The station down the road from us now sells regular unleaded gasoline for $1.92 a gallon. Premium goes for $2.14. Chicken Little is forecasting that we will soon be paying $3.
Prices have certainly jumped recently, and we have dusted off the usual suspects: OPEC, the lack of refinery capacity, commodity speculators, SUV drivers and, of course, the greedy oil companies (in cahoots with you know who, of course … this is an election year, after all).
However, one of the fundamental causes is not on that list — basic economics.
Every business attempts to maximize, or at least stabilize, its profits. And the OPEC countries have seen theirs drop precipitously. Suppose you had a product that sold for $1.15 two years ago and it now brings in only 83 cents, even though demand is still strong. You would probably be disappointed, to say the least, and you would start looking around for some way to bolster your bottom line.
That is essentially what happened to the OPEC countries over the past two years. In global markets, by agreement, crude oil is priced in U.S. dollars. So, as the dollar has lost value relative to other currencies, the oil-producing countries effectively receive less for each barrel they sold — unless the price goes up.
Economists use the term inelastic to describe the demand for a product or commodity that people will buy pretty much the same price irrespective of ups or downs. In the short run at least, the demand for oil is inelastic. If gasoline stays expensive, next year we might buy a smaller vehicle, a hybrid car, or even move closer to work. But right now, we need gas so we can get to our jobs.
Facing an inelastic demand for its product and declining real income, OPEC decided to cut production so the price of crude oil would go up. Their goal was straightforward enough: They wanted their income per barrel to go back up to what it had been before the dollar started its downhill slide.
What new price would bring their income per barrel back to where it had been? The decline in the dollar against the euro since 2002 works out to 39 percent. The average price per barrel of crude oil for the first quarter of 2004 is higher than the 2002 average by exactly the same amount — 39 percent.
This tells us two things. First, OPEC isn’t the villain in this piece. Oil producers were simply trying to bring their profitability back into line after being walloped by the dollar’s devaluation. Second, because OPEC’s action was essentially defensive, it isn’t likely that we are going to see continued escalation of gasoline prices. Of course, the continued pressure on U.S. refinery and storage capacity gives the supply-demand picture for petroleum products a bias toward price increases and encourages commodity speculators. But that is our doing, not OPEC’s.
As to whether SUV drivers are a major factor, it doesn’t really seem so. It wouldn’t hurt for us to drive vehicles that were more fuel-efficient, but it is hard to ignore the fact that overall energy use per capita hasn’t really gone up in 30 years. We may be disappointed with auto manufacturers’ pandering to our love for large vehicles, but it hasn’t done much, if any, damage to our overall record. Population growth is a bigger driving force in total energy consumption than SUVs.
And thanks to the massive, often painful shift in the U.S. economy from manufacturing to service industries, the energy consumed per dollar of gross domestic product is actually about half of what it was before the OPEC oil crisis of 1973. So the increase in the price of oil will not have as strong an effect on our overall economic recovery as it would have had a generation ago.
Besides these, there are some other economic forces gathering to help us out. The U.S. economic recovery is now proceeding so robustly that we are seeing the need for an increase in interest rates. This should ease the pressure on the U.S. dollar and, at the same time, augment OPEC’s income stream so oil production can get back to normal.
Those people who want to believe that it is President Bush’s friends in the oil companies who are behind the price increases — in some incomprehensibly boneheaded plot to further his re-election by sabotaging the economy — will probably continue to believe it. But it is actually just economics at work. It hurts us in the pocketbook, but that’s its nature, sometimes.
James McCusker is a Bothell economist, educator and consultant. He also writes "Business 101," which appears monthly in The Snohomish County Business Journal.
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