The price of gasoline debate

[the gadfly]

Just a few months ago, the price of gasoline was over 4 dollars per gallon in the US. Now, it's less than 2 dollars.

How low will it go? How long will the price last? Where should the price of gasoline be? And what the hell explains the dramatic changes in the price of gasoline?

Discuss.

 

[Misty]

First, we have to look at why the price went up. Three reasons stand out:

1) Demand in Asia was rising at an unsustainable rate. With hundreds of millions of people suddenly wanting automobiles, the increase in demand was far more than could be reasonably handled. When demand goes up but supply doesn't, prices go up.

2) A weakened dollar spurred a commodities boom - not just in oil, but in gold and such as well.

3) Hedge funds jumped into oil in 2007-8 as a way of protecting themselves from a declining economy.


Notice that the recession put the kaibosh on ALL of these - demand is decreasing in Asia, the dollar is rebounding, and hedge funds have given up on oil. (I suspect they're mostly in gold now.)


At this point, I have a feeling that we've probably found a floor. Even if we use the early 00s as a baseline (a time of historically low oil prices), there is really nothing to indicate that oil should be below $35-40/barrel.

That said, as soon as the recession ends, expect oil to go crazy again. Asia is still a major problem for stability of the oil markets, and it's not going away any time soon (barring a major upheaval in China, which admittedly is very possible, especially if the recession gets much worse). On the other hand, one hopes that the Fed will next time move to keep the dollar up as a respectable currency.

 

[Fig]

Yeah. Seriously, oil will come back up (as will the rest of the market)

 

[The Big Al]

Also, oil is expected to peak the year after next. At that point, production will decline.

 

[evkl]

Morgan Stanley predicts $25/barrel oil as the new low for this cycle...

Remember that in the late 90s, they were struggling to keep the price above $10/barrel.

 

[the gadfly]

So, will the price of gasoline near $1/gallon or go lower?

 

[evkl]

I dunno. If demand keeps collapsing there's no reason for the price to see a floor in the near term.

I think that gas prices may actually be one of the better barometers of economic recovery...if the stimulus packages aren't working, gas prices will stay low. Something worth thinking about.

 

[the gadfly]

I dunno. If demand keeps collapsing there's no reason for the price to see a floor in the near term.

Demand vs supply doesn't seem to apply here. Supply hasn't changed significantly.

Demand has gone down, but enough to see that big a decrease in prices? People are still driving to work. I would say few have abandoned their cars--especially since gas is cheaper--for mass transit.

 

[evkl]

Demand has gone down, but enough to see that big a decrease in prices? People are still driving to work. I would say few have abandoned their cars--especially since gas is cheaper--for mass transit.

The real sectors in which demand has gone down are industrial--in America and, especially, China. Also, even with gas prices back down to reasonable levels, there are so many other stresses on the pocketbooks of people that driving hasn't picked back up from the $4/gallon levels. People are now kind of used to conserving.

 

[Otter Mii-kun]

market updates

The CEO of Gulf Oil (a wholesale distributor) yesterday predicted as low as $20 a barrel, with gas prices going below $1/gallon in some areas! Could go even lower-maybe to $17-19 (as in late 2001)

Back in October when oil fell below $80 I heard someone on ABC World News Tonight (a field/assignment reporter) predict the possibility of $30, maybe even $20/barrel.

NYMEX's RBOB Gasoline futures for January '09 closed below $1/gallon for the first time Thursday and closed at .90¢/gallon yesterday, after dipping as low as .89¢/gal
(the RBOB Gasoline contract was introduced in late 2005, replacing a previous deprecated "Unleaded Gasoline" contract. The last time the previous version of the gasoline contract was below $1/gallon was in February 2004.
NYMEX has been trading gasoline futures since 1981, heating oil since 1978, and crude since 1983.)

It's similar to the post-9/11 fallout:
On September 14, the first trading day after the attacks, oil rose 40 cents to settle at $28.03 a barrel, and then more the next Monday: $28.81. However, from the next day on, prices began to fall-indeed going as low as $21.81/barrel on September 25. For the rest of September, and throughout October, oil prices would hang between $21-23/barrel.

