Gas Prices 101

Given the important role that gasoline plays in powering transportation around the world, the price of gasoline can also influence the price of other important necessities. It’s a metric that people pay attention to and have come to associate with the success or failure of elected leaders, the economy, and environmental policies.

But how are gasoline prices determined, and what effect do prices have on consumers? This explainer will describe the factors that affect gasoline prices, how prices have changed over time, and how consumers react to changing prices. By having a clear understanding of what affects gasoline prices and how households respond, we can begin to identify policies that will be most effective in reducing the impacts high prices have on households.

Gasoline prices are determined by a complex world market that begins with the production of crude oil—the substance from which gasoline is derived. Cost-effective drilling technologies implemented in states like Texas, Oklahoma, and North Dakota made the United States the global leader in crude oil production, accounting for approximately 20 percent of the total oil produced in 2021.

Many other leading oil producers belong to the Organization for Petroleum Exporting Counties (OPEC)—highlighted blue in the table above. Founded in 1960, OPEC members work together to coordinate their supply of crude oil to affect the world oil price. Together, the current 13 members of OPEC are responsible for about 40 percent of total world oil production. Further complicating the picture is the fact that, in 2016, OPEC began collaborating with several other oil-producing countries, including Russia, in what is known as OPEC+. OPEC+ has significant influence on the supply of oil in global markets; by collectively increasing or decreasing their supply, they drive down or up the price of crude oil, respectively. For example, when oil supply was outpacing demand during the early months of the COVID-19 pandemic, OPEC agreed to a coordinated cut in oil production to stabilize prices.

Since crude oil is traded on a global market, prices are also affected by global changes in demand.  As shown below, the United States is the leading consumer of crude oil, but there are many other countries, including China, that consume significant amounts of crude oil and thus can affect its global price. The demand for oil tends to increase when the economy is booming and decrease during an economic downturn. 

Crude oil prices are a major component of the price that we pay for gasoline (or diesel) at the pump, as shown below. Other factors include the cost of refining crude oil into gasoline; the distribution and marketing of gasoline; and federal, state, and local taxes on gasoline. For gas stations near refineries, the cost of distribution may be significantly lower due to lower transportation costs. While all US gasoline prices include 18 cents per gallon in federal taxes, state and local taxes on gasoline vary widely; state taxes average 32 cents per gallon, with Alaska collecting the smallest tax (9 cents per gallon) and California the highest (65 cents per gallon).

Gasoline prices can also vary based on other factors that affect gasoline supply and demand. The number of active US refiners converting crude oil into gasoline will limit the amount of supply that can be produced, and states such as California may be further limited by regulations requiring specific gasoline blends that are supplied by fewer refineries. Hurricanes and other weather events occasionally close down refineries and reduce the supply of gasoline (at least in the short run), leading to higher prices. The demand for gasoline can also change based on economic conditions or changes in the types of vehicles that people drive. When the economy is good, people tend to drive more and demand more gasoline, thus driving up gasoline prices. At the same time, as more people drive cars with higher fuel efficiency, meaning they get more miles per gallon, this requires less gasoline to go the same distance and can reduce demand, putting downward pressure on gasoline prices.

Ultimately, the price at the pump will be determined both by supply and demand. Given the global market for crude oil, which comprises a major portion of the cost of gasoline, what happens with the global economy will affect the price. A global recession would put downward pressure on demand and prices. But, even if the United States falls into an economic recession, if other major economies, such as China, continue to grow, gasoline prices could stay high. 

After World War II, the booming US economy was associated with the rise in the use of personal cars and trucks. As more people hit the road, gasoline production also increased. Most of the initial US demand was derived from domestic crude oil production. However, when US production was unable to keep up with demand, the balance was provided by crude oil imports. By the early 1970s, imports accounted for about a third of total US demand for gasoline and other products derived from crude oil.  The increase in imports kept gasoline prices low despite the increases in demand.

However, in the mid-to-late 1970s, this reliance on foreign sources of oil, especially from OPEC, would provide the first shock to the gasoline market. In 1973, in retaliation for the US support of Israel, OPEC cut off oil to the United States and its allies. Overnight, prices of gasoline skyrocketed. Fortunately, diplomatic efforts restored the imports in March of 1974, but the United States would once again face a similar shock in 1979 when Iran cut off its exports during the Iranian Revolution. Coupled with a continued increase in demand, the supply decrease led to a spike in gasoline prices.

Starting in the early 1980s, and lasting for almost two decades, gasoline prices stabilized. However, after the 2001 recession, the long period of global economic growth led to an increase in demand for crude oil and associated increases in gasoline prices. By 2008, with higher prices and advances in drilling technologies, producers began exploring new and more costly sources of crude oil.  After 2012, this increased production drove down prices, until prices began to rise again as world economic growth led to increased demand.

However, in 2020, the COVID-19 pandemic and the associated economic shutdowns reduced global oil demand and gasoline prices, leading older gasoline refineries to permanently close and many crude oil wells be shut down. Thus, as the world emerged from the economic crisis created by the pandemic, the supply of both crude oil and gasoline was lower. With relatively low supply and increased demand, this put upward pressure on prices.

While in 2008, higher prices led to increased oil production and subsequently lower gasoline prices, there is evidence that might not happen again. After 2014, oil companies lost money as prices fell with the glut of new production. Going forward, investors are more wary of increased production that may not pay off. Additionally, when oil production was dramatically reduced in 2020, many workers lost their jobs and have transitioned to other industries. Depending on the state of the economy, it may be difficult to recruit these workers back to the oil industry given the boom-and-bust cycle of employment.

