Why do gas prices rise quickly but fall slowly? The answer is 'the least sexy thing in the world,' says analyst

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Key Points
  • Americans are paying an average $4.24 per gallon at the pump, up from $2.87 a year ago.
  • Crude oil prices have spiked 48% so far in 2022 due to supply shortages and disruptions from the Russian invasion of Ukraine.

Gasoline prices are way up. Americans are paying $4.24 per gallon on average, compared with $3.57 a month ago and $2.87 a year ago, according to AAA.

The reason for rising costs at the pump: an overall uptrend in the cost of the unrefined version of gasoline, otherwise known as crude oil.

Coming off the heels of the pandemic, during which demand for crude oil dramatically decreased, oil supplies were already low to start 2022, notes Peter McNally, global lead for energy at investment research firm Third Bridge. "Inventories were already 10% below normal, which is a big number," he says. "Now you throw in the Ukraine conflict (Russia is 10% of the global supply) and you have supply disruptions. You end up with higher crude costs."

A barrel of crude oil currently trades for about $113 — a 48% increase from the $76 price tag at the beginning of 2022.

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But since shooting up in response to Russia news, crude prices have been volatile. In fact, Friday's per-barrel price is 8% below its $123 peak on March 8.

For consumers, that jumpiness raises an important question: Why does it seem like gasoline prices rise in lockstep with crude oil prices but fall much more slowly?

The answer, says McNally, "is the least sexy thing in the world to talk about." In short: Oil prices move in real time based on trading, while gas prices are tethered to the price the station paid to acquire their inventory.

Why gas prices seem to fall more slowly than oil prices

Oil prices jump because traders speculate on its value in real time. And with uncertainty plaguing the world of oil production, distribution, and refinement, prices are likely to continue to wobble, says McNally. "Are we going to sanction Russia or not? Will countries continue to buy their crude? These are day-to-day, hour-to-hour kind of things," he says. "Combine that with extremely low inventory, and you get volatile prices."

But while crude oil prices move in real time, inventory at gas stations moves quite a bit more slowly. "The folks who are selling the refined product are unlikely to immediately drop prices when there is a drop in crude prices," says Stewart Glickman, an energy equity analyst at CFRA. "They're likely worried that a price drop could be a blip and unlikely to sustain. In that case, margins would take a hit if they cut prices too much."

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The margins gas stations earn at the pump are relatively thin, McNally points out. "There is a lot of competition and gas is a commodity product," he says. "Most of these companies make more money selling cigarettes, coffee, and bottled water in the convenience store."

So, essentially, if a gas station buys 27 days-worth of oil at $115 a barrel and prices its gasoline to earn a thin profit, the station is likely going into the red if it lowers its prices much, even if the price of oil declines over the period.

Are gas prices likely to come down anytime soon?

There are many variables that factor into the price of gasoline, but signs point to things likely getting pricier in the short-term, says McNally. The U.S. is coming up on the summer "driving season" — its period of highest demand.

And when it comes to supply, he says, "the concern is twofold."

The U.S. is low on diesel inventories, which it typically ships to Europe (where more cars use diesel) in exchange for their excess gasoline. Given Europe's heavier reliance on Russian crude, "European producers will have trouble sending gas here," McNally says.

What's more, he adds, U.S. refining capacity — its ability to extract oil from the ground and turn it into gasoline — has shrunk in recent decades and refineries looking to ramp up production face supply chain bottlenecks. "It's hard to see in the next few months where extra supply could come from."

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Over the longer term, crude prices are harder to predict, but Glickman says that a reason for optimism lies in the fact that much of the "bad stuff" that could happen for oil is already reflected in its price. "If you look at crude prices scheduled for delivery in April 2022, they're at $110 a barrel, a price which has embedded in it a tremendous amount of geopolitical risk premium from Russia," he says.

The equivalent price in the oil futures market for April of 2023: $85, which means futures traders expect gas to be cheaper by this time next year. That could be good or bad news for you, suggests Glickman.

"That might suggest that the market thinks the situation in Russia is going to resolve itself rather quickly," he says. "It could also mean there's concern there could be a global recession by next year and that demand for oil won't be as robust."

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