As the price for WTI crude oil continues to hover around $100/barrel, up from about $75/barrel just two months ago, consumers are seeing pump prices fall. The latest survey from AAA shows an average US pump price of $3.295/gallon, down almost $0.05/gallon from a week ago. As with all things related to oil, the explanation is not simple.
The primary reason for the drop in US pump prices is the drop in the price of Brent crude. Because oil is fungible, a barrel of Brent crude imported by tanker to the US is now setting the price that refiners are able to charge for a gallon of gasoline. This has been the situation since the beginning of the year.
A refiner in the midwestern US does not pay the Brent price for a barrel of crude, but a lower WTI or other price discounted even further from Brent pricing. Like oil, gasoline is also fungible, and the value of the gasoline refined from those cheaper barrels is identical with the value of a gallon of gasoline refined from Brent. What economists call the “law of one price” applies here: identical goods have only one price. The price of gasoline, then, was based on the price of Brent crude and refiners charged for gasoline as if the crude input was Brent, no matter what the crude’s actual source.
The wide spread between WTI and Brent prices meant that refiners able to use WTI realized a much larger profit on every gallon of gasoline they sold. Now that the price of Brent is dropping, the spread is closing. The spread is about $11/barrel today, but it has been as low as $8/barrel, after reaching a peak of nearly $28/barrel in early September. The rising price of WTI crude is having a negative impact on refiners’ margins, but no impact at all on pump prices. Pump prices keep falling because Brent crude prices are falling.
Like all good things, it won’t last forever. As WTI and Brent prices converge, the drop in pump prices will stop. And even if WTI prices should surpass Brent pricing again, the oil market will figure out a way to arbitrage the new spread to maximize profits. Enjoy the low prices while they last. Until then, maybe there is more cash for gifts this holiday season.