The high price of gasoline has become a major economic concern for Americans. Rising energy prices are expected to restrict household spending and disproportionately hit low-income consumers.
Our financial model implies a decline in gas prices of 15% to 20% from the current national average of $3.36 per gallon.
Given the decline in oil prices over the past two weeks, gasoline prices are expected to follow, which should provide modest relief. Our model of the relationship between wholesale gasoline futures and retail gasoline prices implies a decline of 15% to 20% from the current national average of $3.36 per gallon.
For the past five weeks, the price of crude on the futures market has been dropping at an average rate of 4.6% per week, with the biggest drop occurring when U.S. allies announced the coordinated release of oil from their strategic reserves.
The jawboning of oil markets by these governments to increase supplies, in conjunction with renewed concerns over global demand linked to the coronavirus omicron variant, have dampened oil prices.
Still, the more important issue for sustaining lower oil prices is the ability and willingness of producers to maintain a sufficient supply. According to Rystad Energy, the breakeven price for producers of tight oil (shale) has continued to fall, reaching $37 per barrel.
At the same time, U.S. production of crude has been accelerating for 10 months. This increase, combined with a pledge by OPEC+ to raise global production by 400,000 barrels per day, should dampen global oil prices in the first half of next year.
This comes after two years of a decline in production that followed the 2019 trade war and then the start of the pandemic in 2020.
Because of the shutdown of domestic and international travel and restricted trade during the pandemic, the demand for energy bottomed out and U.S. production of crude fell by more than 20% between March and September 2020. Production has recovered but remains 12% below its pre-pandemic level.
Restarting an oil field would be expected to be slow, even though horizontal wells can be restarted more quickly than traditional wells. And there is a lag between changes in crude production and the availability of gasoline. We anticipate that the increase in energy costs will be sustained, particularly as winter approaches.
Because crude prices are determined by the global market, and because of the uncertainty of production decisions by OPEC+, consumers are once more faced with uncertainty that is likely to affect their spending.
The takeaway
The oil and energy sector has been in turmoil for the better part of a decade. Only recently, as the financial sector has imposed more discipline, have producers regained a better financial footing.
The key question is whether prices at current levels—West Texas Intermediate at $67.89 and Brent crude at $71.53—will spur more production and provide sustained relief.
