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What Would it Take to Lower Gas Prices?

Source: US EIA

It's a fun game to predict where gas prices will go. Why? Because there are absolutely no consequence if you are wrong. The renaissance in oil and gas production has left price prognosticators with the easy excuse of "well, I didn't expect ___ to develop so quickly". So rather than stand on a soap box and tell you why gas prices will go below $3, let's try a different approach. For gasoline prices to actually go down, there are certain drivers in the market that will make it possible. To determine how it is possible to get to $3.00 gasoline, let's answer 4 questions that should give us a better understanding of the situation.

1) For $3.00 gas, what does crude oil have to cost?
One thing to consider when calculating the price of gasoline; it varies from state to state. Heck, it can even vary from neighborhood to neighborhood. So for the sake of simplicity, we'll only use national averages. The most recent data from the US Energy Information Administration puts gasoline at $3.55 a gallon. Also, as you can see from the picture above, the price of crude oil has a very large part to do with the price of gasoline. As the price of gasoline changes, though, so too does the breakdown of gas prices. This is because some items such as taxes can be fixed amounts. 

Source: US Energy Information Administration, authors calculations

Source: US EIA, authors calculations

Over the past 13 years, there have 7 months where the average price of gasoline was $3.00 (plus or minus $0.10). During those times, the average breakdown of gas prices looked like the graphic on the right. So bringing this all together, it would mean that the average price of a barrel of crude would need to be at about $86 per barrel for $3.00 gasoline, an 18% drop from the average price refiners are paying for crude today. 

2) How does oil get to that level?
There are so many things that can cause oil and gas prices to fluctuate. Sometimes, those fluctuations have absolutely nothing to do with supply and demand. Overall, though, there is one major trend that we can assume. OPEC member nations have made a stated goal that they want foreign oil prices to remain at $100 per barrel, and they will be willing to cut overall production to maintain that price range. Is is possible? That is a question way above my pay grade, but according to Michael Levi at the Council on Foreign Relations it's likely over the next couple of years.

So let's assume that foreign oil prices will stay at $100, that means the overall price cuts would have to come from our domestic production. Based on the type of crude we produce here in the US and the crude quality that US refiners are built to process, our capacity to refine domestic oil maxes out at 8.2 million barrels per day. This means our refiners can run at just over 50% domestic crude. If our refining capacity is running half $100 import crude and half domestic crude, then domestic prices need to be at $72 per barrel, which is 24% lower than today's domestic prices.

3) Can the difference between domestic and foreign crudes get that big?
It hasn't reached that big of a difference, but the possibility for domestic crude oil to be well below foreign prices is very possible when there are bottlenecks in the system. Back in July of last year, domestic crude traded at a $22 discount to foreign prices, and Canadian oil sands crude has been as much as $40 less than American crude prices. These big differences in prices happened because there wasn't adequate takeaway capacity.

While the US's ability to move oil via pipe and rail has been able to remove most of the clogs between the well and the refiner, there is one possible way that we could see another major bottleneck that could cause domestic oil prices to drop. There is essentially a ban on US crude oil exports (with some exceptions for Canada). So if US domestic production of light crude were to exceed our refiners ability to process that crude type, then the system could get clogged and prices could drop

4) Could producers still make money at that low of a price?
That question depends on where you are drilling for oil. Based on Bank of America/Merrill Lynch's 2013 Energy Outlook, there are some oil producing regions in the US that could sustain $76 a barrel oil, and others that can't.

Source: Bank of America/Merrill Lynch 2013 Global Energy Outlook

Combined, the Permian, Eagle Ford and Bakken shale plays represent almost 3.4 million barrels per day of production, and executives at ambitious drilling companies like Contiental Resources (NYSE: CLR  ) , and EOG Resources (NYSE: EOG  ) predict that these three shale plays could reach as much as 6 million barrels per day combined. Unfortunately, these regions do have some of the higher break-even costs, and that would put a lot of strain on production. While many companies would be able to produce at a break-even level if we were to see prices go as low as $74 per barrel, it would severely hamper the overall growth of shale drilling across the entire country. Many of the younger, faster growing companies like Kodiak Oil & Gas (UNKNOWN: KOG.DL  ) and Halcon Resources (NYSE: HK  ) , which have both taken on sizable debt positions to find huge expansion plans, could find them behind the eight ball in terms of financial stability if this situation were to play out.

What a Fool Believes
Could this scenario happen? Potentially. The inability of the US to export crude outside of Canada could be a major price changing event that could not only result in you or I getting cheaper gasoline, but also putting the financial future of many emerging energy companies at risk. Is this scenario definitely going to happen? I don't have the insider political knowledge to know whether the ban on exports will be lifted, so I can't say with any certainty that it will happen or not. If gas were to make its way to $3 a gallon, though, this is probably the most likely way it would happen.

