As Oil Prices Fall, What's Happening To Gas Prices?

Oil prices took a steep dive this week, falling by nearly 13 percent. On Tuesday, the spot price for West Texas Intermediate crude delivered in Cushing, Okla., was $110.60 a barrel. By Friday, it was selling for just over $97 a barrel.

But don't expect cheaper prices at the gas pump right away. It will take some time for cheaper crude to make its way through refineries and to local service stations.

Still, this is the first time in almost two months that oil has traded under $100. Traders worry a stalling economic recovery might unexpectedly reduce American demand for oil.

Demand is an important element in petroleum prices. Over the long term, demand for gasoline is on the decline after a peak in 2007.

Certainly, price has something to do with that. At a national average of nearly $4 a gallon, people are thinking twice about the trips they take. That's showing up in statistics. For the past couple of months, drivers have been purchasing less gasoline than they did last year.

How Prices Affect Consumer Behavior

Sherry Palmer of Parker, Colo., is in that camp. She accepted a job in February in downtown Denver, about 35 miles from her home. She decided to start a new habit and use public transportation.

"It would be crazy — coming from Parker — not to take it," Palmer says. By leaving her sport utility vehicle parked in the driveway, she's saving a lot of money every month: $200, not counting parking, she says.

"That's a substantial change by one individual," says Dan Kaffine, assistant professor at the Colorado School of Mines' economics and business division.

Kaffine studies how gasoline prices affect consumer behavior. He says individuals respond differently, but overall, economists like him can predict how people will react collectively.

"There is a broad [base of] literature out there that says that, in the short run, a 10 percent increase in price will lead to roughly a 1 percent decrease in consumption," Kaffine says.

Beyond price increases, a poor economy also affects gasoline consumption. In 2008, as the economy suffered, the volume of gas sold fell by 3 percent — normal in hard times.

What's not normal is what's happening now. Even though the economy is improving, demand has not returned to previous levels. That's a big deal because for decades gasoline consumption in the U.S. followed a steady course upward.

Oil Consumption Worldwide Growing Faster Than Ever

Big oil companies have understood for years that change is under way.

"Motor gasoline [consumption] is down, it is headed down. It is going to continue to head down," said ExxonMobil CEO Rex Tillerson during a speech at the Economic Club of Washington in October 2009.

Tillerson says the reasons are improvements in vehicle mileage standards, more hybrids on the road and federal mandates to include a higher percentage of ethanol in the nation's fuel supply.

There's yet another factor at play: As baby boomers grow older, they're going to drive less.

So, think back to Economics 101 and you might conclude that if demand is declining, then prices should be going down, not up. But remember we're only talking about the U.S.

"The Chinas and Indias of the world are growing very rapidly, and that's tightening the supply-demand balance and it's causing prices to go up," says Aaron Brady, director with IHS-CERA's Global Oil Research Team.

Brady says oil consumption worldwide is growing faster than ever. Given that, $4 a gallon gas might seem cheap in a few years.