To anyone who drives a lot, today’s national average gasoline price of $3.38 a gallon may not sound particularly cheap. But it’s 13% less than what regular gas cost in early April. This sharp three-month drop in the price of gas is even more remarkable when you consider that gasoline prices typically stay high through the summer after they run up in the spring. But this year, they peaked in early April and have been falling every since. Why has that happened, where do gas prices go from here, and what does the trend signal about the state of the economy?
To answer those questions, it helps to consider the normal seasonal fluctuations for gasoline prices. Two main factors create the basic pattern. First is the economy. Demand for specific types of goods varies at different times during the year. Retailers typically enjoy booming sales between Thanksgiving and Christmas, for example, and then mark down items after January 15, when business slows. For gasoline, demand usually increases when the weather improves in April or May, and that continues through the summer. “Good weather and vacations cause US summer gasoline demand to average about 5% higher than during the rest of the year. If crude oil prices remain unchanged, gasoline prices would typically increase by 10-to-15 cents from January to summer,” according to one industry source.
The other important influence on summer prices is the change in the fuel mix. You might think that gasoline is made up of just one thing – namely gasoline – but actually there are small amounts of all sorts of other petroleum products and additives mixed in. Without getting into excessive technical details, refineries basically have to change the fuel mix as winter gives way to summer. When fuel is relatively cool in winter, there’s isn’t a lot of evaporation and there’s less need to be picky about the makeup of gasoline. But for the summer heat, refineries have to be more careful about the fuel mix to hold down evaporation and limit air pollution and smog. Since summer is more prone to air-quality problems anyway, gasoline is also altered to burn cleaner during the vacation months when cars are packed together bumper-to-bumper on the freeways.
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As a result, gasoline for summer requires some gourmet ingredients and is slightly more expensive. In addition, the fact that refineries have to shut down briefly in the spring for alteration of the fuel mix and general cleaning and maintenance creates a temporary reduction in inventories. That brief spring disruption in supply is the reason gas prices are typically highest before Memorial Day rather than during the summer school vacation when lots of families are on the road.
So why have gasoline prices behaved differently this year, dropping just as the summer vacation season gets under way? It’s the economy, of course. GDP grew at a 3% annual rate after inflation in the fourth quarter of last year and continued relatively strong early this year because of mild winter weather. In fact, although employment normally dips after the holiday selling season, it continued stronger than usual this year. Seasonally adjusted job creation actually rose from 223,000 in December to more than 250,000 in both January and February.
As the winter ended, however, GDP growth turned listless at best. Despite a strong first month or so, the first quarter overall managed growth of only 1.9% at an annual rate, and since then job creation has fallen off a cliff, averaging only 75,000 per month in the second quarter. Given that the economy needs 125,000 new jobs every month to keep up with population growth, the current situation amounts to stagnation.
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Since the oil market is global, weakness in the U.S. theoretically could be offset by growth elsewhere. But other major oil consumers worldwide are suffering their own economic problems. Last Thursday, in fact, the European Central Bank and the People’s Bank of China cut interest rates, while the Bank of England pumped money into the banking system, all in an attempt to bolster their economies. Trouble is, up to now similar stimulative policies haven’t done much good. And all the indications are that global economies continue to slow and that some have dipped into recession, at least briefly.
There is one big wild card in the oil market, however: Iran. Economic sanctions on Iran have made it harder for the Islamic Republic to sell its oil, and industry experts calculate that more than 40 million barrels are in storage, most of it on some 65 tankers in the Persian Gulf. Indeed, it is a sign of just how weak the global economy is that the price of oil has fallen even with so much crude being held off the market. In the event of military conflict to prevent Iran from continuing to develop nuclear weapons, the price of oil could spike upward. And if oil fields are damaged in the fighting, taking large numbers of wells out of production for a year or more, oil prices could soar and remain elevated for some time.
By contrast, even a partial resolution of the conflict that allows Iran to start selling its oil again would flood the market and push prices down even more. Some experts see a further decline of at least 10%. So pray for peace – you might get $3 gas in the bargain.