Gas Prices In America Round 2
OK, so recently, someone contacted me about an article I wrote a couple years ago called Gas Prices in America, which outlined some information about why gas prices are so high. I follow up today with this article to bring some of the thoughts I had up to date.
Many people in America, especially on the political left, will lash out at corporations when gas prices are high. People will use terms like price gouging and make corporations out to be evil profit mongers. In reality, there are 4 major factors that effect the price of gas. Let’s take a look at what major influences there are.
First, let’s look at where the money goes when you buy a gallon of gasoline.
Image from the Energy Information Administration
As you can see, crude oil makes up a majority of the cost of gasoline. Therefore, we have to assume that the price of crude in the market will directly effect Gas prices… or do we? And what is causing crude oil prices to hit record highs? The reality is that the US has about 26 days worth of crude oil supply in storage. So, any short term spikes in prices should be weathered. So, current oil prices have only a muted effect on the current price of gasoline. Granted, extended periods of high oil prices will raise gas prices. So what causes oil prices to go up?
There are a number of factors that can change the price of oil. Much of the world’s oil supply is controlled by OPEC, which regulates the distribution of oil from it’s member countries. However, wars and natural disasters can adversely effect the price of oil as well. Demand for oil is increasing globally, as countries like China and India are beginning to grow economically and demand more resources. Also, another trend we can see is the value of the dollar.
As a highly traded and hot commodity, oil is one of the first products to be effected when the valueof the dollar falls. We often gauge the strength of the dollar against the price of gold, as gold has a relatively consistent value. Below, I have charted the monthly change in average price for oil and gold. As you can see, the trends are remarkably similar.
Oil Vs. Gold % Change – Past 36 Months
In fact, there is not enough evidence to suggest they are statistically different. There are points where the prices fluctuate more then others based on their individual markets, but generally, the graphs are remarkably similar. Oil fluctuates a bit more, but it is a higher volume commodity.
Another major factor in the price of gasoline is the supply of gasoline. This has a huge effect on the price because right now, we are running near a shortage of gasoline. In basic economics, when quantity demanded goes up but supply is fixed, price will go up. This is exactly what is happening. There have been no new refineries built in the last 30 years because of environmental regulations and the NIMBY (Not In My Back Yard) factor. There have been refinery expansion projects, but demand for fuel is increasing faster then the rate of production. Refineries are running at near 100% capacity. This means that when there are any problems with a particular plant or group of plants (as during hurricane Katrina) we will see the effect of that in the price of gasoline. Below is a chart from the Gasoline Price Changes report from the Federal Trade Commision. It shows real price of gasoline against the consumption of gasoline.
As you can see from this chart, we have had an ever-increasing demand for Gasoline. For now, supply is able to keep up with demand, but when we start to exceed the available supply, we are going to see some serious rises in gas prices.
So here we have our four factors that effect gas prices: The price of crude oil, the value of the dollar, the supply of gasoline, and the demand for gasoline. While you could claim that there are evil corporations at work, I have a simple argument against that. If there were companies that could offer a lower gas price, wouldn’t they do that and take all the business from their competitors? Of course they would. A small decrease in unit profit can increase total profit when you increase your volume at the same time. Of course, if you think that it would be possible to provide cheaper gasoline, then you can start your own oil company as I suggested in my previous article. But even if you don’t, then the great thing about America is that we have the freedom of to start businesses. Even if you don’t start a new oil company, someone will find a solution that will make gasoline for less, or create an entirely new form of fuel and transportation that is cheaper. People who are tired of paying too much for gas will switch to public transportation or bicycles. There are endless possibilities that don’t require government intervention or regulation that so many people call for (and arguably add to the problem with environmental regulations). Gas prices will not rise above what Americans are willing to pay; when Americans are tired of paying high prices for gasoline, we will see a shift towards alternatives or a push to assist companies in making cheaper gas by removing some of the barriers for entry and expansion. When that happens, we’ll see some relief from these prices.
Posted: March 6th, 2008 under Economy.