What Would It Take for US Gas to Hit $5 per Gallon?

After returning from a business trip to California, I don’t find media speculation concerning the possibility of $5 gasoline later this year quite as far-fetched as I might have last week. Perhaps seeing $4.299 per gallon posted for unleaded regular on many street corners there, compared to $3.699 or so here, gave me a touch of “availability bias” even if I also understand that gasoline taxes in the Golden State are a full 29¢ per gallon higher than in Virginia, and that environmental regulations there make it very much more difficult for refineries to produce fuel that meets California’s specifications. Without dwelling on regional differences that could make $5 gas likelier in some places than others, I thought it might be worth spending a moment considering what it would take to reach that level on a national average.

In a situation such as the current one, as I described a few weeks ago, it comes down to crude oil prices. Calculating the oil price implied by $5 gasoline requires backing out the other key components of the pump prices we observe. Start with federal and state taxes, which according to API averaged 48.8¢/gal. in January. (That’s only a snapshot, because many states include sales taxes that change in proportion to the overall price level.) You also have to subtract the retailer/distributor margin, which is typically around 15¢/gal. That leaves $4.36/gal., or roughly $183 per bbl, for pre-tax wholesale gasoline. But we still have to account for refining margin, or more accurately the spread between wholesale gasoline and crude oil, since a true refining margin would include the influence of a range of other products and byproducts like diesel, jet fuel, lubricants and petroleum coke. In 2010, before the Cushing crude bottleneck depressed West Texas Intermediate prices to the extraordinary degree we’ve seen in the last year, the average difference between gasoline and light crude futures on the New York Mercantile Exchange was $9.67/bbl. Knock that off the above calculated wholesale price and we get an implied price for light sweet crude of just under $175/bbl.

As of today, Louisiana Light Sweet and UK Brent, the best current indicators for this kind of crude, stood at $127 and $126, respectively, while poor old WTI languished at $109. So based on the above calculation, $5 gasoline would require world oil prices to rise by about $50/bbl–or more if you back-calculate from last week’s average US gas price of $3.72/gal. Short of the saber-rattling in the Persian Gulf turning into a shooting war, it’s hard to see that happening without the kind of economic conditions that took oil close to $150/bbl in 2008. That experience also suggests that if we reached $5/gal., the event might be short-lived as the shock waves it would cause undermined the economy and thus the fundamentals of oil prices.

Unlike Tom Kloza of Oil Price Information Service, I will not don a clown suit if the average US price of gasoline reaches $5 this year. However, I would be very surprised, barring the outbreak of hostilities between Iran and the US or Iran and Israel, a global or self-imposed boycott of Iranian oil exports, or a sudden, unexpected problem in another major producing country. Whether that makes predictions of $5 gas “hyperbole“, as Mr. Kloza apparently suggested, or merely the result of failures to do the math, I leave for you to decide.

Energy Outlook

6 Comments on "What Would It Take for US Gas to Hit $5 per Gallon?"

Plantagenet on Fri, 2nd Mar 2012 5:58 pm

Even if we don’t reach $5 gas this summer, we’ll definitely reach it in the next couple of years.

Kenz300 on Fri, 2nd Mar 2012 7:15 pm

Rising demand from China and India is outpacing supply.

Global oil discoveries peaked 40 years ago.

Deep water drilling, tar sands and oil shale cost more to extract.

OPEC and the oil companies want higher oil prices so that they can make windfall profits.

Geo political risks have added $10 or $20 to the price of oil.

Oil companies and OPEC have done their best to reduce any competition from alternatives.

The era of cheap oil is over. Only a deep recession or depression will reduce demand enough to drop the price of oil substantially.

Cam on Fri, 2nd Mar 2012 11:02 pm

In every day’s production, the percentage of cheaper conventional oil declines, and the percentage of very expensive non-conventional oil increases. This factor alone will relentlessly drive the price of oil and oil products ever higher. Sooner or later total production will decline, then all bets are off!