It is telling that oil company executives do not believe there will be any new refineries built in the United States. Given the factors noted above, it is likely that the United States will permanently face supply constraints on gasoline.

As gasoline prices increase, households have two ways to reduce their gasoline burdens. The first is by changing the type of vehicle they use, specifically by purchasing more fuel-efficient models. The second approach is to drive less (or alternatively, shift a household’s driving to its more fuel-efficient vehicle if it owns one). In this section, we explore how driving and vehicle purchase patterns change in response to high gasoline prices.

Shifts in vehicle demand

One critical aspect that determines how much a vehicle owner will pay per mile of driving for gasoline is the fuel efficiency of their vehicle. Because of this benefit, a more fuel-efficient car will have a higher purchase price than a less fuel-efficient car, holding all other characteristics fixed. This means that when deciding which vehicle to purchase, the consumer faces a tradeoff between the upfront cost of the vehicle and fuel savings from future driving.

When gasoline prices increase, the amount a consumer is willing to pay for a more fuel-efficient vehicle should increase. In fact, there is evidence that when gasoline prices increase, demand for less fuel-efficient vehicles falls, as consumers demand higher fuel economy to reduce the cost of driving. This increased demand for more fuel-efficient vehicles will increase their prices and will induce vehicle manufacturers to increase their supply of vehicles with higher fuel efficiency, which results in an overall increase in fleet fuel economy. For example, between 2002 and 2007, gasoline prices increased by 80 percent (from $1.75/gallon to $3.16), and consumers shifted away from US manufacturers who were producing less fuel-efficient vehicles than their more efficient Japanese counterparts (see below). The increase in gasoline prices during that time can actually explain almost half of the decline in market share of US manufacturers, given the relatively low average fuel efficiency of US-manufactured vehicles at that time.

During periods of high gasoline prices, we also see a shift in the type of vehicle that is purchased. Instead of traditional gasoline-fueled vehicles, customers can increasingly choose to purchase hybrid or electric vehicles (EVs) as these come onto the market. Research using 2006 data demonstrated that hybrid vehicle sales would have been almost 40 percent lower had gasoline prices been 1 dollar per gallon cheaper. More recently, as gasoline prices spiked, demand for EVs has soared; EV registration increased by 60 percent in the first three months of 2022, and overall interest in EV purchases similarly increased by 70 percent during that time. As greater numbers and styles of EVs are available in the market, we should expect to see greater shifts toward these vehicles under times of high gasoline prices. Understanding whether a greater variety of EVs enable larger shifts in purchasing behaviors is still an open question.

Policies can also direct the average fuel efficiency of the US vehicle fleet. The federal and state governments can enact policies that require companies to make improvements to their vehicles’ fuel efficiency, usually by a certain percentage each year. For example, the most recent changes to the federal Corporate Average Fuel Economy (CAFE) standards will require an average of 49 miles per gallon for passenger cars and light trucks in model year 2026, an increase of 8 percent annually for model years 2024 and 2025, and 10 percent annually for model year 2026. More about fuel efficiency standards and other policy options that affect gas prices will be covered in more detail in an upcoming explainer.

Shifts in driving demand

Another approach that households can take to reduce the burden of higher gasoline prices is by changing their driving patterns. This can include reducing the number of trips taken, shifting toward public transit or other non-private modes of travel, or biking/walking instead of driving. However, given fixed commutes and the potential lack of alternatives, the ability of households to reduce their driving demand in response to changes in gasoline prices is limited. Several US studies have found low price responsiveness, though there is significant variation in this. Households living in locations with better access to public transportation have been found to be much more price responsive, while rural households that are farther distances from urban centers have longer commutes, less access to public transit options, and are less able to change their driving patterns in response to increases in gasoline prices.

Household gasoline price burdens

Gasoline consumption is an important part of US household energy expenditures. Recent estimates have found that households in the United States spend about three percent of their total budgets on gasoline, though this burden appears to have decreased over the years, with earlier studies finding much higher average burdens. Reductions in burdens over time may be explained by the increasing fuel efficiency of the vehicle fleet, as shown below.

There is, however, significant variation in the amount of a household’s budget that goes to gasoline costs. Though the average household gasoline budget share is 3 percent, the amount varies from under 1 percent to 23 percent depending on household location, local fuel prices, income, vehicle fuel efficiency, and driving needs. For example, rural and suburban households spend a greater share of their budgets on gasoline (in some parts of the country, up to two times more), given higher than average driving patterns and lower average vehicle fuel efficiency. The figure below shows the range of gasoline spending burdens as a share of household income at the census tract level, demonstrating a wide range of burdens across location.

Burdens also vary significantly across income. Higher income households tend to spend smaller shares of their income on gasoline than most other income brackets, given that the cost of gasoline per gallon is fixed and they have more disposable income to purchase more fuel-efficient vehicles. Conversely, the lowest income group spends the highest share of their income on gasoline, may have less access to public transportation (especially in rural areas), and given their smaller cash pools are less able to make choices to purchase more fuel-efficient vehicles.

This type of finding suggests that targeted electric vehicle subsidies toward lower income households may help to reduce inequitable gasoline burdens, as suggested by RFF Senior Fellow Joshua Linn.