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Why are fuel prices so high? Fuel prices are a problem for both businesses and consumers.

Fuel prices are a problem for business and consumers — Why costs are so high

A sign shows gas pricing at a gas station on May 10, 2022 in San Mateo County, California.

Liu Guanguan | China News Service | Getty Images

The spike in fuel prices is difficult to ignore and at the forefront of customers’ thoughts as billboards advertise that petrol now costs $4, or $5, or even over $6 a gallon in some regions.

With prices reaching historic highs, Americans are feeling the effect at the pump immediately. But increased gasoline costs are a drag for the larger economy too, beyond simply people having less spending money. The growing cost of fuel, particularly diesel, implies that everything moved on a truck, rail or ship is impacted.

Energy expenses are a big contribution to the decades-high inflation statistics popping up, as prices for all manner of products and services march upward.

“Energy, in a sense, is the tail wagging the dog here,” Bob McNally, president at Rapidan Energy Group, said Wednesday on CNBC’s “Power Lunch.”

“Diesel is actually the economic fuel. It’s the lifeblood of the economy, transportation, electricity in certain situations … so it truly is ingrained in economic activity and it’s filtered through so many things and services.”

What causes such high gasoline prices?

The rise in gasoline costs is mostly due to the rise in oil prices. The Russian invasion of Ukraine is the newest cause for petroleum prices to rise, although prices were already rising before the conflict.

Low pricing and institutional shareholders wanting larger returns pushed energy firms to cut down on investment and less lucrative projects even before Covid.

Then, during the height of the epidemic, when demand for petroleum goods plummeted, companies cut production even more. Because no one was traveling anywhere and companies were closed, significantly less gasoline was required. The abrupt decline in demand caused West Texas Intermediate crude, the US oil benchmark, to temporarily trade in the red.

Since then, economies have recovered, industry has rebounded, and people are once again driving and flying. Beginning last autumn, this resulted in a rise in demand and an increasingly tight oil market. President Joe Biden tapped the Strategic Petroleum Reserve in November as part of a concerted effort with other countries, notably India and Japan, to bring down oil prices. However, the relief was fleeting.

The invasion of Ukraine by Russia at the end of February shook an already shaky energy market.

On March 7, US oil hit its highest level since 2008, hitting $130 per barrel. Russia is the world’s greatest exporter of oil and goods, and it provides natural gas to the European Union. While the United States, Canada, and others immediately prohibited Russian oil imports following the invasion, the European Union stated it couldn’t do so without causing harm.

Now, the EU is attempting to reach an agreement on a sixth round of sanctions on Russia, which includes oil, despite Hungary’s opposition.

Oil prices have already fallen from their post-invasion highs, but they remain far over $100. To put that figure in perspective, a barrel of petroleum sold for $75 at the start of 2022, whereas prices were closer to $63 at the same time last year.

The sharp increase in oil prices, and hence gasoline prices, is presenting problems for the Biden administration, which has urged producers to pump more. Oil firms are hesitant to drill after promising shareholders capital discipline, and executives claim that they simply cannot pump more. They’re dealing with the same concerns that are affecting the rest of the economy, such as labor shortages and growing pricing for components and raw supplies like sand, which is essential for fracking.

Oil prices account for more than half of the total cost of a gallon of petrol, but they are not the only determinant. Prices are also influenced by taxes, distribution, and refining expenses.

Refining capacity constraints are starting to play a bigger impact. Refining is the process of converting crude oil into the petroleum products that people and companies use every day. Since the pandemic, the quantity of oil that refineries can process has decreased, particularly in the Northeast.

Meanwhile, sanctions are preventing Russia from exporting petroleum products, forcing Europe to seek other sources. Refineries are practically at full capacity, and crack spreads for diesel — the gap between refiners’ cost of oil and the price at which they sell their products — have reached new highs.

All of this is driving up petrol costs. According to AAA, the national average cost a gallon of petrol set a new high of $4.589 on Thursday, up from $3.043 at this time last year. The figures haven’t been adjusted for inflation.

