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Why Are Gas Prices So High?

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Why Are Gas Prices So High?

High gas prices are caused by high oil prices...and traders.

Photo: Getty Images
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The Straits of Hormuz control access to Middle East oil.

Photo: Getty Images
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Thank commodities traders for high gas prices.

Photo: Spencer Platt/Getty Images

High gas prices are caused by commodities traders. They bid up the price of gas contracts on the commodities futures markets. These commodities exchanges allow investors to buy contracts of gasoline for future delivery at an agreed-upon price. However, many traders have no intention of taking ownership of the gasoline. They plan to sell the contract for a profit, instead.

High prices of gasoline can also be caused by high crude oil prices. That's because oil costs account for 72% of the price of gasoline. The remaining 28% comes from distribution, refining and taxes, which are more stable. When oil prices rise, you can expect to see it at the gas pump six weeks later.

Like most of the things you buy, both gas and oil prices are affected by supply and demand. Since 2008, both gas and oil prices are affected more by the ups and downs in these futures contracts. The price depends on what investors think the price of gas or oil will be in the future. When traders think gas or oil prices will be high, they bid them up even higher. In this way, commodities traders create a self-fulfilling prophecy. This leads to an asset bubble. Unfortunately, the one who pays for this bubble is you!

You can expect prices to rise every spring. It seems to get earlier and earlier each year. That's because oil futures traders know demand for gas rises in the summer. They therefore start buying oil futures contracts in the spring in anticipation of that price rise.

Rising gas and oil prices are somewhat impacted over the long-term are by a decline in the value of the dollar. Since oil is denominated in dollars, a roughly 40% decline in the dollar in the last 10 years puts upward pressure on oil prices.

Why Are Prices Going Up Right Now?

The price at the pump is rising now because the price for domestic oil (West Texas Intermediate) rose to $101 a barrel. Traders bid up prices when militants took control of Mosul in Iraq. Although we don't get much oil from Iraq, the uncertainty was enough to force up prices.

Prices rose in April 2014 because new pipelines from the Cushing, Oklahoma storage hub lowered inventories to the lowest level since November 2009. In addition, the price of imported oil (North Sea Brent) rose to $110 per barrel thanks to political unrest in Ukraine and Nigeria. The Energy Information Administration expects average national prices to remain at $3.60 a gallon until May. For more, see Will Oil Prices Drive Up Gas Prices?

When Else Have Prices Been High?

In early 2013, Iran started war games near the Straits of Hormuz. Nearly 20% of the world's oil flows through this narrow checkpoint bordering Iran and Oman. If Iran threatens to close the Straits, it raises the fear of a dramatic decline in oil supply. Oil traders bid up the price to $118.90/barrel by February 8 in anticipation of such a crisis. Gas prices soon followed, rising to $3.85 by February 25. They rose again in August 2013 because oil prices hit a 15-month high that summer. That spike was created by political unrest in Egypt.

In September 2012, prices rose to an average high of $4.50 a gallon in California. That was because of supply shortages from two causes. The first was a power outage at the Exxon refinery in Torrance CA, which itself was caused by a heat wave. The second was a shutdown of a major north-south oil pipeline. These came on top of East Coast refinery shutdowns due to regular seasonal maintenance. Although prices have dropped a bit in October, chances are they won't drop much further for the rest of 2012.(Source: DeBord Report, Why Are Gas Prices So High?)

In August, prices were high as a result of Hurricane Isaac, which hit the Gulf Coast region on August 28, 2012. In anticipation of the Category I hurricane, refineries in the area shut down production. As a result, crude oil production lost 1.3 million barrels per day. This caused the average national price of gas to jump $.05 in one day, to $3.80 on Wednesday. Prices in Ohio, Indiana and Illinois rose even further, as the storm closed a pipeline that feeds the Midwest. (Source: EIA, Hurricane Isaac Affects U.S. Gulf Coast Energy Infrastructure, August 29, 2012; ABC News, Isaac Brings Higher Gas Prices, August 30, 2012)

In February 2012, concerns about a potential military action, by either Israel or even the U.S., against Iran caused high oil prices. Second, some oil refineries in the U.S. were closing, according to an EIA report. Third, oil and gas prices tend to rise every spring, in anticipation of increased demand during the summer driving vacation season.

