Gas prices will stay below $3 (redux)

Peter S Magnusson ♦ January 16, 2016 ♦ Leave a comment

On Friday, oil prices fell to below $30, the lowest in 12 years. Wall Street journal obviously had an immediate explanation: turmoil in the Chinese market and an expected increase in Iranian crude production:

Decade after decade, business press invariably have just the right explanation for market movements – as long as they get to sleep on it.

Back in October, 2008, I wrote a blog post entitled Gasoline prices will stay below $3. The recent sharp decline in prices prompted me to re-visit the prediction. It’s a curious thing about predicting the future. It’s not so hard. The real trick is figuring out the timing (and then figuring out what to do about it). To recap, here’s what I said:

But, you say, gasoline will keep getting more expensive, won’t it? Nope, it won’t. In fact, I’ll “betcha” that it will hold (inflation-adjusted) steady below $3.50 for the foreseeable future, and I’m pretty sure it will stay below $3, where it’s headed now.

My core argument was that there are plenty of carbon-based energy reserves of various sorts that become economical at different price levels. Upwards $100 per barrel (corresponding to about $4 per gallon in gasoline) the supply starts approaching “infinity”: coal-to-gas and tar sands each on their own correspond to about a century’s worth of energy consumption.

The chart shows crude oil prices and (national average) US gasoline prices for the period 1982-2014. Prices are indexed to 2008 dollars to track my prediction.

My bet back then was that it definitely won’t go above $3.50, and not likely above $3. Turns out that I was partially right: it peaked at $3.43 so I won the bet with a whisker. But it stayed above $3 for several years. That made little sense to me – crude oil sustained above $75 (which corresponds to $3 gas) allow vast energy source alternatives to become economical.

To recap from 2008: Gasoline comes from oil. Though a barrel of oil is 42 gallons, only about 19 gallons of gasoline is produced during refining – the rest includes diesel (about 9 gallons), jet fuels (about 4 gallons), heating oil (about 2 gallons), and another 10 gallons of assorted products. These resulting products complicate the demand side of the pricing equation, since they cater to related, but different, markets. On the cost side, there’s also refining, distribution, and taxes.

I’ve improved my rule-of-thumb from 2008: if you want to know roughly what the gasoline price will be in the US based on the price of crude oil, just divide by 35 and add $1. That rule would have gotten you within 5% of the actual gasoline price for more than half of all years since 1973, and almost 90% of all years since 1991. (Remember to inflation-adjust the “$1” part of the rule.)

At the current $30 prices, that means gasoline at $1.85 or lower. Note that if you’re in California, various market inefficiencies lead to about $0.15 higher prices, so you should add that to the rule. That means at below $30 per barrel, we’re heading below $2 gasoline.

There are fundamental reasons for making long-term judgment calls on pricing. Way back in 2005, in Wired issue 13.12, they had a look at what energy sources come online (economically speaking) as the price of oil rises. I haven’t seen a similarly good overview put together since. But I did briefly check a subset of their table: ultradeep offshore wells, tar sands, coal to gas, natural gas, ethanol, and biodiesel are all economical at prices of $3.00-$3.50/gallon or less. And of course, since 2005 we’ve added fracking to that list.

That’s a blend of renewables and massive reserves (in the trillions of barrels of reserve). So the prediction (inflation-adjusted) remains that gasoline has little reason to go into that price range for long, let alone above it.