of crude oil. The prices of the two commodities remained high during the period of time ranging from 2002 up to 2008. However, the prices fell in the period of 2008 while the global supply for oil remained the same.
A study of the global economic recession that was experienced during the period beginning in 2008 explained the cause of price changes. It was realized that before the recession, there was a high global demand for crude oil over the supply of the same. This pushed the prices up with respect to the laws of demand and supply. The fall of global demand following the recession therefore led to the reduced prices experienced since the year 2008 (Killian 92).
The market of gasoline in the United States is also determined by a number of internal factors which are independent from the market of crude oil. One of such occurrences was the “damage to the gulf coast drilling wells and refineries” (Gas, 3). The damages for example would translate to the shortage of gasoline leading to subsequent increased prices.
The high prices of the gasoline can also be attributed to the government policies that have over time been oriented to only one aspect of controlling the price. The “chimney plan: to perpetuate the nation’s addition to cheap petroleum” (Gas 3) has been criticized as a profit oriented move rather than price control. It is however viewed that steps to reduce the consumption of gasoline would rather reduce the price as opposed to increasing its supply (Gas 3).
The Market of Crude Oil
In the earlier decades, the rises in oil prices in the United States were attributed to political aspects like the wars in the Middle East and embargoes by the Arab states as retaliation to the United States’ support for Israel, which limited supply of crude oil into the United States from the Middle East countries.
The major determinant in the oil sector is still recognized to be its supply relative to its demand. The industrialization of countries like the people’s republic of China and India has put pressure on the global supply of oil due to the relatively increased demand.
The threat of the United States’ supply of oil has been worsened by the move of oil supplying countries in the Middle East to reserve their oil for domestic use. The increased consumption by the two giant countries, China and India, has led to increased global oil prices due the increased demand. There is therefore need for “international effort to reduce demand for oil” (Katel 7). With this respect, no solution has been identified to help control the prices downwards.
This factor is beyond the control of the United States according to professionals in the energy sector. According to Medlock, “it is going to be difficult for the energy supply to expand production at a significant enough pace to drive down prices” (Katel 7). The external drivers of the international oil price is passed to the price of crude oil in the United States and subsequently the prices of the separated components of the crude oil of which gasoline is part (Katel 24).
Volatility Relationship between Crude Oil and Petroleum Products
The prices of crude oil also depend on a number of features in the oil producing countries. A research study by Lee and Zyren indicated that stability in these countries significantly determines the prices of crude oil. According to the research, wars such as the “invasion of Kuwait and gulf war 1” caused instability in the market of crude oil.
It was also reported that political environments in the crude oil producing countries such as “transitional regimes” also affect the international market of crude oil (Lee and Zyren 101). In the same study, it was realized that “the petroleum price variance is greater than crude oil variances” (Lee and Zyren 101). The volatility in the prices of crude oil and those of petroleum products was significantly realized across all periods of the research.
The volatility between the prices in the markets for gasoline and that of crude oil is closely related, with an inverse response, to the revenues of the two commodities. The volatility can therefore be viewed as a conditional variable being dependent on the turn over rate of the two products.
From the research, Lee and Zyren noted that the price volatility between crude oil and the gasoline in the United States was greatly caused by the regulations in the crude oil market. It was also noted that the volatility in the prices was not significantly dependent on previous markets of either crude oil or gasoline. Similarly, price volatility doesn’t have significant effects on the future markets of the two products.
The research generally represented the view that price volatility between crude oil and gasoline in the United States is an independent significant element (Lee and Zyren 111).
Pump Prices and Oil Prices
Apart from the asymmetry in volatility in the United States market for gasoline and the crude oil market, it has been established that a further asymmetry occurs between prices of the two commodities. Contrary to the business conception that reduced costs of production yields reduced selling price of a particular product, the oligopolistic market of gasoline gives the oil companies an advantage to temporarily dictate the retail gasoline price.
A disparity is then significantly realized when the price of crude oil falls. When this happens, individual oil companies are always reluctant to lower retail prices as they try to optimize profits before any competing oil company lowers its price as a market strategy. The fall in crude oil prices does not therefore always result to fall in gasoline price (Adilov and Samavati 62).
However, Adilov and Samavati still expressed the view that there could be factors that have changed with time to level a direct relationship between the gasoline retail price and the price of crude oil.
They argue that the asymmetry in the price of the two commodities is not concrete due to the fact that gasoline market is currently invested by increased number of companies. Marketing strategies, according to the two authors is expected to cause price reduction among competing oil companies when crude oil prices fall in a bid to “undercut competitors” in the oil market (Adilov and Samavati 62).
This argument therefore suggests that the prices of the two commodities exhibit some dependence as a result of the competitiveness of the United States oil retail (Adilov and Samavati 63). General opinion has also been expressed that the gasoline prices in the United States are always a factor of the prices of crude oil.
The reduction of gasoline prices in the United States during the global recession in 2008 in a way indicated the dependence of the American gasoline prices on the global demand for crude oil. The concept was developed from the observation that gasoline prices were high before the period but fell on the onset of the global recession. The reduction of gasoline price was then attributed to the change in demand of the crude oil market as countries reduced their demand for the product (Killian 92).
There is significant support for the opinion that the price of gasoline in the United States depends more on the internal factors in the United States such as the production facilities and policies among others. It has also been illustrated that there are a number of economic factors that leads to the asymmetry of prices in the two markets. The arguments in view of the dependence of the two markets lack the support of many significant drivers in the gasoline market in the United States.
They are isolated arguments that can be easily challenged by the consideration of the internal drivers in the United States. It can therefore be concluded, contrary to other opinions, that to a significant level, the market of gasoline in the United States is dictated by other factors that are different from the market of crude oil. The gasoline market is actually occasionally asymmetric to the market of crude oil.
Adilov, Nodir and Samavati, Hedayeh. “Pump Prices and Oil Prices: A Tale of Two Directions.” Atlantic Economic Journal 37 (2009): 51-64. Gas. Nation. EBSCO, n.d. Web. 06 April 2011.
Katel, Peter. Oil Jitters. CQ Researcher, 2008. Web. 06 April 2011.
Killian, Lutz. Explaining Fluctuations in Gasoline Prices. A Joint Model of the Global Crude, 2010. Web. 06 April 2011.
Lee, Thomas and Zyren, John. Volatility Relationship between Crude Oil and Petroleum Products. Atlantic Economic Journal 35 (2007): 97-112.