The Storm Spike - Updated

If you're wondering why the price of gasoline at your local stations has suddenly spiked, despite little movement in crude oil prices, and even if you don't live anywhere near Texas or the path of Hurricane Ike, here are a few factors to keep in mind:

1. Although the price of oil is a major component of the cost of a gallon of gasoline, the crude and refined product markets are separate and distinct, and if there aren't enough refineries to turn it into transportation fuel, the price of oil isn't very relevant to the price at the pump. In the short term, refineries without electricity matter more than damaged oil platforms.


2. US gasoline inventories were already extremely low, before Ike made landfall, both in absolute terms and in days of supply. That's the result of months of high oil prices and weak gasoline demand, which together have crushed refining margins and made producing gasoline a break-even proposition.


3. Prices are set by supply and demand. For the moment, with many Gulf Coast refineries shut down or running at reduced rates, we are a nation that uses 9 million barrels per day of gasoline but has less than 8 million barrels per day of supply, including the million barrels or so we routinely import. Extra supplies from Europe and elsewhere are at least 10 days away. When supply and demand are so mismatched and inventory so low, the only choices for rationing supply are higher prices or gas lines and run-outs, which we may yet see in some areas. In general, our gut instincts about "gouging"--fed by misinformed or cynical politicians--are deeply unhelpful in such circumstances. Panic buying is even worse, because it can create a shortage by itself.


4. Service station owners have also been squeezed between weak demand and high prices this year. When they saw spot wholesale gasoline prices spike over $4/gal. on Friday, they knew their next deliveries were likely to cost them a lot more. Stretched by months of weak retail margins, they are in no position to absorb that hit without raising prices in anticipation of it.

As of Monday morning, it appears that the Texas refineries have not sustained major damage. Most should be able to restart within a week or two. Imports will increase in the meantime, and refineries not affected by the storm can run at higher rates, to make up for lost production and rebuild inventories, allowing prices to come back down pretty quickly.