With a rising gas tax, what price will we see at the pump?

Now that Minnesota’s gas tax is increasing, will it mean higher pump prices for consumers as Gov. Tim Pawlenty and nearly every news organization in the state has said? 
“No, you can’t say that,” said Mary Welge of the Oil Price Information Service (OPIS) in New Jersey, a national authority on fuel pricing. 
“There are so many factors that go into pricing that a state tax increase is relatively small,” Welge said. 
Consider: Minnesota’s gas tax will increase by 2 cents April 1. Assuming pump prices for regular gas would average $3.10 by then, the 2-cent tax increase would be .6 of 1 percent, which is so small it won’t even figure into a rounding error.

While it’s generally true that increases in costs are paid by the consumer, very small cost increases often are not passed on. And in the dizzying world of gas pricing, it seems something so small as a tiny uptick in a gas tax has no influence, as a practical pricing matter.  
In the case of pump prices, pricing is based almost entirely on supply and demand. “It’s what always drives pump pricing,” Welge said. 
By the time Oct. 1 rolls around when another 3 cents in state tax is added for a gallon of gas, some experts — including those at OPIS — are projecting that regular gas could be at $4 a gallon or more. And that would mean the additional 3 cents would once again be less than 1 percent of the influence on gas prices, and be lost. 
Prices in other states
The point of state taxes and pump prices for gas can be seen in a survey of states. Minnesotans currently pay an average of $3.04 for a gallon of regular, which includes 20 cents in state gas taxes. 
However, Georgians pay only 12 cents in gas taxes and yet pump prices in that state average $3.16. Indiana’s gas tax is 2 cents a gallon lower than Minnesota’s, and its pump prices average a dime more. 
Wisconsin’s gas tax is 11 cents higher than Minnesota’s, but pump prices next door average only a nickel more. 
And anyone who drives around the Twin Cities metro has observed that pump prices can vary by a dime a gallon at stations only a short distance apart. 
“It’s supply and demand at the retail level, with the price of world crude having an obvious influence,” Welge said. 
The crude oil factor
The price of world crude is another interesting subject. Welge said the “fundamentals” of supply and demand are not driving those world prices — at least so far as the United States is concerned. 
Supply and demand are in balance worldwide, Welge said, and the driver of world crude prices now is financial, most prominently the falling value of the U.S. dollar. 
C. Ford Runge, an economist at the University of Minnesota explains: World crude prices are pegged to the U.S. dollar, so when the value of the dollar falls world prices are increased to make up the difference. 
What it also means is that stronger currencies relative to the U.S. dollar, like the Euro or the Yen, act as a buffer to crude prices in nations with those stronger currencies. And so, as the dollar falls the Euro gets stronger and an adjustment in world crude prices has no effect in the European Union. 
“OPEC [the Organization of Petroleum Exporting Countries] has been upset about the situation for some time now,” said Runge.  He said there is talk about pegging world crude to a “basket of currencies” for stability.  But with falling confidence in the dollar, the effect will be that gas prices will continue to rise here as the dollar loses world value. 
Welge said that in the current pricing situation Americans may expect to see gas prices at or above $4 a gallon by summer. 
At his press conference the other day after his veto of the gas tax was overridden, Gov. Tim Pawlenty said that when gas prices soar to those levels there will be political pressure from consumers to decrease the state gas tax. 
So would lopping a nickel off the state tax mean that consumers notice a decline in price at the pump?
Not necessarily, Welge said, because the same supply/demand and world crude prices factors have influence far beyond a nickel.

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Comments (5)

  1. Submitted by David Brauer on 03/03/2008 - 01:15 pm.

    Ron – two points.

    First, while I’m sure supply/demand and world crude prices are more important to the price calc, especially in the short term, there’s no doubt that over time, the tax impact is fully felt. It becomes a base cost. While it’s true other factors are also in play – proximity to a refinery, for example, vendors will not eat the tax over any period of time. (I agree that other factors may dwarf the increase, though, and given the price swings, I don’t feel people will freak about a relatively modest gas tax percentage, contrary to Pawlenty.)

    Second, Runge’s point about the currency basket is really important. (I wrote about this on MinnPost in a different context; the sinking dollar’s role in Middle East inflation.) It makes Bernanke’s Fed cuts a very dicey proposition – lower interest rates lower the dollar’s value,and oil is one place you see the ensuing inflation quickly.

    To me, it says of two horrid options – recession and inflation – the recession possibility is worse. But inflation is becoming pretty bad, and it will soon be a lot worse. $4 a gallon gas is certainly not the end of it.

  2. Submitted by Tom Poe on 03/03/2008 - 05:39 pm.

    In the case of pump prices, pricing is based almost entirely on supply and demand. “It’s what always drives pump pricing,” Welge said.

    Ron: Why do you quote these idiots? They’re the same jerks that just announced our prices will rise because there’s a shortage of a secret additive needed to produce gasoline.

  3. Submitted by John Olson on 03/04/2008 - 07:36 am.

    David, do not confuse “inflation” with “recession.” The former is a “cause” and the latter is an “effect.”

    Dr. Runge’s comments on currencies are spot on and may end up being the underlying key (culprit?) to our current economic situation.

    Also keep in mind that the cost of transporting gasoline and diesel (or any other commodity or finished product, for that matter) goes up as diesel prices go up. And don’t forget that the health of pipelines also plays a part in transportation cost. If the pipeline is shut for whatever reason, other means must be used that are less efficient and more costly.

    What always amazes me is that a guy in Venezuela or Iran can hold a press conference and within hours the price at the pump has gone up.

  4. Submitted by Steve Elkins on 03/04/2008 - 10:56 am.

    David wrote that: “First, while I’m sure supply/demand and world crude prices are more important to the price calc, especially in the short term, there’s no doubt that over time, the tax impact is fully felt. It becomes a base cost.”

    This is not always true. Where commodities are concerned, much of the cost increase will be absorbed by the original producer in the form of lower prices for the raw material. The fact that a tax has been added does not change the market-clearing price for the commodity. The tax is not added to the price of the finished good, its deducted from the price of the raw material.

    This is a point that Thomas Friedman keeps trying to make: By restraining ourselves on adding taxes to gasoline, we’re just moving money from our pockets back to pockets in the middle east.

  5. Submitted by Don Gulseth on 04/15/2008 - 08:56 pm.

    Each penny affects the demand for gasoline. The supply has an inflexible aspect to it – the distribution factor of petroleum products. Example:
    If all pipelines,refineries are operating at 100% of capacity (they are close) and the demand is for 101%, the price may have to move up 10% to reduce demand until the demand is at 100%. Another example is summer gasoline verses winter gasoline. In the winter less gasoline is built out of a barrel of crude because the demand for more heating oil. As a result there is more heating oil produced out of one barrel of crude . There also is less demand for gasoline during the winter over all. Along with the price of crude these factors to the volatility of pricing.

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