|Source: Aaron Lawrence|
Gas prices are on the rise again advancing almost 20 cents a gallon from a month ago. Some states are well above $4.00 a gallon including California, Illinois, New York, Maine, Oregon, Washington and Alaska according to AAA. But what does this mean for the struggling economic recovery, and how did prices get so high in the first place? While top economists argue over the complex issues, basic intuition can explain a lot.
“It’s the economy, stupid” – A quick look at the supply and demand of gasoline shows the reason for the recent run up in prices.
Increases in demand including the economic recovery, and rising incomes around the world have increased pressures on crude oil and gas suppliers. Real GDP, business profits, and dividend payouts have all increased in 2012 compared to last year’s numbers (bea.gov). This means that firms and households have more disposable income (even though it may not feel that way) to spend on all goods including gas. Even though China’s growth has slowed, easing pressure on worldwide gasoline demand, the US recovery has replaced their demand leading to the next point – supply.
The supply of gasoline depends on two things, refining capacity and crude oil inputs. The US is actually the world’s largest exporter of gas. This is good news, but the U.S. Energy Information administration reports that US refineries are currently refining 2.3% less than 6 months ago, and operating capacity has also declined by 2.2%. The recent embargo on Iran’s crude oil supply sends a negative shock to supply and will affect prices. Saudi Arabia is doing their best to keep supplies high on the crude oil front, but we face another issue when it comes to the refining process for gas.
High gas prices do not end at the pump either. Gas is an input in almost every production process because of energy costs (gas based power plants) or transportation. As costs rise, we can expect prices of products to rise as well. The situation gets worse when we consider that summer is rapidly approaching. Demand for gas tends to spike during the summer months as families plan vacations and take long road trips. While tapping into strategic oil reserves can give temporary relief—and higher poll numbers—this action does not solve the problem because reserves must be bought back again in the future, possibly at a higher price.
There is some comfort in to be had in higher gas prices – it creates an incentive to use less gas and motivates people develop alternative sources. Until this happens, however, we will be subject to the roller coaster ride of wild gas prices.