On November 6, the price for Light-Sweet closed below $20 a barrel for the first time since July 1999. In mid-November, prices fell even further-as low as $17/barrel ($17.45 on November 15), actually sending gas prices to BELOW $1/gallon in some places!
Prices ranged from $18 to $21, but stayed mostly below $20 through January 2002.

Currently, according to GasBuddy.com, the national average for "regular unleaded" stands at $1.735, down 10¢ from a week ago, and compared to $2.31 a month ago, and $2.761 at this time a year ago.
In Michigan, the statewide average is at $1.605/gallon, down nearly 13¢ from last week, and compared to $2.14 a month ago, and $3.025 at this time last year!


Having said all this, however, I'm sure we'll have $5, maybe even $10+/gallon gas soon, especially with all the money the Federal Reserve is printing in order to "save the economy" from "absolute doom", "end this recession", and to "save homeowners from foreclosure", among other things. (and the media going along with all the Fed's actions saying they're "the only way out")

 

[evkl]

Printing money is about the only weapon the fed has to combat the deflation we might actually experience otherwise. This is the first time since like 1960 there's a reasonable shot at deflation. Unlike stagflation, which was the main source of recent recessions, production is way down and prices are collapsing as a result of a demand collapse for major (optional!) commodities that are the underpinnings of the world market.

 

[the gadfly]

The real sectors in which demand has gone down are industrial--in America and, especially, China.

I dunno. Yes, the demand for oil by industy world-wide has gone down (although there are exceptions), but I doubt demand has gone down that much overall to account for the dramatic plunge in oil prices. Judging by the price of oil, you'd think more than half of the industrial and consumer worlds had stopped buying oil.

I would think that much of the price of oil is due to irrational expectations. Either that or the price is more elastic than anyone would have guessed.

 

[evkl]

Gadfly, that assumes that for every 1% increase in demand, price increases 1%, and vice versa for decreases. That typically isn't how real models of pricing work...a 1% decrease in gasoline demand could drop prices 10% or more.

 

[the gadfly]

Gadfly, that assumes that for every 1% increase in demand, price increases 1%, and vice versa for decreases...a 1% decrease in gasoline demand could drop prices 10% or more.

So, that would explain why gasoline prices increased from around $3.10 per gallon at the beginning of 2008 (here in California) to over $4.50 per gallon by June? Our demand for gas increased that much? A 1% increase in demand could increase prices by 10% or more?

Seems to me gasoline demand would have decreased as the price increased. We didn't exactly get generous pay raises at year's end and our expenses didn't decrease.

But the price of gasoline kept increasing.

And now our demand for gasoline is much lower than it was a year ago? I would think demand is inelastic over the short-term.

 

[evkl]

So, that would explain why gasoline prices increased from around $3.10 per gallon at the beginning of 2008 (here in California) to over $4.50 per gallon by June? Our demand for gas increased that much? A 1% increase in demand could increase prices by 10% or more?

Seems to me gasoline demand would have decreased as the price increased. We didn't exactly get generous pay raises at year's end and our expenses didn't decrease.

But the price of gasoline kept increasing.

And now our demand for gasoline is much lower than it was a year ago? I would think demand is inelastic over the short-term.

The real inelasticity is in supply, not demand...you can only produce so much at a time to meet demand, and you can only take out so much of the supply chain. So a slight increase in demand during a construction boom with basically the same supply jacks prices WAY up; similarly, basically any excess supply causes the price to crash. Without an equilibrium the price of gas is a mess.

 

[The Big Al]

Also, most of the insanely high prices we saw this summer were a result of hedge funds going insane. They kept betting on oil going higher and higher which drove up the price. Oil was incredibly overinflated which tends to lead to a monumental crash when the price turns the corner.

 

[evkl]

I would argue that speculation had very little to do with the recent bubble...there was a rational expectation in the spring that relations with Iran could go ice cold, China's growth might continue at a double-digit clip, and that we might be near peak oil. Just because these expectations turned out to be wrong doesn't mean they weren't rational at the time. You had the prospect of both a supply decrease and a demand increase--leading to a prospective increase in price.