Gas prices depend upon oil prices. That's because oil costs comprise 72% of the price of gas, with the remaining 28% coming from taxes and distribution costs. Oil prices, in turn, are set by the free market by commodities traders. They bid on oil futures contracts every day. Usually they bid prices up when they think there is going to be more demand, like during the summer vacation driving season. They bid them down when there is less demand during the winter. For more, see How Crude Oil Prices Affect Gas Prices.
However, this open bidding system is also based on the expectations of the traders. They bid prices up or down even if they only think supply or demand will change. This creates wild swings in the price of oil and gasoline, sometimes leading to an asset bubble. They are chasing profits, regardless of actual supply and demand. This is exactly what happened in 2008.
The financial crisis created the extremely uncertain environment in every other asset class that made traders bid oil prices up to record levels. It began in 2006, when housing prices began falling. This destroyed the value of mortgage-backed securities (MBS), which derived their value from underlying mortgages. When home prices fell, financial analysts couldn't determine what the MBS were really worth. The banks, hedge funds and pension funds that held these derivatives tried to sell them, or cover up the fact they held them.
By 2007, banks were even unwilling to lend to each other overnight. They were afraid they'd get now-worthless MBS as collateral. Banks that had bought too many MBS were in danger of running out of cash because they couldn't get loans. In March 2008, the Federal Reserve brokered a deal to keep Bear Stearns from collapse.
At first, the bailout reassured investors, who thought the worst was over. But in April, it turned out that investment bank Lehman Brothers had even more MBS than Bear Stearns. By the middle of April, some traders began turning away from risky financial stocks and toward oil futures, boosting oil prices. As the financial industry and stock market started looking worse as a place to invest, the rising prices in oil futures made it look more attractive. This drove prices up throughout the spring, until July. That's when Fannie Mae and Freddie Mac were bailed out by the Federal government, signalling unprecedented damage in the housing and derivatives industries. That's when investors started getting out of their positions in oil futures.
In September, investment bank Lehman Brothers went bankrupt, sending stock prices around the world plunging. Widespread panic created a run on the ultra-safe money market funds, as companies stampeded into cash. It wasn't until October that Congress passed a $700 billion bailout for financial firms to prevent more bankruptcies. However, it was already too late, as businesses started laying off workers. By the end of the year, oil prices had plummeted to $43.70, sending gas prices down to $1.87 a gallon. For more, see Financial Crisis of 2008.
Resources for Table
- EIA, Weekly Gas Prices, All Blends
- EIA, Demand for Gasoline
- EIA, Gasoline Inventory
- EIA, Weekly Prices for Brent Crude Oil
- EIA, Demand for Oil
- EIA, Weekly Stocks of Crude Oil
- Google Finance, Dow Index Daily Closing
- History of Dow Closing Average
- Recession History
- History of Gold Standard
- LIBOR Rate History
- About.com Guide to the 20th Century
- BLS, Historical Inflation Rate
- 2008 GDP Statistics
- Financial Crisis Timeline
- Stock Market Crash of 2008
2008 Gas Prices Timeline
|Week in 2008||Gas Price||Oil Price||Dow Close||Event|
|January 7||$3.16||$96.50||12,827.49||Economy lost jobs for the first time since 2003. GM announced $38 billion loss.|
|February 4||$3.03||$91.77||12,635.16||Fed lent $300 billion to banks with bad debt.|
|March 3||$3.21||$101.90||12,258.90||Bear Stearns bailout. Fannie and Freddie absorbed $300 billion in toxic debt.|
|April 7||$3.38||$100.88||12,612.43||Hedge fund manager David Einhorn shorted Lehman. BEA revises Q4 2007 GDP estimate, reporting economy actually contracted .3%. Some investors shifted from stocks to commodities, boosting oil prices.|
|April 14||$3.44||$106.60||12,302.06||Stock market drops over uncertainty.|
|April 21||$3.56||$110.42||12,825.02||Stocks rise as most investors regain confidence.|
|April 28||$3.65||$114.34||12,871.75||Fed cut rate to 2%, LIBOR rose to 2.85%, indicating bankers' unwillingness to lend to each other. BEA announced Q1 GDP at .6%, calming fears of recession.|
|May 5||$3.66||$111.98||12,969.54||Fannie Mae announced $2.2 billion loss.|
|May 19||$3.84||$122.58||13,028.68||Einhorn questioned Lehman's accounting, sending its stock price down 20%.|
|May 26||$3.99||$126.47||12,548.35||More investors shifted from stocks to oil futures, creating an asset bubble.|
|June 2||$4.03||$128.76||12,503.82||Worst jobs report in 5 years send investors out of stocks.|
|July 7||$4.17||$141.07||11,231.96||Fannie and Freddie stocks prices fell 16-18% on July 7. Oil hit record $143.68/barrel on July 11.|
|July 14||$4.16||$137.43||11,055.54||Fannie's stock fell another 22%, Lehman's dropped 31%.|
|July 28||$4.01||$126.70||11,131.08||Fannie and Freddie bailout passed. Investors start shifting out of both stocks and commodities to ultra-safe Treasuries.|
|September 1||$3.73||$103.69||11,516.92||Lehman goes bankrupt Sep 15. Fannie and Freddie nationalized Sep 17. Run on money market Sep 18. Fed takes over AIG. Paulson asks Congress for $700 billion bank bailout on Sep 21. WaMu goes bankrupt on Sep 26. Hurricanes Gustav and Ike shut down refineries, but oil prices keep falling. Dow drops 777 points on September 30 after Senate rejects bailout bill.|
|October 6||$3.54||$91.90||9,955.50||Congress passes bailout on October 6 as Dow dropped 800 points. Dow closed below 10,000 for the first time since 2006. On October 8, Fed cut rate to 1.5% but LIBOR rose to 4.52%, indicating absolute panic among bankers. On October 29, Fed cuts rate again to 1%, and LIBOR finally responds by falling to 3.46%. Economy lost 150,000 jobs.|
|November 3||$2.46||$59.43||9,625.28||Investors pull out of commodities, sending oil prices down. Citigroup bailed out. Economy lost 533,000 jobs.|
|December 1||$1.87||$43.70||8,149.09||OPEC removes 2.2 million barrels from daily production. Fed cuts rate to zero. LIBOR falls to 2.19%. Big 3 auto bailout.|