U.S. Has Few Good Options to Counter the Gas Price Spike

A protracted Strait of Hormuz closure will crater consumer sentiment, and there isn't much Trump can do about it.

The effective closure of the Strait of Hormuz – that normally accounts for one-fifth of global oil flows – has spiked U.S. gasoline (“gas”) prices more quickly than any event in recent history.

We worked on gas policy in the Biden administration and have first-hand experience with the economic and political fallout from spiking prices, as well as with options the Trump administration may be considering to lower them.

1. Rising gas prices weigh heavily on consumer sentiment. The media ramps up coverage when gas prices hit $3.50 per gallon, and each $1 increase in the national average gas price reduces consumer sentiment by 4.5 points or more.

2. Short of a reopening of the Strait, options to address rising gas prices are limited. Releases from the Strategic Petroleum Reserve can reduce prices, but this takes time. Other options, such as E15 waivers or encouraging greater domestic crude production, would have effects that are too small or too slow to be of much use.

3. So long as prices are determined on global markets, the U.S. status as a net exporter does not disproportionately shield U.S. consumers from gas price increases.

Rising Gasoline Prices Crush Consumer Sentiment

Following Russia’s invasion of Ukraine, when gas prices rose to $5.02/gallon, consumer sentiment cratered. Crunching the numbers over the full 1978-2019 period, we find that each $1/gallon increase in gasoline decreases consumer sentiment by 4.5 index points or more, after accounting for other key macroeconomic factors.

The negative effect of higher gas prices is, in part, mediated by greater media coverage. As we showed in our work with Giacomo Fraccorali, media coverage of gas prices ramps up when the pump price hits $3.50 a gallon. Indeed, we expect an even faster ramp-up in media coverage this time, due to the unprecedented pace of price increases and the already heavy media coverage of the war.

The Trump Administration Has Limited Options

Short of a reopening of the Strait of Hormuz, the Trump administration has limited options to address the price spike.

• SPR releases. Releasing crude oil from the Strategic Petroleum Reserve could modestly reduce gas prices over time. During the Biden administration, releases of 1 million barrels a day lowered pump prices by an estimated 13-31 cents per gallon. For engineering and contracting reasons, it takes time for SPR releases to hit the market. Given the implementation lag, the markets may interpret any planned release as a signal that war is becoming more protracted, sending prices higher rather than lower in response to an announcement.

• Sanctions relief. Removing sanctions on Russian crude won’t materially address the global crude shortage. Sanctions were designed to reduce Russian revenue while keeping Russian crude on the market. Removing sanctions may help countries that are particularly exposed to the Strait’s closure replace lost barrels, but since it will not add new crude to the global market, it is unlikely to put meaningful downward pressure on global crude prices.

• E15 Waivers: An E15 waiver allows finished gasoline with 15% ethanol content rather than the normal 10%. Because ethanol is typically cheaper than gasoline blendstock, allowing finished gasoline to be sold with a higher ethanol content can directly lower fuel prices. However, since ethanol has a lower energy density than gasoline blendstock, consumers have to purchase more overall fuel per mile traveled, offsetting the direct effect and yielding a negligible effect on pump prices on net.

• Tax holidays. Suspending federal or state gas taxes may offer some relief, but the impact will at least partially be offset by higher gas prices. The federal government assesses an 18.4 cent per gallon tax on gasoline, and state taxes average 33.5 cents per gallon. Suspending these taxes may seem like a promising way to protect consumers. However, with the tax eliminated, the gasoline price will need to rise even higher to induce the “demand destruction” needed to equate supply and demand. Beyond this, federal gas taxes fund the already depleted Highway Trust Fund. Any suspension would further drain those badly needed reserves, not to mention the difficulty of reinstating the gas tax after the market normalizes.

• Increased domestic production. While persistently higher prices would raise domestic production, U.S. producers are unlikely to rush into any new capital expenditures if they expect prices to revert in the 6-plus months they need to ramp up production. As of this writing, 6-month forward crude futures are not significantly elevated.

Net Export Status Does Not Shield U.S. Consumers From Increases in Gas Prices.

In the last few years, increased domestic production has flipped the U.S. from being a net importer to a net exporter of crude and petroleum products. This increase makes the global economy somewhat less reliant on free transit through the Strait of Hormuz. However, to the extent prices continue to be set on the global market, U.S consumers are not disproportionately shielded by greater U.S. productive capacity. Instead, the main beneficiaries are the U.S. oil majors who, while avoiding operational disruptions, can sell into higher prices on the global market.

A specific example of this is occurring in California, where the industry is requesting increased permits for drilling in response to the crude price spike. Regardless of the merits of increased permits, the increase in production will take years, and since California prices are determined by global markets, any price effects will not disproportionately flow to California consumers.

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