More on the Price of Gasoline

After posting my rant on the use of the price of a gallon of gas a political cudgel, I sat back for a moment and thought about the relationship some more.

Using the same data sets available from the U.S. Energy Information Administration I came up with these two charts that show the close coupling of the price of a gallon of gas and the price of a barrel of oil:

How coupled?  How about a correlation coefficient of 0.921.  These numbers can be interpreted a lot of different ways, but anytime a correlation coefficient is above 0.9 in the social sciences, which is where I place economics, it is considered “strong.”  In this case, I will take it as fact that there is a strong correlation between gasoline prices and the price of a barrel of oil.

At this point, most people would leave things well enough alone.  However, given the political heat that the President is taking on the price of gas and the rhetoric from the right—again “drill, baby, drill”—I feel it is necessary to go one level deeper.  If the price of gasoline and the price of oil are strongly correlated, it begs the question—what is driving the price of oil up?

If you are Sarah Palin or any number of politicians on the right, you automatically assume that the problem is a lack of domestic production.  Really?  In the U.S. the production of crude has remained relatively stable from the period starting in January 2008 and ending October 2011:

In fact, if you look at U.S. production in January of 2008 compared with October of 2011 the U.S. is actually producing 10.8% more crude oil.

What about demand?  For the same period as the two previous charts here is gasoline demand in the U.S.:

From January of 2008 to October of 2011, the same period for which the U.S. production of crude rose 10.8%, demand decreased 8.4%.  Yet, over the same period the price of gasoline rose 10.3% and the price of oil actually declined 2.0%.  No one ever said ferreting out root cause would be easy.

The key to this riddle resides in the fact that oil and, to some extent, gasoline are commodities traded on the world market.  A barrel of oil pumped out of the ground in Alaska can be sold in California or China or India or Botswana.  Again with these crazy ideas regarding the free market.

The International Energy Agency’s Oil Market Report estimates that worldwide demand for crude oil will increase from 86.6 million barrels per day in 2008 to 91.2 million barrels by the end of 2012.

Therefore, the demand for oil globally is rising despite a decline in demand in the U.S.  Thus, the price for a barrel of oil will continue to rise because demand will likely outstrip the ability of oil producers to meet the increases in demand barring major new discoveries of easily extracted energy.

I realize that this can get a little dense at times, but given the times I think it is necessary to take a reason and global outlook on events in order to cut through the fog of stupidity that envelops our country from time to time.  It seems to happen in four year cycles.  I wonder what that is correlated with?

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