The Powerful Case For $1 Gas

January 6, 2009 by Douglas A. McIntyre

Blue_hills_2In July, the average price of gas in the US was $4.11. According to the carefully followed Lundberg Survey, the number was about $1.66 on Dec. 19.  In some regions petrol dropped as low as $1.37.

The widely held impression that gas is tied to the price of oil is not entirely true. The cost of refining and shipping gas varies from region to region. Some refiners make more money on diesel fuel and devote more of their capacity to that and  to oil by-products used by industry and heating. In these areas, supply of gasoline suffers.

It is fair to say that the prices of gas and oil do come relatively close to tracking one another. Oil at $130 does not yield gas prices at $1.75. The cost of a gallon of gas is 40% of what it was this summer. Oil is down much more, trading at about 30% of its mid-year peak.

Oil has been moving up over the last week because of the trouble in Gaza. Some analysts think that the military conflict there coupled with trouble in Nigeria and more tightening by OPEC could take crude back toward $70.

The case that oil is going to $20 is nearly as compelling.

It has been clear for two or three weeks that the recession will be much worse than many people wanted to believe and that it will span the globe. Fast-growing economies such as those in China and India are not being spared as their economies contract.. Factory output in the world’s most populous country is down and exports are falling. China could enter a recession and have negative quarterly growth in the first or second quarter of this year. Data out of Russia and India show that those big emerging economies are no better off than the EU or US.

It would be a mistake to underestimate how much the demand for crude could fall, and fall quickly, if the need for fuel drops sharply in Europe, Asia, and America simultaneously. If the plunge in demand is spread across most industries and the use of gasoline, diesel, fuel oil and industrial by-products all collapse at the same time, OPEC many find it hard to chop supply fast enough. Since OPEC only represents 40% of the world’s oil production, there is no guarantee that it can completely control pricing.

Recent data from Gallup indicates that people are not driving much more with gas at $1.70 than they were when it was at $4. Most families with a car or two have already realized that the economy is getting much worse. People are worried about jobs. Work and paying the mortgage trump going for a drive unless they are driving to work. Car pooling is increasing even though the American love of independence on the road alone in a car has been part of our national character since Henry Ford gave us this tool.

If problems in the Middle East are resolved fairly peacefully and other regions which produce oil can avoid significant turmoil, oil should dive back toward $30.

Oil prices are up 25% over the last two weeks. This rise in oil prices has encouraged some analysts to forecast that gas prices could go up 20 or 30 cents in the near future..

The case for lower gas prices is a simple case. The recession could move unemployment in the US to 11% or more. It could cut corporate earnings for several quarters. Air traffic could drop and with it jet fuel demand. Many companies could cut back on trucking.

Gas will move to $1 because things will get so bad that it can’t stay higher, for better or for worse.

Douglas A. McIntyre