Predicting Gas Prices: Three Factors to Watch

If you knew how much your corner gas station was going to charge tomorrow, you'd be able to save a few cents by beating the increase, or by holding off until the price goes down.  And if you could make such a prediction every day, the savings could add up to several dollars a year.  It's not enough to change your life, but it helps a bit.  And when the $4.00 per gallon gasoline returns to the U.S. market - as you know it will sooner or later - the small savings on each gallon will be that much more important to your budget.

Now, if you could make a reliable forecast of long-range changes in the price of gasoline, you could make a killing in the futures market.  However, that is beyond the scope of this article.  It is, in fact, impossible.  Let's just stick with saving a few bucks on our yearly gasoline budget.

The retail price of gasoline is determined by a number of factors, including, whether we like to admit it or not, human whim.  It is impossible to predict the exact price at any particular gas station unless you are the owner, and it is equally impossible to predict the lowest or highest price within a particular geographical market.  However, what we can predict is the general movement of prices at a large number of gas stations in a given area.  The extremes - highest and lowest prices - are most affected by the truly random factors which can never be predicted perfectly.  But the average price in a given market is driven by some predictable and well-known factors.

Here are three of them:

1. Gasoline futures prices.


2. Local constant factors.


3. Current local retail prices.

Gasoline Futures Prices

News media are always reporting the wholesale price of crude oil, and often run stories that describe how it affects the price you pay at the gas pump.  This is an important factor, but it's a bit removed from the gas pump.

A better indicator, more closely coupled to retail gas prices, is the price that investors are paying for "futures" in refined gasoline.  We won't go into details about what exactly gasoline "futures" are, but you can readily guess the most important thing you need to know:  This reflects what the gas stations will be paying to refill their gas tanks in the near future.

Look for reports of gasoline futures prices.  They are published every day in financial news outlets, and the latest price is posted and updated in near real time throughout the business day on many financial news Web sites.

Watch the price of gasoline futures over the course of a few weeks and months, and you will see a relationship between this price and the retail price of gas in your area.  Of course, this relationship is not exact.  Sometimes the futures price will go up, but the retail price will go down in the same day.  But over the long term, the two prices will tend to move in the same direction.

This relationship is not the same in all places, either.  For example, let's look at yesterday (as I write this), December 11, 2008, and let's look at the retail price of gas in two U.S. cities.  The futures price of unleaded gasoline was $1.08 per gallon when the market closed.  In Atlanta, Georgia, the retail price of gas that afternoon was $1.56 per gallon, and in White Plains, New York, it was $2.39 per gallon.

So, what is the relationship?  It varies from one place to another, as we can see, but there are local factors to consider.

Local Constant Factors

By observing the price of gasoline futures and the local retail price of gas over a period of time, you can figure out the relationship between these two prices for your area.

Take another look at the examples cited above.  On December 11, 2008, the retail price of gas in Atlanta, GA was 42 cents higher than the futures price, and in White Plains, NY, it was $1.31 higher.  Will these relationships always hold?  Will you always be able to add 42 cents to the futures price and find the retail price in Atlanta?  Probably not.

Here's another way of looking at it.  The retail price of a gallon of gasoline in Atlanta was about 1.44 times the futures price, and the retail price in White Plains was about 2.21 times the futures price.  Proportional relationships like this tend to work better.

The difference in retail price between these two cities has to do with several complex factors, including the cost of transporting gas to the gas stations, local business taxes, local employment costs, and the vague "what the market will bear" factor.  Nevertheless, these factors themselves change rather slowly, and therefore you can come up with a proportional relationship between the futures price and the local retail price, and this proportion works pretty well.

If you keep track of the futures price and your local retail price over a period of time, you can eventually come up with a proportioning factor that comes pretty close to predicting the retail price of gasoline for your area.

Current Local Retail Prices

Another important factor in predicting tomorrow's gas price is, what is the price today?  Gas stations tend to change their prices slowly.  When their costs go down, they want to keep their retail prices as high as they can in order to maximize profits, but they have to follow the other gas stations to avoid being undersold.  When their costs go up, they must raise their selling prices in order to remain in business, but they must be cautious to avoid driving their customers away.

So, even if the futures price were to increase dramatically, say 10%, in a single day, the gas stations in a given area will adjust their retail prices a bit more slowly.

If you build a mathematical model of the retail price of gasoline based on the gasoline futures price and the local constant factor described earlier, it just won't work.  Your model must also account for this "drag" factor whereby tomorrow's gasoline price is held back from moving, either up or down, by today's price.

There are many other factors affecting the price of gasoline, but the three described here are the biggest ones.  You can watch these three factors from day to day and figure out whether you should buy gas today, or hold off until tomorrow and save a few cents.  It won't change your life, but it feels good to "beat the system," even in a very small way.