International macroeconomist on Rita's effect

McDaniel College's Dr. Kevin McIntyre answers selected readers' questions Q&A: Oil Prices

September 23, 2005

Lori, Baltimore: Do you think gas prices will spike and then rise after Rita passes through?

Dr. McIntyre: Gas prices have recently jumped based on where the futures market (a market where traders buy and sell oil contracts at a specified price in the future, hence the term) thinks oil prices will be over the next few months. The ultimate answer to your question depends on how much (if at all) Rita further disrupts oil production and refining in the Gulf of Mexico. The good news is that foreign suppliers such as Canada and the OPEC group have ramped up production since [Hurricane] Katrina hit.

Kim Asch, Georgia, Vt.: Give us your best prediction -- how high will prices go? And how high will they need to go before there is an authentic effort in this country to develop alternative fuels?

Dr. McIntyre: I'd say that the maximum oil price we could see over the next several months is in the neighborhood of $70 a barrel. This is a maximum, though; about $60 to $65 is what most experts are predicting.

Regarding your second question, some perspective might be helpful here: in inflation-adjusted terms, oil prices would need to get to about $90 to be where we were in the early 1980s, and would likely need to go significantly higher to see the same broad impact we saw during that period. Alternative fuel sources exist (solar, wind, fuel cells, etc.) but they are just not cost effective right now.

For these, or any new technology to be adopted on a large scale, a combination of persistently higher oil prices and cost improvements in alternate technologies needs to occur; if historical precedent is anything, this is a decades-long process. In the short term, and if gas prices remain where they are, I would expect to see lower sport-utility vehicle sales, more smaller cars being brought to market and more cardigan sweaters being worn at home.

Rich Lownes, Philadelphia: How can we have so many years of reasonable increases in oil prices, yet in the last year, prices have about doubled? I know we have had Katrina and other influences, but some other forces must be at work to make prices rise so fast. Thank you.

Dr. McIntyre: This is a good question. The big jump in oil prices seen over the past few years is primarily due to economic growth in the United States and China.

As we all know, China is a large and rapidly growing economy, and their oil needs are increasing accordingly. Add to that a consistently strong United States, and world oil demand has jumped dramatically of late. Factoring in real or perceived supply disruptions ranging from political instability in the Middle East to a bad Atlantic hurricane season just adds fuel to the fire (no pun intended).

Miss P, Baltimore: With the rising oil prices, how are persons who are low income or are on a fixed income and do not qualify for any type of assistance going to afford oil to heat their homes in the winter months?

Dr. McIntyre: These individuals will have to either reduce their consumption of heating oil or reduce expenses elsewhere; it's a bitter pill to swallow sometimes. Most utilities -- including Baltimore Gas and Electric Co. -- and fuel suppliers have pricing plans that allow consumers to more or less evenly distribute their fuel bills over the course of the year so as to somewhat guard against big jumps in heating bills in the winter months, which should help.

Mary Prise, Baltimore: I would like to know how foreign imports get priced in general. When traveling out of the United States, I have noticed some American products are priced higher than they are at home, but some products are not. Is imported oil priced in this same way, and how does the effect of the hurricane get factored in?

Dr. McIntyre: For commodities such as oil that are traded in large, global markets, international differences in prices are due primarily to differences in taxes; that's why a gallon of gas costs two to three times more in Europe than it does in the United States.

Other explanations for cross-country price differences include transportation costs (which are reflected in import prices), trade restrictions of various sorts (Canadian lumber and British beef immediately come to mind here), and differences in demand in each country (the French, for example, have a much higher demand for Brie than Americans).

John Boyle, Baltimore: Why is it that gas prices never return to the level they were at before incidents happen in the economy? Every year, they seem to advance 50 or 60 cents.

Dr. McIntyre: Actually, petroleum has been remarkably resistant to inflation over the past 20 years; there had been no inflationary trend in oil prices since the mid-1980s until the past few years. Generally speaking, commodity prices are very volatile, and it is my impression (and I may be wrong) that the public seems to remember big jumps in gas prices a lot better than it does price decreases.

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