OPEC announced it would cut production by 100,000 barrels a day for September, returning to August levels. Oil prices were 25% off their recent high, but are creeping back up. (CNBC)  In light of the record profits recorded by oil giants in the second quarter, it seems like a good time to revisit an earlier EconExtra on gasoline prices, this time using a brand new Planet Money podcast.  

EconExtra is a series of posts that go beyond the textbook, relating current events and recent developments in economics to content standards, and providing resource suggestions to help you incorporate the current events into your lessons. This week we follow up on an EconExtra from June, “Why are Gas Prices so High?”

Background and Recent Developments

Global energy markets have seen some turmoil lately. Some of the pandemic-related production bottlenecks have eased, but the war in Ukraine is still wreaking some havoc. (Gazprom just announced it would keep its main natural gas pipeline to Europe closed indefinitely.)  The price we pay at the pump may not be making headline news as much, but it is still high.

There have been supply shifts on the margin in recent months as well. The US started to release strategic oil reserves to ease some price pressure. But last week, OPEC announced it would cut production by 100,000 barrels a day beginning in October, returning to August levels. Oil prices were 25% off their recent high, but are now creeping back up. (CNBC)

Over the summer, oil companies around the world announced record profits, prompting politicians and consumers to call for some action. (The UK was looking at instituting a windfall profits tax on oil companies, but the new Prime Minister does not support it.)

Here is a sample of the results:

• Saudi Aramco second quarter net income rose 90%. (CNBC)
• Chevron profits more than triples from the prior year. (Chevron)
• Exxon profits almost quadruples from the prior year. (Reuters)
• Shell smashes its previous record first quarter earnings. (Reuters)

Resources

The June EconExtra “Why are Gas Prices so High?” focused a lot on the refinery component of gasoline prices. This recent Planet Money episode “Breaking Down the Price of Gasoline,” follows the details of what is driving every component of the price we pay at the pump, and helps us do the simple math (division and addition only) to reach the national average price of about $4/gallon. The largest component is the cost of crude oil, and the podcast spends a lot of time (about half of the 28 minutes) explaining the crude oil market.

The crude oil market is a global market and the “Law of One Price” drives the price per barrel to converge. This is explained really well in the podcast. The underlying question asked for each component of the price is whether or not it can be intentionally held high. The largest producers (OPEC and Saudi Aramco) can influence the price of oil by withholding it from the market, but the price of crude is driven largely by demand. Remember when crude oil prices went negative at the beginning of the pandemic? (NPR)  On the cost side, it really only costs these companies around $20/barrel to extract/produce the oil, so this is not a market driven by costs.

The podcast then runs through what is driving the costs behind refining, transporting and distributing gasoline as well as the level of federal and state taxes to give the complete picture.  

Lesson Idea

Create a graphic organizer for students to fill in as they listen to the podcast. This can be adapted depending on whether you assign this as an at-home assignment or listen to it as a class.   It can be as simple as this table summarizing the components of the average price of a gallon of gas ($4):

Here are some suggested discussion questions.

1) Can you explain the mechanism that drives the global price of crude oil to converge (the Law of One Price)?

2) Who, if anyone, has the power to manipulate crude oil prices?

3) What happened to drilling capacity (use the US as an example) during the pandemic that made it so difficult for oil companies to bring the supply of oil back up to pre-pandemic levels?

4) What world event has compounded the (supply) problem?

5) When was the last time a refinery was built in the US? Why won’t more be built? Are refineries enjoying windfall profits?

(see EconExtra“Why are Gas Prices so High?” for more on refining.)

6) What is the underlying “cost” of producing a gallon of crude oil?

7) If you were a policy-maker, would you address the windfall profits that oil companies, are enjoying right now as suppliers of crude oil and refinery operators? If yes, how?

About the Author

Beth Tallman

Beth Tallman entered the working world armed with an MBA in finance and thoroughly enjoyed her first career working in manufacturing and telecommunications, including a stint overseas. She took advantage of an involuntary separation to try teaching high school math, something she had always dreamed of doing. When fate stepped in once again, Beth jumped on the opportunity to combine her passion for numbers, money, and education to develop curriculum and teach personal finance at Oberlin College. Beth now spends her time writing on personal finance and financial education, conducts student workshops, and develops finance curricula and educational content. She is also the Treasurer of Ohio Jump$tart Coalition for Personal Financial Literacy.