It’s been a relief watching gas prices tumble during the last three months, from a peak of $5.02 per gallon in June to less than $3.70 now. But that may be as good as it gets.
Gas prices depend on oil prices, and turbulence is brewing once again in global oil markets, largely because of Russia’s ongoing war in Ukraine. Europe is on track to ban most purchases of Russian oil, starting in December, and Russian president Vladimir Putin could retaliate by cutting Russian oil production. The United States, meanwhile, is developing a plan for advanced nations to impose a price cap on Russian oil, to cut the energy revenue Russia earns and limit its ability to finance the war.
A decline in oil supply, from Russia or anywhere else, would push up prices. So would new logistical hurdles as oil gets rerouted, along with anything else that raises production costs or uncertainty. Putin might even try to time disruptions to maximize political upheaval in the United States and Europe.
“The risk of an oil supply shock is heightened in the coming months,” investing firm Raymond James said in a Sept. 13 research note. “We particularly view this risk as heightened given upcoming elections in [European] nations and the fall midterms in the US.”
Two factors pushed gasoline prices to record highs earlier this year. The first was a surge in oil prices in the aftermath of Russia’s Feb. 24 invasion of Ukraine. US crude prices jumped from $85 per barrel before the invasion to a high of $122 in June. There was never really a shortage of oil. But there were concerns that the war would disrupt supplies, with that “fear premium” pushing up prices.
The second factor was a drop in refining capacity in the United States and elsewhere. During the COVID downturn in 2020, oil and gasoline prices cratered and energy firms closed some underperforming refineries, which convert crude into gasoline and other finished products. Total US refining capacity has declined by about 5% since then, and refineries are now operating near full capacity. It’s costly to build new refineries, and the move to electric cars and renewable energy dissuades energy firms and their investors from adding new refining capacity.
Oil prices have fallen since June because the supply disruptions many traders feared didn’t materialize. But there may now be even more tangible reasons to worry about a supply crunch. If the European ban on Russian oil purchases goes into effect in December, as planned, Russia will try to sell that oil to other customers, such as India and China. But the International Energy Agency estimates Russia’s total exports could drop by 20% or so, which would be enough to put upward pressure on prices.
The US plan for a price cap on Russian oil wouldn’t necessarily push prices up. In theory, it would do the opposite, since purchasers of Russian oil abiding by the cap would pay less than market price. But there’s never been a buyer’s cartel on that scale, trying to enforce a maximum price, and it’s hard to predict how markets would react.
Putin, for his part, is unlikely to go along with any plan meant to thwart Russian energy sales. “The wild card is what the Russians do,” Helima Croft, global head of commodity strategy at RBC Capital, said at a Sept. 9 webinar sponsored by the Brookings Institution. “The Russians have made abundantly clear they do not want to play along with price caps. In coming months, we should prepare ourselves for the Russians to strongly signal that they will certainly continue to cut off the [natural] gas but they may cut off the oil as well.”
If there is a supply shock this winter, it’s not clear other oil producers would ramp up output to make up the difference. OPEC nations, led by Saudi Arabia, don’t have as much spare capacity as they used to, and they like high prices that produce windfall profits.
The United States is now the world’s largest oil producer, but that doesn’t mean drillers can simply open the taps when the world needs more oil. Many US energy firms lost money or struggled with weak profits during the last several years, because of overproduction. They’d rather milk high profits on tight supply than invest in new facilities that could end up losing money if prices crash again.
The energy transition comes at a price
The shift to renewables is also creating an energy gap as fossil fuel firms refuse to expand, for fear of losing money, and greener forms of energy take years to come online. “The energy transition is not going to come without a pretty big price tag,” Sarah Emerson, president of research firm ESAI, said during a Sept. 13 Atlantic Council event. “We’re beginning to pay that price, because of lack of investment in infrastructure. We’ve got to accept the fact that gasoline is going to be a premium product for some time because of these kinds of periodic disruptions.”
Can American drivers accept that? Can politicians? President Biden has clearly tried to push gas prices down, by releasing 180 million barrels of oil from the US reserve and browbeating drillers to produce more. His power is limited, however. Oil sales from the national reserve will end in October, and that in itself could put upward pressure on prices. The White House has hinted that Biden could release more oil, but the reserve is already low and needs to be refilled, in case there’s a hurricane or other event that unexpectedly shuts off supply.
At the moment, there’s only modest upward pressure on gas prices, with wholesale gasoline up about 6% from a low point on Sept. 7. It’s possible Europe will postpone the December ban on Russian oil purchases, which could bring further relief or at least keep prices stable at current levels, more or less.
Yet the Ukraine war has reached a dangerous new phase, with Russian forces losing terrain and Putin growing more desperate for any leverage he can gain against Ukraine and its allies. Putin has already shut off natural gas shipments to Europe through the Nord Stream pipeline, and he may feel it’s necessary to escalate his energy war by tampering with oil supplies as well—regardless of whether the European ban or the US price cap plan go into effect.
Dec. 5 is one date to watch, since that’s when the European ban is due to take effect. Putin, however, follows his own calendar, and may have different timing in mind. If gas prices stay below $4 per gallon into 2023, consider it a victory.