Running on Empty: The Economics and Politics of Gasoline Prices

Running on Empty: The Economics and Politics of Gasoline Prices

May 12, 2011

Mother Nature is intervening again in U.S. energy markets. Just as falling oil prices are puncturing upward pressures on gasoline prices, prospects of serious flooding in areas of the Gulf states where refineries are concentrated has sent gas future prices soaring again. With the economy sputtering a bit again, it’s not welcome news for the President, or for the rest of us. But it shines a light on what actually drives the gasoline market in the United States and, by the way, refutes the energy policies of the President’s critics. And the reason it matters so much politically lies not so much in the actual price of gas, which Washington can do little to affect, as in the economy’s underlying problems with jobs and incomes. 

While speculators place bets that Mississippi Valley flooding will interrupt gasoline supplies, those supplies have played no role at all in rising gas prices over the last several months. Partisans can cry, “drill, baby, drill” all they want, but Energy Department data show that the United States has been a net exporter of gasoline since the beginning of 2010.  In short, America produces more gasoline than it consumes. From January of last year through this past February – the most current data on energy trade — the United States exported an average of 5.5 million more barrels per-month than it imported.  And from last November through February, as prices at the pump marched up from $2.86 per-gallon to $3.20, the net trade surplus in gasoline jumped to an average of 9.8 million barrels per-month.

U.S. demand for the oil that goes into making gasoline also can’t explain rising gas prices, since our oil consumption is still about 2 million barrels per-day below the levels in late-2007, just before the onset of the 2008-2009 recession.  Yet, gasoline prices in April averaged $3.42 per-gallon, 22 percent above the 2007 average of $2.80 per-gallon.

The answer to this painful riddle does not lie in supply and demand.  Rather, most of the explanation lies in the Saudi Arabian’s government’s dogged determination to keep worldwide oil prices high even as worldwide demand eases, as it has with the recent stumbles in the American, European and Japanese economies.  And the rest of the answer can be traced to the increasing ability of large financial institutions to wield enormous leverage in order to dominate futures markets in oil and gas. 

The consequent high prices are understandably frustrating to Americans who have taken steps to reduce their energy demand, assuming like all good free marketeers that lower demand will translate into lower prices.  The share of U.S. vehicle sales going to light cars is up to nearly 60 percent, and hybrids’ share has doubled in the last five years (to about 6 percent).  But for most drivers, the recent increases in gasoline prices swamp any gains in miles-per-gallon. The administration’s critics whine all of this could have been avoided, if the Administration approved more permits for offshore drilling in deep water.  But permits for shallow-water drilling are up; and in any case, the Energy Information Agency says that opening up the outer continental shelf would probably reduce gas prices by no more than 3-cents per-gallon twenty years from now.

In the long-run, technology will have a much larger impact on future oil and gasoline prices than today’s squabbles over drilling rights or tax breaks for U.S. energy companies – that is, so long as prices remain near their current levels.  For example, the United States has enormous natural reserves in oil shale and tar sands.  If oil prices stay near where they are today, oil from shale and sands will compete quite nicely with Saudi crude – and leave little room for the rulers in Riyadh to push up prices much further.  And with another five to ten years of development, the Administration’s favored clean-energy alternatives also will likely become competitive, again if current oil prices stick.

None of this can affect the current U.S. politics of high oil and gas prices.  But what matters most politically about those prices is actually not their level at all, but how much those prices crimp spending by Americans on everything else.  In short, the politics of oil and gasoline prices depends in the end on whether people’s incomes are going up or down.  The 1990s saw a happy convergence of rising incomes and falling energy prices, underwriting a boom in both consumption and business investments to meet the increased demand. But the Saudi dictatorship swore that they would never let that happen again, which is why we now have to live with high energy prices in the face of weakening demand.

In an industry that doesn’t much follow the laws of supply and demand, a genuine fix for gasoline prices is simply beyond the power of the President and Congress.  The only course left is the harder work of getting incomes moving up again.  And that will require, just to begin, some serious steps to stabilize housing prices, jumpstart business and job creation, and provide opportunities for adult Americans to upgrade their skills with information technologies.