Falling Oil Prices will lower Gas Prices, if the Fed stops Printing Money

Posted by PITHOCRATES - May 9th, 2011

Falling Oil Prices and you at the Gas Pump

Here’s something you don’t see every day.  Oil prices have fallen (see Special report: What really triggered oil’s greatest rout by Matthew Goldstein, Svea Herbst, Jennifer Ablan, Emma Farge, David Sheppard, Claire Milhench, Zaida Espana, Robert Campbell and Josh Schneyer posted 5/9/2011 on Reuters).

Never before had crude oil plummeted so deeply during the course of a day. At one point, prices were off by nearly $13 a barrel, dipping below $110 a barrel for the first time since March.

Apparently the speculators aren’t all that eager to buy and hold oil right now.  Something must have spooked them.  Because it’s May and the summer driving season is about to ramp up.  People driving around to enjoy their summers.  Some 3-day holiday weekends.  And a vacation or too.  Demand for oil should be up.  Not down.  So what happened?

A routine report on U.S. weekly claims for unemployment benefits spooked investors, showing the labor market in worse shape than expected. That fed a growing pessimism about the resilience of the global economy after industrial orders slumped in Germany and the massive U.S. and European service sectors slowed. Then the European Central Bank surprised with a more dovish statement on interest rates than expected, signaling its wariness about the euro zone outlook. The dollar rose sharply.

Oh.  So that’s what spooked them.  Recession.  Which is another name for continued high unemployment.  Looks like people will be taking more ‘staycations‘ this year.  Just like last year.  Which means people won’t be gassing up the family car for those long trips.  Instead of gas they’ll be buying more expensive groceries.  So the speculators don’t want to buy oil.  Demand for oil will drop.  And something with low demand has a low price.

A range of factors, both economic and political, were also at play. The recent rise in raw goods has been fueled in part by the U.S. Fed pumping cash into the markets by purchasing $600 billion in bonds. This program has pushed interest rates extraordinarily low, making borrowing essentially free once adjusted for inflation. Investors have been using the super-cheap money to buy into commodity markets. But the Fed’s program is slated to end on June 30.

The U.S. Fed in their infinite wisdom printed more money to entice business owners to expand business and hire more people.  Unfortunately, this also created inflation.  Made our money worth less.  And this raised prices.  So we bought less.  And if we’re buying less, businesses aren’t going to expand.  They’re going to contract.  To reflect the falling consumer demand.  So where did all that printed money go?  Wall Street.  Investors borrowed the money ‘for free’ and invested in commodities.  Which drove the prices up.  And oil is a commodity.  Now that the Fed is shutting off the ‘free money’ spigot, they’re not buying anymore.  They’re selling.  Hence the fall in oil prices.

China, the world’s fastest-growing consumer of commodities, also is tightening monetary policy to tamp growth rates and control inflation, raising the prospect of a slowdown in demand for oil.

And one of the big things that triggered the huge run up in oil prices back in 2008, an explosion of Chinese demand, is reversing itself.  They are trying to control inflation.  By slowing their economic growth.  And, of course, slower growth requires less energy.  And less gasoline for cars.

Put all of this together and it explains why oil prices are falling.  Which is typically what happens in a recession.

Recession and Tight Monetary Policy always lowers Gas Prices

The greatest factor in the cost of gasoline is the cost of oil.  Oil goes up and gas soon follows.  Oil goes down and gas follows.  Eventually (see Just say no to $5 gasoline by Myra P. Saefong posted 5/6/2011 on MarketWatch).

Despite Thursday’s drop, crude futures are still more than 9% higher, year to date. Crude oil makes up 68% of the price of gasoline at the pump, according to the EIA.

Overall weakness in the dollar is also to blame for rising gasoline prices. “The U.S. dollar has an inflationary impact on U.S. buyers, while also triggering increased buying in equities and commodities to stave off lost currency value,” said Telvent DTN’s Milne.

And there’s an “overlap” between refinery maintenance and a cluster of bad luck for Gulf Coast and Midwestern refineries, including electrical outages and storm-induced shutdowns, said Kloza. “This is the catalyst for the last leg [of the gasoline-price rise], which may take us to $4-$4.11, but also should soon stall.”

So we’re not going to see a corresponding fall in gasoline prices right away.  But it’s coming.

Still, gasoline prices may hold a $5 average in California, where a strict gasoline formula makes the state more susceptible to higher prices, and in New York, due to tax issues, he said.

Of course, there’s always concern over the start of the Atlantic hurricane season, which begins on June 1, given the potential for disruptions to oil production and refineries in the Gulf of Mexico.

Be grateful you don’t live in California or New York.  At least, when you’re buying gas.  The environmentalists have added about $1 a gallon to the price of gas in California.  And New York is just tax-happy.  Add that to the recent storm damage, heavy rains and Mississippi flooding, prices won’t be coming down anytime soon.  But they’ll be coming down.  Because they always do during a recession.  As long as the Fed stops printing money (which was President Carter‘s problem.  Prices stayed stubbornly high in the Seventies despite recession until Paul Volcker finally tightened monetary policy).

Drill Baby Drill

Supply and demand determines the price at the pump.  That’s why prices go up during the summer driving season.  And down when much of the world is shoveling snow.  Oil is the biggest factor in the price of gas (68%).  Therefore, the less oil on the market the higher gas prices go.  And the more oil on the market the lower gas prices go.  Simple supply and demand.  Which provides a very easy solution to bring gas prices down.  Drill, baby, drill.  The next best thing we could do to keep prices down is to increase refinery capacity.  The more capacities available to refine crude oil the less storm damage will affect the price at the pump.  Finally, roll back environmental regulations and cut taxes.  Californians could easily see a drop of a dollar a gallon.  Even with current oil production and refining capacities.

Energy policy can be very easy if only you can separate the politics from it.  But when your political base is defined by those politics, that ain’t going to happen.  So get use to high gas prices.  Because they’re being kept artificially high for political reasons.  And enjoy your staycation this year.  And next year.

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