In my April 11, 2015 blog I asked the question "How do crude oil prices affect prices at the pump in Vancouver", and I showed that crude oil prices have a close but not perfect statistical relationship with gasoline prices that you pay at the pumps in Vancouver. Specifically, I estimated a statistical relationship that can also be used to predict what prices should be, and how far actual prices are away from the predicted price. If the observed price is higher than the predicted price, gas is "too expensive", and when the observed price is lower than the predicted price, gasoline is "too cheap".

The chart below is updated daily and shows the most recent price of crude oil (in US Dollars per barrel, for West Texas Intermediate), along with the average of the last two weeks and the minimum and maximum during that period. The average is then used as input into the regression analysis described in my April 11 blog, and the output is the price in Canadian cents per litre (¢/L) for regular gasoline in Vancouver. The colour band shows how the "expected price" from the forecast compares to the observed price as reported by Gas Buddy. The chart shows whether gas is cheap, expensive, or priced normally.

The colour bar reveals how the observed average gas price in Vancouver compares with the forecast. Technically, the line for the Vancouver average is the "z-score", which expresses the price deviations in terms of the standard deviation of the forecast (i.e., the root mean square error). The little white markers at the top of the color bar show the locations of the -3, -2, -1, +1, +2, and +3 standard deviations. The green range between -1 and +1 standard deviations covers about two-thirds of observations and tells us that prices are "about right". The light-to-mid blue and yellow-to-orange areas (between -1 and -2 on the left, and +1 and +2 on the right) cover about 95% of the observations. The mid-to-dark blue area and orange-to-red area (between -2 and -3, and +2 and +3) cover 99.7% of the observations. Situations below the -3 mark (dark blue) or above the +3 mark (fire red) at the end of the color bar cover less than 0.3% of the distribution and should be considered extreme and circumspect. Scientists call that a "3-sigma" event, and then you should call me and ask what on earth is going on—because something significant is happening. Today, August 25, the observed price is about 13 cents higher than the predicted price. That difference is a little less than two standard deviations: unusually high, but not a reason to ring the alarm bells.

The long-term relationship used to estimate the predicted gasoline price in Vancouver also takes into exchange rate changes, due to our currency's status as the Canadian Petrodollar. When the price of crude oil goes down, so does our Dollar. Of course, there are also other factors that move our exchange rate, such as interest rate changes. A fuller model would take such additional "drivers" into account.

What explains the discrepancies between predicted and observed gasoline prices in Vancouver? Markets for crude oil and gasoline are closely connected but do not follow each other precisely. Gasoline is a refined product, and thus bottlenecks at refineries and existing gasoline inventories are crucial factors determining the price at the pump. Local demand and supply factors can lead to local deviations that are different from those in other regions of the country. Seasonal factors may also come into play. During September, after the end of the driving season, refining capacity is often taken offline for repair and maintenance (so-called "turnarounds"). Inventory levels can also be different regionally. In Western Canada, refineries tend to have much lower level of crude oil inventories (about 5-7 days) than refineries in Eastern Canada (about 15-20 days). Similarly, inventory levels of refined gasoline differ. In anticipation of planned maintenance shutdowns, refineries build up inventory. Larger inventories put further downward pressure on crude oil prices. The bottom line: reduced refining capacity is currently responsible for unusually high gasoline prices, combined with strong demand from motorists.

As was reported widely, for example in Shut refineries put pressure on oil prices as inventories grow in the Globe and Mail on August 18, BP had to reduce operations at its Whiting, Indiana refinery. Ten other companies are expected to take refining capacity offline for up to two months starting in September. Thus the current price premium will probably stay with us for a little longer. Rest assured, though, that eventually prices at the pump will fall into line with crude prices again. In another (rather technical) blog I asked Do gasoline prices rise like rockets and fall like feathers? and found that gaps between crude price and pump prices do not persist for long, and there is little indication of asymmetric effects. With a little bit of delay, you should be able to look forward to rather low prices at the pump by October or November.