The sign out front reads $2.899 for a gallon of gasoline. Prices haven’t been this low for at least four years. What happened? Will the price stay this low?
The short answer is that a lot of things happened, some of them mysterious. And it can’t remain this low forever, but perhaps for a few months. It’s all about the market for oil and perhaps some pernicious politics that, as always, make oil prices a geopolitical game.
The price of oil is fixed largely by what it costs to get it out of the ground. It doesn’t just bubble out of the ground for free, after all. The daze of oil that cheap are long gone, given our appetite for it over the last century. It has to be extracted.
The price for a gallon of gasoline here in St Paul is about the price of West Texas Intermediate (WTI) crude oil in dollars per barrel ($/bbl), divided by 42 bbl/gal, plus about one dollar per gallon for taxes (45 cents total), refining, transportation, and retail mark-up. That gets you the price give or take 10 cents, allowing for neighborhood and brand.
The issue at hand is the price of the benchmark WTI, a middle grade of oil that serves as a standard for prices around the world. Here is the price of WTI since 2010:
Note that after 2011 the price has always bounced off of $80/bbl up to around $110/bbl, a pump price of $3.60 per gallon here. There’s a reason for that.
As noted before, the United States has moved towards energy independence by producing most of the oil we consume right here in North America in the last four years. The cost of getting the oil out of the ground is generally about $80/bbl for most of the wells operating, if not higher. That includes shale oil that is fracked, or broken apart, using a tremendous amount of water to pull the oil out of the ground. Once WTI hits $80/bbl, they shut off – reducing production and supply, thus raising the price.
So by all logic the price of WTI can’t fall below $80/bbl. However, it did – now running $78/bbl or so. The wells don’t just shut off overnight, so there is generally some over-shoot as the supply turns off and stocks run low. And once off, they don’t turn on overnight, either. The chart shows us that it takes about five months for the price to hit a high point before turning down, or that about next April we can expect $3.30-3.60 per gallon here.
Then again, something is up in Saudi Arabia. Normally, they respond to low prices by voluntarily throttling back their own production, estimated to cost considerably less (generally, about $40/bbl). They haven’t this time. Exactly why remains a mystery, but there is some interesting politics involved in this. Low prices put pressure on both Iran and Russia, Syria’s two remaining friends in the world. It may be that Saudi Arabia is going to hold the price low to flush out Bashar al Assad, Putin, and the Mullahs that run Iran at a very sensitive time.
Yes, the story is that unrest in the Middle East may have lowered oil prices. Isn’t world politics fun these daze?
Then again, the Saudis might want to punish US producers and make them a bit more shy about fracking the bejaysus out of Oklahoma, as they have been doing. No one really knows the Saudis’ motives, so we can all speculate any way we want.
This naturally brings out the conspiracy theorists, who see Saudi Arabia as doing the bidding of the US. It is true that low prices help the US (help the economy, put pressure on our enemies at a sensitive time for both) but they do hurt the profits of US oil companies. To call this a conspiracy, you’d have to say that somehow the Obama administration put pressure on the Saudis against the wishes of US oil. That would be interesting.
It seems more likely that the Saudis are operating on their own for their own interests, meaning that we don’t know when that part of the operation will end. That could mean that prices stay low longer than anticipated this time.
It’s also worth noting that the dramatic improvement in the US balance of trade will at least partially reverse, putting downward pressure on the US Dollar at a time when interest rates are likely to rise (we can estimate that the Fed Funds Rate should be as high as 2.25% now) putting upward pressure on the greenback. More imports sends more US Dollars out to the world and makes them cheaper, thus helping the US maintain its competitive position in manufacturing and generally maintains the global Dollar Standard, which has been under some strain lately.
In any case, the pleasure you take at the pump comes partly at the expense of a great deal of pain in Russia right now. Prices are unlikely to fall much more, and they shouldn’t stay this low forever. But if there is a complicated chess match being played, it may take a long time for the next move given that the oil game is always headlined by Grand Masters.
The best bet is that this is temporary, and gasoline will be up 15-25% by next Spring. But for a better estimate, watch the Saudis.