Why Don’t Gas Prices Always Move in Sync with Oil Prices?

Since crude oil makes up nearly 70 percent of the pump price of regular gasoline, it makes sense that gas prices would follow a similar pattern as oil prices. However, the pass-through (or the effect of changes in oil prices on gas prices) is not symmetric. In the most recent issue of the St. Louis Fed’s The Regional Economist, Assistant Vice President and Economist Michael Owyang and former Senior Research Associate E. Katarina Vermann examined how the pass-through varies across different sets of circumstances.

Asymmetric Pass-Through

In reviewing previous academic work measuring pass-through, Owyang and Vermann noted that economists generally found that gasoline prices adjust faster when they are low relative to oil prices than when they are high relative to oil prices.

Owyang and Vermann estimated that a $10 rise in the price of a barrel of oil is correlated with an approximately 25-cent increase in the price of a gallon of gasoline adjusted for taxes and markups. They measured the asymmetric response of gas prices to fluctuations in the pass-through by considering separately the months in which the adjusted average national retail gas price to oil price ratio was either above or below 25 cents to $10. They noted, “Consistent with much of the literature, we found a small difference in the speed at which gasoline prices were attracted to the long-run ratio depending on whether prices were above or below this ratio.”

Pass-Through across Seasons

Gas prices also vary according to season. Between 1995 and 2014, retail gas prices rose, on average, 0.4 percent during the two weeks prior to Memorial Day and 1.6 percent during the two weeks prior to Labor Day before retreating in the fall.

One reason is the rise in demand during summer months stemming from increased summer driving. Another reason is the change in the cost of production due to changes in composition. Some areas allow ingredients in the winter that are cheaper to produce, making winter gas less expensive. In the summer, some warmer areas require additives that reduce the vapor pressure and make gas less volatile. Because summer gas is more costly to produce, the prices during the spring and summer will naturally be higher.

Owyang and Vermann split their sample into summer and winter months and found more evidence of asymmetry: “During the winter, the rate at which gas prices are pulled down by oil prices appeared to be higher than it was during the summer. Moreover, splitting the sample by season appeared to amplify the asymmetry, which appeared to be higher during the high-demand summer season and when the cost of gasoline production was higher.”

Pass-Through across Cities

Several reasons exist for gas prices to vary between cities, including:

• Taxes
• Supply differences due to the costs of moving gas from the refinery to the retail location
• Commuting patterns
• Population density
• The quality and use of public transportation

Owyang and Vermann calculated pass-through across 162 cities using weekly pretax retail gas prices and the Brent oil price over the period 2005-2013 and found two main differences. First, the long-run relationship between gas and oil could vary across cities. Second, the effect of changes in oil prices on gas could vary across cities.

Conclusion

Owyang and Vermann noted, “The market for gasoline is local, with variations in market concentration, demand, regulation and taxation. Thus, it may not be surprising that we found more asymmetry at the local level than at the national level.”

Additional Resources

• Regional Economist: Rockets and Feathers: Why Don’t Gasoline Prices Always Move in Sync with Oil Prices?
• On the Economy: The Divergence of Spot Oil Prices
• On the Economy: Are Wages and the Unemployment Rate Correlated?