An energy giant that wins no matter the price of oil
OPEC still has a large say in the price of oil, but its grip on prices is slipping every day thanks to advanced technology in exploration. Of all the companies that are giving OPEC headaches, this one behind-the-scenes energy giant is at the heart of this transition. We have put together a brand-new Motley Fool special report that goes in depth about the company we're calling "OPEC's Worst Nightmare." Simply click here and we'll give you access to this valuable report that unveils the name of this industry leader.

Read/Post Comments (5) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 17, 2013, at 7:46 PM, gheerty wrote:

    Do your RESEARCH !. Gas has been below $3 in TX & OK & LA ...and other states for several weeks. And today is 11/17/13. A national average is a stupid indicator to use. The variation is so great an average $/gal is not a good measure. The crude/barrel price is also becoming less reliable. Why ? OPEC has less power than it did 18 months ago. Supply & demand and proximity to refineries that produce the gasoline required for the season...which is different from winter to Fall....and among states. Refiners will limit supply to keep a barrel above $82.

  • Report this Comment On November 18, 2013, at 8:23 AM, zzyzx123 wrote:

    Distribution and marketing are the biggest variables. The others are fixed costs. Distributors are what make gas prices go up 50 cents a gallon on holiday weekends.

  • Report this Comment On November 18, 2013, at 12:07 PM, Cyclebuilder wrote:

    To put it mildly you have to remmember that gas prices have stayed below $1.00 for well over One Hundred years. I am now 58 yrs. old and when I was old enough to drive at age 16 Gas Prices were .24 cents a gallon. They had stayed at reasonably decent prices until the late 1990s when Preident George Bush Removed the Cap with Gas Companies, It use to go back to the Consumer. But since that time, Our USA Government has raised the prices with the Speculators Regulating the Prices. I think its a total Ripoff by our Government, In this time of Crisis we should not be paying these prices. If the Gas Prices were to change today they should really be at $1.45 a Gallon. I just recently put gas in my truck a total ripoff $40.00 and all I got was 13 Gallons of gas. I dont care about the fact that there are more cars on the road, You have to look at the point that cars are lighter, Have smaller engines and get alot more miles to the gallon. So in that respect I say for our Government to stop sticking there hands out and pocketing the money that should go back to the Consumer. Get the gas prices back down to where they belong, Then food and utilities would go down to the point that maybe there could be an American Dream again. Its We The People, Not You The Government. The People of this Country are getting Sick and Tired of our Government taking control of things that should be taken care of by the People in this Country, As well as the Taxes we pay which is getting out of Control everything nowadays has got taxes on top of taxes and the actual price is less then the taxes are, and they say they dont have any money. Stop the Foolish spending and they would have the Money ! To Much Greed in Our Government Today !

  • Report this Comment On November 18, 2013, at 12:28 PM, Cyclebuilder wrote:

    I had also forgot to mention the point that gas prices would change once a month, Nowadays they change by the day which is also a rippoff cause the gas at the pump has already been paid for. Get prices back down where they belong, There are people that say they should be at .75cents a gallon, Im being generous by saying $1.45 a gallon is a decent price to pay today. It would be nice to be able to do something with my money besides trying to pay nothing but Bills and get out of debt. There use to be a time when you could have a decent nest egg to fall back on but not any more. Everybody dose not have the time or the money to do anything today and most of the people in this country dont have a back bone like we did when we were young. We use to protest against our government when things werent right for the people in this country. Wake Up People, Stand Your Ground and Start Complaining. Our Government is making you think that were getting a break at $3.00 a gallon for gas when we should be paying $1.45 a gallon. If We The People are the Squeeky Wheel that complains We will Surely get the Greese and the prices will drop. Just try for one day everyone including the truck drivers in this country going without buying any gas. Everyone on the same day not buying gas and I would bet the prices would drop by around .50cents a gallon within a week. The more times we would do that the less we would pay at the pumps, I think the government would get the message !

  • Report this Comment On November 18, 2013, at 9:17 PM, Mark1946 wrote:

    "What does it take to lower gas prices?"...Easy one!...REMOVE CRUDE OIL as a "betting game commodity" from the Wall Street corporate elite SPECULATOR GREED, who are only concerned with MEGA PROFITS for themselves and their investors. OPEC doe NOT set the price we pay for crude oil per barrel...The "domestic terrorists" at the NYMEX jack-it up with every lame excuse they can imagine. Eliminate their uncontrolled GREED and watch gasoline prices drop by two thirds at the pump.

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