What's the deal with gas prices?

The Cost Of Energy

Your Money

August 21, 2005|By Kevin G. Hall | Kevin G. Hall,KNIGHT RIDDER/TRIBUNE

Why are gasoline prices so high? Why have they shot up so fast? Why don't they fall back just as quickly when the price of oil dips in global markets? Here are some answers.

Q. Why are gas prices so high?

A. Global demand for oil has grown quickly in recent years, driven up especially by China's and India's fast-growing economies, although the United States remains by far the biggest oil consumer. Global demand for oil is now about 84 million barrels a day. That almost equals the entire supply available; global oil-production capacity exceeds demand by only about 1.5 million to 2 million barrels per day.

In such circumstances, anyone who needs oil soon must pay what the market asks, since there aren't many sellers with excess oil available to seek bargains from. In addition, with the supply-demand balance so tight, markets fear that a single terrorist act, a natural disaster such as a hurricane or earthquake, or even an accident at a major refinery could result in shortages. So buyers are willing to pay higher prices today to ensure that they'll get what they need tomorrow if supplies are short.

Q. Why did oil prices rise so fast?

A. The price of crude oil jumped sharply in recent weeks in part because of heightened fears of shortages. Oil traders are particularly nervous about forecasts of a busier-than-usual hurricane season. Hurricanes disrupt deliveries by oil tankers and can halt production at offshore rigs in the Gulf of Mexico. They also threaten refineries on the United States' Gulf Coast. Other factors included temporary shutdowns at some U.S. refineries and Washington's warnings of possible terrorist attacks in Saudi Arabia, the world's biggest oil producer.

Q. Oil contracts typically are for delivery a month out, so why did gas prices jump along with oil prices instead of a month later?

A. Gasoline retailers say wholesalers are raising costs to service stations almost immediately as oil prices rise. Dealers then pass on that cost to customers as soon as the stations take delivery from tanker trucks.

Q. Prices in my neighborhood are higher than just a few blocks away. Is this price gouging?

A. No. In a free market, gas stations can charge what the market will bear. Today, gas prices are set through "zone pricing." Wholesalers of gasoline have complex software programs that gauge the income and population density of neighborhoods. They set higher prices for retailers in areas with higher income and population. Essentially, they're charging the most where they can get the most, just as many restaurant chains, shoe stores and grocery stores do. It's just more visible with gasoline.

Q. After rising to more than $67 per barrel, oil prices fell to $65.35 by Friday and were even lower in midweek. Why didn't gas prices drop too?

A. Rockets and feathers. It's an industry expression to say prices rocket up but drop as slowly as a feather. Economists have documented this. One dealer said privately that it was simply profit-taking on the way down to make up for losses when consumers bought less gasoline because of higher prices.

Q. Aren't oil cartels to blame for the high prices?

A. Today's high prices are driven by demand, not supplier-imposed shortages as in the 1970s and 1980s. The Organization of Petroleum Exporting Countries says that its members are pumping oil at almost full throttle and that developed nations should build more refineries. Refineries are working at near capacity and can't keep pace.

Q. So refiners are to blame?

A. Critics allege that refiners avoided adding capacity in order to create a tight market that gives them greater profits. The industry says environmental regulations and local opposition from homeowners make it impossible to site new refineries. Financial experts say low return on investment is the real reason that refineries, which cost billions of dollars, haven't been built for years in the United States.

Q. Is this the peak?

A. Oil analysts have said prices may well exceed $70 a barrel, and a shock event could drive them over $100 a barrel. Gasoline prices would rise proportionately.

Q. Is relief in sight?

A. Historically, gas prices tend to dip after Labor Day, when the peak summer-driving season ends. But as refiners shift their mix to produce home heating oil, they'll produce less gasoline, which could keep supplies tight and prices high.

Q. Will prices ever fall significantly?

A. Experts are divided. Oil historian Daniel Yergin thinks global production capacity will expand by 2010 to yield another 16 million barrels of oil per day. He suggests there could even be an oil glut that causes a collapse in prices.

Matthew Simmons, an investment banker who specializes in oil, wrote a controversial new book, Twilight in the Desert, suggesting that Saudi production has peaked and soon will shrink, putting a big dent in world production. To Simmons, $3 a gallon sounds cheap compared with what's coming.

Q. Are financial speculators getting rich at the expense of motorists?

A. Speculation clearly plays a part. Oil is sold in contracts for delivery of 500 or 1,000 barrels, so most investors are larger players. Only about 5 percent of oil contracts trading on the New York Mercantile Exchange are delivered as oil; the rest are contingency bets, mostly canceled, so there's a lot of paper trading hands.

If you have a company-sponsored retirement plan or invest in a mutual fund, chances are your portfolio is doing well thanks to commodity index funds, energy stock indexes and hedge funds that are active in the oil futures market.

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