As a result, the prices for a gallon of gasoline hit the benchmark $3.50 by February 15, two weeks earlier than in 2011. By mid-March, the national average had jumped to $3.87 a gallon. That's because the price of oil reached its benchmark of $100 a barrel two weeks earlier, as well. Oil went on to hit $109.77 by the end of February, before dropping slightly to $107.40 in mid-March. (Source: EIA)

In April 2011, fears about unrest in Libya and Egypt sent oil prices up to $113 a barrel. In May 2011, as oil prices dropped, the price at the pump stayed high. Why? Commodities traders were concerned about refinery closures due to the Mississippi River floods.

In the summer of 2008, gas prices rose to $4.17 a gallon as oil prices skyrocketed to $143.68 a barrel, even though demand and supply were fairly constant. During the 2008 financial crisis, commodities traders drove up the price of oil, even though supply increased and demand fell. The EIA cited an increased flow of investment money into commodities markets. In other words, money that used to be invested in real estate or the global stock market was instead being invested in oil futures. For more, see Gas Prices in 2008.

In summer of 2009, the price at the pump again rose, despite the recession, which decreased demand. Commodities traders were the reason for both. Prices also usually rise during the summer vacation season, as driving increases. Finally, gas and oil prices also increase whenever there is concern about surging demand from China and India, or a curtailment of oil supply. (Source: EIA Short-Term Energy Outlook)

What Makes High Prices Go Down?

The summertime vacation driving season usually increases gas prices by an average of ten cents per gallon. This price increase is despite the increased use of ethanol. Prices usually go down in the winter, since transportation needs are lower. This even offsets an increase in oil usage for winter heating in the northeastern United States.

What Can We Do About It?

The most immediate thing we can do is reduce our usage of gas, either through driving less or increasing fuel efficiency. Surprisingly, the best way to increase fuel efficiency is to keep tires inflated. These, and other suggestions, are included in the "Related Reading" section of this article.

Longer term, we can change our need for oil and gas by switching to alternative fuel vehicles, using public transit and moving closer to work to reduce commuting time. This will reduce the impact on each of us individually by reducing use.

Could this reduction in itself reduce the high price of gas? It could, if it could reduce demand for oil enough to lower oil prices. It would have to happen on a sustained basis over a long period of time. That's because gasoline accounts for only 20% of each barrel of oil. Oil companies would still profit from the non-gasoline parts of their business. Therefore, even if consumers could conceivably stop 100% of gasoline use, oil prices might only decline 20%.

Would a Gas Boycott Work?

Could a gasoline boycott halt rising prices, even if oil prices stayed high? Probably not by much. That's because the other elements that go into the price of gas would take a long time to change. Taxes, which comprise 13% of gas prices, would require legislative approval, which could take months. Refinery costs (8%) couldn't be lowered, and neither could distribution costs (7%), both of which are fixed.

A boycott of one brand of gas could actually increase prices, since there would be fewer gas outlets. Those companies that were boycotted would simply sell their gas to those that weren't boycotted, defeating the purpose.

A boycott of all gas companies would lower prices if it impacted the oil business. Only 20% of oil is used for gas. Perhaps the oil companies could get by with a 20% loss for a while. They might just raise prices on jet fuel, heating oil and other industrial uses. In addition, other pressures on the price of oil, such as dollar decline and commodities traders, would not be impacted by a gasoline boycott. (Source: EIA, Factors Affecting Gas Prices)

The only real way to lower gas prices is to lower demand for gas and oil over a long period of time. This would work, since the U.S. consumes 25% of the world's oil. This has increased over the last 20 years, from 15 million barrels per day (bpd) to 20.7 million bpd. A concerted effort might convince commodities traders that oil was a bad investment, thus allowing oil prices to return to pre-bubble levels. Article updated July 23, 2014

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