By Mike Walden
Drivers suffered through almost daily hikes in gas prices when the war in Ukraine began. In the early weeks of the war oil prices jumped almost 25 percent. Then for a few days afterward there was a pullback, with oil prices falling over 20 percent. But during the same time period gas prices at the pump continued to rise, increasing both when oil prices rose as well as when oil prices dropped. It wasn’t until a week after oil prices fell that pump prices also took a dip.
This situation has been dubbed the “rockets and feathers” of gas prices. The analogy means gas prices jump quickly like rockets when oil prices rise, but gas prices fall slowly like feathers when oil prices drop.
Indeed, one study found gas prices fall twice as slowly as they rise after a major change in oil prices. This means, for example, if it took four weeks for gas prices per gallon to increase 25 cents, it would take them eight weeks to fall 25 cents once oil prices returned to their starting level.
This pattern seems totally unfair to drivers – indeed, it likely seems unfair even to people who don’t drive. When the price of oil increases, fair persons would expect the price of gasoline to also increase because gas is derived from oil. People may not like the fact the price of gasoline rose, but they understand it.
But fair people would expect the same to occur when oil prices dropped. They would expect gas prices to also fall just as fast as they rose when oil prices rose.
This controversy about oil prices and gas prices isn’t new. When I joined the NSCU faculty in the late 1970s, the same issue was a hot topic in the media.
So, what’s the answer to the gas price puzzle? There are several potential explanations.
One possible answer is collusion. This means gas station owners get together and agree to only slowly reduce the price when their costs fall. However, for this theory to be accurate, owners would need to cooperate and coordinate their pricing. But since there are over 14,000 gas station outlets in the country, with no single company controlling more than five percent of the market, collusion between owners to keep prices high is unlikely the answer. For collusion to be effective, it requires a handful of companies, not thousands.
Another possible explanation is that gas station owners worry that when the wholesale price of gas they pay drops, there is no assurance the price won’t again rise, especially in a volatile period like the one we are experiencing. Hence, owners wait until they see a trend in oil prices. Their reasoning is that customer relations will be better if the higher price is kept for a while until the downward price trend is confirmed, versus immediately lowering the price but then being forced to quickly raise it again if oil prices go back up.
While the above story is plausible, many economists think there is a better explanation for the “up like a rocket but down like a feather” pattern of gas prices. Interestingly, the explanation is based on how drivers react to changes in gas prices.
While some drivers consistently shop around for the lowest gas price, most buy gas at one or maybe a couple of gas stations. They may be stations close to their homes or on a route to work or school. Even if we could save a penny or two per gallon by buying at another station, we know that some of those savings will be eaten up by driving to the less convenient station. There’s also the matter of the value of our time to find the lowest gas price.
But, when gas prices rise, more drivers shop for the lowest gas price in their area. With gas costs taking a bigger chunk of their income, drivers are motivated to seek any savings they can. The use of gas price apps increases and local news programs regularly report on the locations of the lowest gas prices.
The opposite behavior occurs when gas prices drop. Fewer drivers shop for the lowest price. One reason is they are just happy to see prices fall.
Sellers of gasoline know these behaviors. When oil prices drop, station owners will cut their gas price, but more slowly. Why? Because they know fewer drivers will shop for the lowest price. Instead, drivers will be relieved prices are finally dropping, and hence they feel less motivation to look around for the lowest price. Gas station owners will take advantage of this behavior to earn a little more as prices slowly fall. Gas prices will eventually decrease as much as oil prices; it just takes longer.
While this explanation may currently explain the “up like a rocket and down like a feather” pattern of gas prices, my prediction is it won’t last. Why? Technology is the reason. More drivers will use apps that will not only search for the lowest gas price in the area, but will also calculate the benefits and costs to the driver of buying gas at alternative stations. Will these apps make drivers “permanent shoppers”. You decide.
Walden is a William Neal Reynolds Distinguished Professor Emeritus at North Carolina State University.