High gas prices at the pump
As I have been watching the price of oil drop over 50% from last summer, I have driven past the local gas stations and wondered… If the price of oil has dropped 50% then why are gas prices not following suit? Most people would naturally jump to the conclusion that it is the greedy gas station owners. However, that thesis does not hold up well when you consider that competition between local gas stations drives down the prices to where they are barely making a profit. What is it about gas prices that have people so confused?
What is the cost of gas in Massachusetts?
While this post is written with the great state of Massachusetts in mind, I have compared the state vs the national average for prices at the pump and they are not much different. Massachusetts is a bit higher than the national average as you can see here, but not by much.
I’m just thankful I don’t live in Canada with their gas prices.
What is a spread?
As you look at these charts you will notice an obvious “spread” difference in prices between Canadian and US gas prices. Normally this spread stays the same with some small variation. This is not always the case, but for many reasons you can count on it remaining the same. If the spread gets too narrow or too wide someone will come in and arbitrage it back to the “normal” levels. I know I am skipping a lot of the details, but whole books have been written about this subject and I don’t intend to write one here. All you need to know is that a free-market works to keep that spread at an equilibrium. Just eye-balling the numbers above, it looks as if the normal spread is about $1.15/gal between Canadian and US gas prices. It also looks as if there is not much more of a $0.05 difference on either side of $1.15. This spread is important to understand.
Why does a spread exist?
In short, it is due to taxes, delivery costs, and even a country subsidizing the cost of gas to its citizens. For example, the cost of gas in Venezuela is $0.04/gal, but it is highly subsidized by the government. Although I have not confirmed this, Wikipedia says that the government gives it to gas stations for free and that $0.04 is their profit. In case you are playing trivia anytime soon here are some fun facts about Venezuela. The average price of gas is $0.04/gal, it imports one-third of its gas and it is the 5th largest exporter of crude oil. Oh, and it will probably default on its debt soon since the oil prices are dropping sharply. It is hard to run a country which is highly dependent on oil prices to fill the state coffers when oil prices have dropped over 50%
Consider that the spread is the cost of bringing gas to the pump.
Global Gas prices
The global price of gas can vary from country to country. The Q4 2014 global price of gas is shown in this chart,
In the US it cost $2.93 /gal, it costs the average person 1.95% of a day’s wages per gal of gas, and annually 2.27% of income is spent on gasoline. Compare this to Norway which is $9.26/gal, 3.41% of a day’s wages per gallon, and 0.66% of wages annually is spent on gas. Another one is India which costs $4.32/ gal and about 96.90% of a day’s wages per gallon, and 1.33% of annual income is spent on gas.
While this is all very interesting, unless you plan on moving internationally or visiting other countries (which might be a good idea if the US dollar continues to rise), this mostly doesn’t matter to people in Massachusetts.
Local Massachusetts gas prices at the pump
This shows the change in oil prices vs the change in gas prices. Since June 2014 Crude oil prices have dropped over 56% and gas prices have dropped over 58%. Below is a picture I took last week of prices at a local gas station. It doesn’t look like the $2.35/ gal seen in this picture.
While we have not hit the lows which we saw in 2009 (approximately $1.59/gal), I suspect we might get close to that number soon. There are many reasons that oil price are dropping and may continue to drop as discussed in my latest post Where is the price of oil going? If you want to learn more about oil, What Products are made from petroleum outside of gasoline and Is it time to buy oil stocks? you can read these posts to further your education. I have also discussed oil prices in this month’s Inflation Monitor, which you can access for free.
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About the author: Kirk Chisholm is a Wealth Manager and Principal at Innovative Advisory Group. His roles at IAG are co-chair of the Investment Committee and Head of the Traditional Investment Risk Management Group. His background and areas of focus are portfolio management and investment analysis in both the traditional and alternative investment markets. He received a BA degree in Economics from Trinity College in Hartford, CT.