Supply, demand and pain at the pump

Americans are feeling the pinch at the pump, but connecting the dots between the gas prices and the turmoil in world oil markets is like watching a set of dominos topple. One fall leads to the next, and so on.

The latest part of this chain reaction came after President Biden banned all imports of Russian gas, oil, and energy—including liquefied natural gas and coal—in response to the invasion of Ukraine.

"When anything happens in the oil and gas sector, there are two things to contend with: the actual effect and the reaction," said Dennis Kissler, trader with BOK Financial^®. "An embargo on Russian crude caused a squeeze in the market. Then Russia was able to sell directly to China at a discount, so now China will buy less on the open market.

"At all of these points, there are market shifts and consumer assumptions that also drive price fluctuations."

Case in point: The U.S only gets 3% of its oil for fuel from Russia, but gas prices at the pump increased by an average of 79 cents in two weeks. Kissler said there are many considerations at play: not all oil is created equal, and it's a global commodity, so prices aren't set just by the U.S.

The U.S. produces primarily crude oil, which makes gasoline, while Russian oil is heavier and ideal for diesel fuel.

"Right now, the U.S. is trying to rely on other countries to make up the difference in production," Kissler said. So, part of the price increase seen at the pumps is due to global demand dramatically outstripping supply.

"Our U.S. crude inventories are well below the five-year average, and we're 86 million barrels below levels from just one year ago and 60 million barrels below the five-year average," he said. "That means there's more demand than what is being produced in crude."

"The price we're paying is high; as long as we're seeing demand outstripping supply worldwide, the consumer is going to pay for it at the pump," Kissler said.

What's next for consumers?

There are two ways out: increase production or decrease demand.

"It's often said the cure for higher prices is higher prices," he said. "If we see higher prices, the drilling will come back and we will have supply back in equilibrium of demand.

"Alternatively, higher prices at the pump can also lead to lower consumer demand. More abundant supply drives prices down."

Kissler said drilling has been slow to re-start since it was halted during the pandemic. He added that there's been a slower rate of return for oil companies: drilling costs and labor costs have gone up, so the break-even cost is higher.

He added for domestic crude prices to stabilize or move lower, we will need to see U.S. crude storage migrate back toward the five-year average, which at this point means the U.S needs additional production.

"They have to charge more to be able to do more," he said. "In short, they need to make a profit in order to do more drilling and alleviate the demand issue. Higher gas prices mean more profit, so they can drill more, which lowers prices."