Wednesday, March 07, 2007

Why Are Gasoline Prices Rising?

I'm often asked to comment on energy prices. MSNBC asked me today why gasoline prices are rising again. First, since oil prices are up about 20% from their early January lows, it isn't surprising to see gasoline prices up about the same amount after a bit of a lag. Second, because gasoline is a refined product, refinery problems add to its cost. For example, we recently had a couple of refinery fires. Also, many refineries are down for routine maintenance. In addition, refineries are now switching to more expensive summer blends that produce less smog.

People often wonder why gasoline prices vary so much from state to state. Many New Yorkers, for example, make a point of filling up in New Jersey whenever they can. Price differences have to do with state and local taxes that are added on top of federal taxes. California has the highest gasoline prices in the country. It also has the highest taxes. In addition, California demands a much cleaner burning fuel than is required by federal laws. It is simply more expensive to produce "California" gasoline.

I'm also often asked why gasoline prices go up faster than they come down. I'm not convinced they do, but economists have studied this issue of sticky prices for many goods. When input prices go up, manufacturers often raise prices for finished goods in order to protect profit margins. But when input prices fall, they aren't as quick to reduce finished goods prices. This may be partly due to a belief that the drop in input prices will prove to be temporary. It may also be due to a desire to enjoy fat profit margins for a while. Yet, I haven't seen any evidence that gasoline prices are any stickier than the prices of other consumer goods. On the contrary, it appears that gasoline prices are extremely responsive to a change in oil prices. The correlation coefficient between gasoline and oil prices is well over 90%.