US is world's top oil producer. So why does gas cost so much? | Opinion
It was American ingenuity, not American oil production, that eventually helped ease prices at the pump during the 1970s oil crisis. It could happen again.
The United States – not Iran, Saudi Arabia or any other Persian Gulf country – is the world's top crude oil producer. That may leave some wondering why gas prices here go up when there's a shortage elsewhere in the world, as with the ongoing conflict with Iran.
Gasoline is one of the products created when crude oil is extracted from the ground and refined, along with others like jet fuel, diesel and asphalt.
So when the price of crude oil increases, the cost of producing refined products, like the gas in your vehicle’s tank, increases.
Elasticity in economics describes how responsive the supply of one variable is to its price. For example, the supply of generic manufactured goods, like white T-shirts or plastic phone cases, is highly elastic. If the market price for these items rises, manufacturers can easily increase production by running extra shifts, because the raw materials and labor required are readily available.
However, the supply of oil is "inelastic," meaning that the supply of crude oil production cannot quickly rise in response to high prices. Even though the United States has plenty of reserves, it can take years to develop new oil fields.
Current demand in the United States for refined oil products significantly exceeds domestic crude oil production. As a result, the United States must import crude oil.
About 20% of the world’s crude oil is shipped through the Strait of Hormuz. In recent times, this passage has become a chokepoint for the flow of crude oil to international destinations.
When access through the strait is blocked or restricted, this decreases the availability of oil worldwide.
Supply and demand have a ripple effect
Prices at your local pump change quickly in response to overseas conflict, not because of irrational noise or price gouging, but because the gasoline in your car is made with crude oil supplied by the global market.
What's truly remarkable about global market prices is that they don't just summarize some information; they summarize all relevant information. Think of the global price as the Kelley Blue Book for crude oil.
Just as the Blue Book shows how much a 2019 Chevy Blazer could be worth based on its condition, mileage, etc., the global price of crude oil tells consumers how much a barrel of oil is worth, based on how much it currently costs to get it to market.
A barrel of oil is worth a lot more when there is armed conflict in an important oil-producing region. Increasing gasoline prices communicate a real change in the global supply of crude oil.
Your gas-powered car cannot be converted to an electric vehicle. Airplanes, international shipping and railroads cannot easily pivot away from petroleum-based fuel. Therefore, consumers have little choice in the short term but to accept market increases.
What if the United States capped gas prices so they could no longer rise in response to changing conditions in the marketplace? Oil refiners would no longer find it profitable to produce gasoline, so production would be limited or scrapped altogether.
Assuming consumers would drive the same amount, that would result in shortages. This is a recipe for the gas lines we experienced in the 1970s.
Consumer habits can change over the long term
Do our current market realities have to be that way forever? Not necessarily.
Economics is the study of how people respond to incentives, and high prices are among the most powerful incentives of all. Sustained conflict around the Persian Gulf and the resulting high price of crude oil might encourage industries and consumers to look for alternative fuels or reduce their usage altogether.
The growing availability of renewable energy sources and electric vehicles could reduce America's long-term dependence on oil. A similar adaptation occurred when car manufacturers increased production of gas-efficient cars following the 1970s oil crisis.
The adaptation was slow, but the average miles per gallon for standard passenger cars improved from 13.5 mpg in the mid-1970s to 27.5 mpg by 1985.
It was American ingenuity, not American oil production, that eventually helped ease prices at the pump.
Robert Shimer is the George J. Stigler Distinguished Service Professor in Economics and the College at the University of Chicago and one of the faculty directors of Economics for Everyone, which teaches fundamental economic concepts as a way to understand the world.