Why Are Gas Prices So High?

Like most of the things you buy, oil prices are affected by supply and demand. However, oil prices are primarily controlled by oil futures contracts, which are traded on the commodities futures exchanges. The price depends on what investors think the price of oil will be in the future. When traders think oil will be high, they bid it up even higher. In this way, commodities traders create a self-fulfilling prophecy by bidding up oil futures prices. This leads to an asset bubble. Unfortunately, the one who pays for this bubble is you!

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

In the winter of 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.

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, gas prices hit the benchmark $3.50 a gallon 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, gas prices 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 a gallon as oil prices skyrocketed to $145 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. (Source: EIA Short-Term Energy Outlook) In summer of 2009, gas prices again rose, despite the recession, which decreased demand. Commodities traders were the reason for both. Gas 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.

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 of gas prices on each of us individually by reducing use.

Could this reduction in itself reduce gas prices? 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%.

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.

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 March 11, 2013