The price of gasoline is one of the most important variables in daily American life. The vast majority of Americans own cars—there are some 240 million of them on the road—and rely on them to commute to work and for general transportation. Whenever gas prices get too high, it can cause an economic shock for hundreds of millions of people. So whenever those prices show signs of heading towards the $4 a gallon mark, a mild panic ensues. Typically, it arises from the genuine concern of ordinary citizens, and then is promptly fanned into something resembling hysteria by opportunistic politicians and pundits.
Exhibit A: Drill, baby, drill.
Republicans take advantage of the gas anxiety to claim that a lack of domestic drilling and too-tough regulations that are causing prices to spike. Specifically, they allege that Obama’s tree-hugging energy policies are preventing oil companies from opening reserves and providing the markets with cheap, American-made oil. This is nonsense, but it plays well with voters. In reality, oil is traded as a commodity on the global marketplace, and its price is prone to wax and wane according to various market forces. In fact, domestic drilling policy is one of the least important factors in today’s price of oil. So let’s take a quick look at what actually determines how much you’re paying at the pump.
Global supply and demand
This is the biggie. Gasoline prices are tied to oil prices, and oil consumption is booming, especially in places like China, India, and Brazil. It’s not relenting in the U.S., either. But supply remains relatively fixed—new oil discoveries are fewer and far between in modern times, and that which we do find is often harder and more expensive to get. As the commodity grows scarcer on a global level, prices rise. That’s why many experts now believe that the era of cheap oil is over—and that we can expect it to continue to rise in the longterm. As for the short term, Reuters offers a look at how global demand can mess with prices;
Japan, for example, is replacing some of its nuclear energy with oil. Its oil imports appear to be running about twice pre-tsunami levels. In addition, there has been some pick-up in demand from Asia. Note that the IEA forecasts oil consumption to rise 830k this year after a 740k bpd increase last year. The unusually cold European winter is also thought to be boosting demand.
Instability in oil-producing regions
As you’re likely aware, much of the world’s oil comes from nations in more volatile parts of the world. And when the market perceives a risk that political instability, diplomatic tensions, or regional violence might cut off the flow of oil, it reacts. That’s why we saw prices spike after tensions escalated with Iran. Marc Chandler at Brown Brothers Harriman told Reuters that the “Iranian confrontation and its response (to cut sales to the UK and France) has also taken supply out of the market. The bellicose rhetoric and fear of an escalation raises the risk premium as well.”
Additionally, civil wars or political uprisings can have similar effects. “Between Sudan, Yemen and Syria, nearly 750k barrels per day (bpd) have been taken out of production due to political instability,” Chandler said. “On top of this Libyan oil output is about 600k bpd below pre-civil war levels.”
Since political volatility racks many of the world’s largest oil exporters—Nigeria, Venezuela, Libya, Iran, Iraq, Sudan, etc—it plays a very real factor in influencing both global supply and the risk premium of the oil coming out of the region. Bankers who trade in oil futures will make bets that such volatility will increase the cost of oil, and they can raise the cost of the commodity as a result. Which brings us to the next three major factors—head over to part two: