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’s issue can be incorporated in even the most basic discussion of supply and demand.  It will be interesting to visit this issue in the beginning of the next school year to track what happened to oil and gasoline prices over the summer months, and to see if anything has changed.

The Headline Issue

The school year may already be over for some of you, but there has been much furor over gasoline prices in recent months, and it does not appear that much will change any time soon.   Initially, the price of oil, driven up by the war’s impact on global supply, was easy to blame. But as the price of oil has moderated, the price of gasoline is going even higher. This is something known as “crack spread.” Crack spread is essentially the refiner’s profit margin.  

How did we get here? Refinery capacity has been dropping a lot over the last several years for a several reasons. Demand is suddenly back to pre-Covid levens and supply cannot come close to meeting it. When Covid first hit and everything shut down, demand for refinery products plummeted, and some refineries shuttered. Then there were severe weather issues in Texas that impacted refineries there. A refinery fire took out a refinery in Philadelphia before the pandemic hit.

Prices rise to what the market will bear. In a textbook supply and demand world, these high prices and margins going to refineries would be incentive for them to increase capacity and build more refineries or bring more capacity back on line. But the real world situation is not like the textbook. No new refineries have been built since 1977. The high price has refineries running at 95% of capacity, but not adding any additional capacity.

Why not? There are a few reasons. First of all, it takes a lot of time and a lot of money to build a refinery. Financing this big investment in a fossil fuel at this point in time is a challenge, given the preference for investing in renewable/clean energy and a less than stellar transparency of oil companies’ investments. So, unless demand backs off (people buy smaller, more efficient or electric cars), these higher gas prices may be the new normal.

Resources

Here are three articles that can be used to explain the situation to students.

• Marketplace outlines the situation generally.
• This CNBC article goes further into detail about the more subtle trends and reasons leading to the current situation. This includes some recent historical context, and discussion of both the demand for products and the petroleum industry investment issues.
• The Grid article goes into great detail on the issue of refinery capacity worldwide: why it has decreased, and why it is not likely to increase, including environmental issues and long-term projections for demand.

Lesson Idea

Have students read all three articles (they aren’t long) and answer/discuss the following questions.

1) Approximately how much of the price of a gallon of gasoline is driven by the price of crude oil? What is the other factor driving up prices at the pump to such high levels? What other common products are derived from crude oil? Are the prices of those products also high? What other industries are impacted?

2) Are high prices driven by demand for gas, supply of gas, or both?

3) What sorts of things could people do to reduce some of the demand pressure on prices? Which actions could be taken immediately? Do you think people would be willing to take these actions? How about over the longer term: what could people do, and do you think they would be willing to do those things?

4) Do you see any quick solution to the supply side of this issue? How about longer- term solutions? What (other than time) are factors that will impede expansion of supply?

5) Do you have any ideas to suggest to policy makers that might address either the demand or supply side of this problem?

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.