The national average for a price of a gallon of gasoline is quickly approaching $3. Some states are already there. Facebook memes and Twitter trolls have been quick to blame the change in administrations, noting that prices have jumped about 45 cents per gallon since President Joe Biden took office. But is that really the case?
The reality is gas prices have been increasing for nearly a year. Correlation can be a funny thing. As Tyler Vigen, author of “Spurious Correlations” points out, one can also find a strong correlation between the divorce rate in Maine and the per capita consumption of margarine. As statisticians like to say, correlation is not causation. And as economists like to say, a better place to look is supply and demand.
Several factors influence the price at the pump, the largest being the price of crude oil at 43% of the cost. Although the U.S. is the world’s largest oil producer, oil is a globally traded commodity. Therefore, events that affect the supply and demand of oil in the U.S. and around the world make their way into the price displayed at the station.
In an effort to boost prices when they began falling sharply a year ago, the Organization of the Petroleum Exporting Countries and Russia agreed to continue curtailing production. Now, however, demand is picking back up. In the U.S., the deployment of the COVID-19 vaccine and states easing lockdown restrictions have Americans traveling at the highest rate since the pandemic hit.
Economic activity in other major energy-consuming countries, particularly China, has also increased. Consequently, the price of a barrel of crude is hovering around $60, nearly double what it was a year ago.
Refining is the second-largest cost, making up a quarter of the retail price for gasoline. The recent severe cold snap in the Gulf Coast not only reduced domestic crude production by 10%, it also knocked 20% of the entire country’s refining capacity offline.
In addition, spring is the season for refineries to retool their operations to switch from winter blends of gasoline to summer blends. The summer blend reduces smog-forming components when fuel evaporates more quickly in warmer weather. It’s also more expensive to make, adding 5 to 15 cents to the price depending on the region as states have different standards.
Federal and state taxes, on average, add another 30 cents per gallon and make up 22% of the retail price. In theory, the gas tax is an efficient user fee to maintain the National Highway System. In practice, however, special interests siphon off gas tax dollars for projects like public transit, where the merits of the project should be evaluated and paid for at the state or local level.
Americans pay higher “hidden costs” today from bad public policy decisions made decades or even more than a century ago. For instance, the Jones Act, passed in 1920, mandates that any goods shipped by water between two points in America must be transported on a U.S.-built, U.S.-flagged vessel with a crew that is at least 75% American. By preventing foreign competition, the Jones Act drives up costs for no material economic or national security benefit. As a result of the policy, Southern Methodist University professor James Coleman has pointed out, “northeastern U.S. refineries pay more than three times as much to ship oil from Texas rather than from West Africa or Saudi Arabia.”
Another hidden cost is the Renewable Fuel Standard, passed in 2005 and expanded in 2007. The policy mandates that billions of gallons of ethanol (primarily corn-based) be blended into gasoline each year. A 2019 Government Accountability Office report found, outside the Midwest, the mandate pushed fuel prices higher for limited, if any, environmental or climate benefit.
The poor legacy of market-distorting policies should serve as a warning for President Biden. While it is inaccurate to blame the current administration for the recent rise in gas prices, actions made today will have long-lasting impacts. We may not see the price impacts of canceling the Keystone XL pipeline or banning new oil and gas lease sales on federal lands reflected in the price today. But decisions that restrict supply now will have a price impact later.
Notably, restrictions on domestic production and transportation will likely have the unintended environmental consequence of relying on riskier modes of transportation like trail or truck or offshoring production (and pollution) to other countries.
The economic impact may not seem like all that much. A few pennies here and a few there. Collectively, though, the price impacts of such policies start to add up. Multiply it by the 337 million gallons of gas Americans consume each day, and it really starts to add up. As Americans continue to grasp with the economic fallout of the pandemic, every penny should count.