What gas prices do — and don’t — tell us about the economy

Gasoline is the only product in modern-day America whose price is listed on giant signs almost everywhere you go. Most people, even if they don’t drive, probably have a pretty good sense of what gas costs — currently averaging $5 a gallon nationwide.

The ubiquity and visibility of gas prices make them an easy shorthand for the rest of the economy, especially when they’re going up. And they often drive how people are generally feeling about the state of the economy and politics.

But gas prices aren’t really the best metric for understanding the broader economy. They’re very good for understanding the state of oil and refining but reveal less than you might think about the real-world impact on people’s lives.

There is a better, less alarmist measurement for understanding what’s happening to gas prices — one that shows that, even as gas prices near record highs, most households are still better off than they were in 2008.

What actually determines the price of gas

Gas prices, which have increased almost 50 percent over the past six months, are not yet at a record inflation-adjusted high, though they may still get there. JPMorgan analyst Natasha Kaneva said there’s a very real risk it might reach $6 by August. To beat the actual 2008 record, adjusted in 2022 dollars, gas prices would have to rise past $5.33.

The biggest driver of the cost of gas is the price of crude oil, which has been going up since October and is hovering around $120 a barrel, up from $70 a year ago. Russia’s war in Ukraine led the US and Europe to sanction Moscow, including its crude oil, which made up about 12 percent of the global market. (Before the war, the US got less than 4 percent of its oil from Russia, but those sanctions have affected oil markets globally by making it more expensive for others to access that oil.)

Demand for oil has also bounced back from the depths of the pandemic faster than oil production.

A second major driver of rising prices is the costs of refining crude oil. These costs are also going up: Refineries have shut down in the past few years, outpacing the new refineries being built. And while capacity has increased per refinery, most US refineries are already working at nearly full capacity. In short, demand for more refined oil has approached pre-pandemic levels, but refinery capacity hasn’t kept up.

The final two factors are how much it costs to get gas to your corner retail station and taxes. These are pretty marginal: Although some states have suspended their gas taxes, which pay for road improvement and highways, they make up a relatively small amount of the price.

The federal Energy Information Administration illustrated how those costs break down, current as of April:

EIA

One thing you’ll notice missing: the president. President Joe Biden’s drilling policies have nothing to do with gas prices.

This hasn’t stopped Republican politicians and conservative commentators from pointing to canceled leases in the Gulf of Mexico and Biden’s climate policies as a primary culprit for rising prices. But energy analysts are quick to point out this is not how oil markets work. The White House “can do symbolic things that don’t really lower prices, and they can do really dumb things that are counterproductive,” Bob McNally, an energy analyst at Rapidan Energy Group who served in the George W. Bush administration, told the Washington Post.

Oil supply doesn’t work as simply as turning on a faucet, and the president doesn’t even control the tap. “In the US right now, the constraints are within the industry itself, and have very little to do with any policies from the federal government,” said Sam Ori, executive director of the Energy Policy Institute at the University of Chicago.

Instead, oil companies have been “very reluctant to plow any of that revenue into capital investment for new wells,” Ori added.

Oil companies are having other issues, too, such as accessing the labor and materials like steel needed for putting pipes in the ground. The industry does plan to increase production in the US by about 1.8 million barrels a day this year, but these were planned changes, and already accounted for in the current price.

All this paints a grim picture looking forward for filling up your tank, since there are no easy fixes. Prices may continue to go up.

But it’s still not quite as dire as all this sounds.

The oil industry isn’t the economy

If there is one clear economic outcome from high oil prices, it’s oil company profits. The big five oil companies posted their best profits in over a decade at $35 billion in the first quarter of 2022, margins that will continue to climb as long as prices remain high.

Otherwise, there’s certainly a correlation between gas prices and the health of the US economy, but the exact relationship is murky. “When prices rise, it doesn’t necessarily mean that the economy is falling apart; when prices fall, it doesn’t necessarily mean the economy speeds ahead,” said Clark Williams-Derry, a researcher at the Institute for Energy Economics and Financial Analysis.

The pandemic is an extreme example: Oil prices crashed along with demand. The price of crude oil went briefly negative because producers had to pay to haul it away, since there was such a major surplus and such little capacity for storage. Low prices don’t ensure a booming economy, and they can also make renewable adoption even harder. In September 2020, when gas prices were under $2.20, millions of Americans were out of work, with hundreds of thousands of workers losing their jobs every week.

If political rhetoric still links oil prices to the broader economy, it’s due to lessons learned from the oil shocks of the 1970s that are now dated. “In the 1970s, the reason that the oil crisis was so deadly was the US economy was far more oil-intensive,” Ori said.

Today, we can get more with less. US petroleum consumption has actually been roughly flat the past two decades even as the population and economy have grown. And improved fuel economy standards have helped ensure oil plays a shrinking role in the economy. Looking forward, that trend will continue. New Corporate Average Fuel Economy (CAFE) standards for the auto industry require fleets to reach an average 49 miles per gallon by model year 2026 (up from 28 mpg).

One of the major problems with our collective oil price obsession is that it ignores that demand also responds to high prices. More people switch to other options like electric and public transit, and might be more likely to go electric or buy a more fuel-efficient car in the future. When gas spiked in 2008, driving behaviors and buying patterns also changed, as hybrid vehicle sales rose and SUV sales declined.

All this means that the interaction between gas prices and the economy as a whole, and even between gas prices and household budgets, isn’t as straightforward as it first seems.

A better way of understanding gas prices

That doesn’t mean people aren’t hurting because of rising prices. For households that run on oil, electricity and cooling is especially expensive in the summer months because of these rising prices. The price of natural gas, a fossil fuel that supplies about 40 percent of power to the grid, has also risen. And the EIA says it expects the average US household will spend about $450 more this year than last year, on an inflation-adjusted basis, for gasoline.

But there is a better metric for how much pain people are feeling from gas prices: how much disposable income people are spending on gas.

Right off the bat, this figure tells you that gas isn’t the primary expense for most households. “In reality, it’s an important but a relatively small share of the budget,” said Williams-Derry.

Gasoline spending plummeted to 1 percent of disposable personal income in 2020 as a result of shutdowns and low gas prices that year. It went back up to between 1.5 and 3.2 percent in 2021. And even though it’s rising in 2022, it’s still far below other times oil was over $100 a barrel.

Despite gas prices climbing to near-2008 territory (adjusted for inflation), this ratio is still far below 2008 levels. The EIA notes that as of early 2022, it is closer to the “average ratio of 2.5% from 2015 to 2019,” and forecasts it could rise to 3.2 percent this year before falling again late in 2022.

EIA Short-Term Energy Outlook, May 2022

All this is more nuanced than gas price signs plastered everywhere. But the fact that the share of income most households are spending on gas is lower than 2008 is good news: It shows that, through more disposable income, less dependence on oil, or both, the rising price of gas doesn’t have to hurt people quite as much as it did in the past. It also shows the way to policies that would help offset the impact of rising prices even more, from energy efficiency and alternative modes of transit, or even policies that temporarily boost people’s incomes.

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