For the first time in history, every state is now averaging more than $4 a gallon, with California’s statewide average exceeding $6.

Diesel costs are also rising. On Wednesday, retail diesel prices touched an all-time high of $5.577 per gallon, up 76 percent in a year.

According to Yardeni Research, households now spend $5,000 per year on fuel, up from $2,800 a year earlier.

What impact do rising gasoline costs have on businesses?

Although demand destruction, or the degree to which high prices affect consumer behavior, has not yet occurred on a large scale as a result of rising gasoline prices, the effects are spreading across the economy. Higher gas prices imply not just less money in customers’ wallets, but also increased expenses for businesses, some or all of which will be passed on to consumers later.

Target is one of the businesses facing rising prices. Target’s stock plummeted 25% on Wednesday, its worst day since 1987, after the retailer’s earnings report, which included a warning about inflationary pressures.

“We weren’t expecting the quick changes we’ve witnessed in the previous 60 days. As gasoline prices have gone to all-time highs, we did not expect transportation and freight costs to skyrocket as they have “On Target’s quarterly earnings call on Wednesday, CEO Brian Cornell said.

According to CNBC, increasing gasoline and diesel prices would cost Target an additional $1 billion this fiscal year, a “substantial rise that [Target] didn’t foresee.”

Walmart executives made similar remarks. “During the quarter, fuel prices rose faster than we were able to pass them through, causing a timing problem,” Walmart President and CEO Doug McMillon said during the retailer’s first-quarter earnings call on Tuesday. “In the United States, fuel was approximately $160 million more than we projected for the quarter.” McMillon went on to say that the firm made “progress aligning pricing to the rising expenses” throughout the quarter.

Domestic and import freight prices have risen “significantly” in the previous year, according to Tractor Supply officials, who anticipate these trends to continue through 2022.

“The cost of shipping an international container has more than quadrupled compared to pre-pandemic prices, and the cost of gasoline is around one-and-a-half times more than it was merely a year ago,” Amazon said in its quarterly report.

“Significant increases in cost of sales compared to the comparable 2021 first quarter,” according to Monster Beverage management, “mainly owing to increasing freight rates and fuel expenditures.”

The airline sector is also experiencing the effects, with higher jet fuel costs, particularly on the East Coast.

Southwest Airlines reported a “substantial increase in market jet fuel costs” in the third quarter, while United Airlines CEO Scott Kirby told CNBC that if current jet fuel prices persist, the company would spend $10 billion more in 2019.

C.H. Robinson CEO Bob Biesterfeld summed it nicely. “However, the difficulty that we have is actually the growing and record cost of diesel fuel, which has such a tremendous influence on total freight price,” he said on CNBC’s “Closing Bell” on Wednesday.

To put the increase in perspective, he noted that moving a package from Los Angeles to the East Coast now costs over $1,000 more than it did last year.

“That puts a huge squeeze on inflationary prices,” he said.

Is there any hope for you?

Experts predict that demand destruction may be the only way to keep gasoline prices from increasing.

For the busiest driving season between Memorial Day weekend and the Fourth of July, John Kilduff, partner at Again Capital, predicts a $5 national average.

He added on CNBC’s “Squawk on the Street” on Wednesday that “it looks [the national average] has to move higher.” “We saw gasoline demand spike to summertime levels last week… there’s still room for additional upside here.”

Kilduff attributed high demand to two important factors: pent-up demand after the epidemic and a healthy labor market, which implies individuals would spend whatever it takes to go to work.

The national average, according to Andy Lipow, president of Lipow Oil Associates, will peak between $4.60 and $4.65.

He pointed out that stock market declines had driven down gasoline futures, giving customers a little relief at the pump.

However, since petroleum is utilized in so many consumer items, particularly plastic, even if gas prices fall briefly, expenses throughout the economy may remain high if oil prices remain high.

According to McNally of Rapidan, reining down product inflation now will need a recession. “It’s not looking promising. But [gas prices] must rise since there is no indication of true demand surrender yet… they will continue to rise until that occurs “he stated.

Written by Editor

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