Canada is one of the top oil producing nations in the world, producing around 4.3 million barrels per day according the US Energy Information Administration (EIA). You might assume that with crude oil prices testing their August lows that Canadians are seeing extremely low pump prices for gasoline; however, this is not the case.
With WTI prices down over 50% compared to this time last year, many are confused as to why this hasn't led to substantially lower pump prices. Here are 3 reasons Canadians haven't seen lower pump prices.
There is an Oversupply of Crude Oil, Not an Oversupply of Gasoline
First let's make the distinction between crude oil and gasoline. Crude oil is an unrefined commodity, while gasoline is a refined product. In other words, from a refinery's perspective, crude oil is the raw material (input) while gasoline is the finished product (output). The refinery makes the spread between the two prices.
There is obviously a correlation between crude oil and gasoline, but it's important not to forget that the two commodities have different market dynamics affecting their prices.
What has caused crude prices to decline is an oversupply. There has been an increase in crude oil production, leading to a higher supply of crude being stored. This crude is waiting to be sold to refineries.
Refineries, who produce the gasoline, can't buy all of this crude as there are physical limitations on how much refined product they can produce. Two factors limit the amount of gasoline being produced:
- Refineries have a maximum capacity. Once they hit this capacity, they can't produce any more refined products.
- Refineries can be, and need to be taken offline for repairs and maintenance from time to time which can restrict capacity.
The differences in market dynamics can lead to a disconnection between the correlation of crude oil and gasoline prices.
The Taxes Included in Gasoline Pump Prices are Fixed
In many countries, including Canada, gasoline is taxed. In Canada this is a fixed amount (in cents), as well as a 5% sales tax. Taxes in Canada represent on average 39.3 cents per litre (taxes vary by province).
This means that a portion of the pump price can't be affected by fluctuations in crude oil prices. For example if the pump price is posted at $1.00 CAD per litre, only around 60% of that price can actually be affected by the price fluctuation of crude oil.
The USD/CAD Currency Pair
The exchange rate can also have an impact on pump prices as Crude oil is priced in USD while gasoline in Canada is priced in CAD.
When the exchange rate increases, it becomes more expensive for refineries to purchase the unrefined commodity, as they buy in USD.
Although crude prices have dropped substantially, the exchange rate has also increased substantially. This time last year, the USD/CAD exchange rate was around $1.12, while today it sits around $1.33.
All of these things can add up to a limitation on the correlation between crude oil prices and gasoline pump prices. So next time you're at the pumps, don't be surprised to see relatively high pump prices when you hear of dropping crude prices.