Published November 06, 2006
It wasn't long ago that Americans were worrying whether they could afford to drive down the street, but with gasoline prices running in reverse — down more than a dollar since mid-August — motorists now are wondering: What happened?
Price at the Pump
It's not easy to break down exactly how the retail price of gasoline is set. The price you pay at the pump is determined by key factors such as the cost of crude oil, refinery processing costs, marketing/distribution costs, retail station costs and taxes. But experts say that other inputs can push prices one way or another, too.
Take, for instance, the sharp climb of prices at gas stations from spring to summer of this year. An increasing number of analysts attribute those gains to forces outside the market and production processes.
“The April to August increase in prices was artificially produced, and we have the figures to prove it,” said Dr. Kent Moors, president of ASIDA, an oil industry consultant group.
“Since the first quarter of 2002, the average has risen periodically to levels that cannot be explained by changes in market conditions,” Moors said. “For example, when crude oil was at $70 a barrel in the second quarter of this year, East Coast U.S. averages should have been in the range of $2.55 to $2.62 a gallon. Instead, averages were 34 cents higher."
This "April Surprise" and other major price fluctuations like it can be attributed to a number of factors:
The Hedging/Fear Factor
“Investing can over-inflate the market.” Darin Newsom, senior analyst at DTN in Omaha, Neb., said.
“Early in 2006, we had increased buying in energies by investment traders,” said Newsom. “This was not based on standard factors but on fears. It really pushed the market higher. These are huge investment traders. And off the market went in April and May. Then the market seemed to lose some of its fizz. In August, traders lost interest in the market. On top of this, supply and demand went neutral to bearish.”
“Investment traders can be disruptive in the short term,” said Fernando Diz, associate professor of finance at the Whitman School of Management at Syracuse University. “There is so much more money, so much speculative and concentrated money in the hands of hedge funds, it can affect pricing in the short term.”
Other factors, however, usually keep the market in check, including the amount of inventories available, Diz said. “Supply and demand are the main factors that cause prices to go up and down,” he said. “It all depends on how the market participants see events affecting demand and supply. Supply has always been the most important factor affecting pricing in energy. Instability in places where the supply comes from most affects prices.”
While Diz said that OPEC’s “influence has been touted as irrelevant in the long run,” he does agree that the group has “more of a psychological short-term affect on markets.” Others argue the influence could be more menacing.
“Supply and demand doesn’t hold all the secrets. Not in the world of OPEC,” said David Ownby, director of the petroleum and chemical industry services practice at LECG in Houston, TX, and a 35-year veteran of the oil and gas industry. “OPEC controls 40 to 50 percent of total barrels. They can manipulate the market and set prices.”
OPEC's not alone in that capacity.
“People will tell you it’s what the market will bear, but this is fundamentally a disingenuous argument,” Ownby said. “Company A may sell to Company B at market prices. But if the same company owns A and B, price depends on what they need to charge to maintain profit.” Oil companies, he said, own the refineries, and the refinery margin – the difference between what they pay for crude and what they sell gasoline for – is the basis of gas prices. “By owning the refineries, the oil companies control three levels of margins,” including retail outlets.
Oil producers and refiners are also prime speculators. “If they’re afraid higher prices will affect their future margins, they will use the market,” said Diz. “If they see prices going up, they may add to the volatility.”
'Tis the Season
Prices also fluctuate seasonally. In the wintertime, refineries convert from producing primarily motor gasoline for summer travel to focusing on home heating oil. In a normal market, motor gas prices start to decline in September as the conversion takes place, because there is a stockpile of motor fuel. While the motor gasoline prices tend to decrease, the price of diesel and home heating oil goes up in the winter, based on greater demand. But this demand can also boost gasoline prices if it impacts the price of oil itself.
Geographical and political concerns also influence gas prices. For example, Hurricane Katrina triggered an increase in gas prices in September 2005, after it took out more than 25 percent of U.S. crude oil production and as much as 15 percent of refinery capacity. Likewise, events in Korea, China, Lebanon and Israel, coupled with OPEC’s latest quota cut threat, could all send prices higher at the pump.
But experts say the glass — or tank — is half full.
“It looks good right now for the consumer,” said Ownby. Unless the winter is particularly cold, there’s another major hurricane or the geopolitical issues come into play, “the market will continue to soften, and we will have lower prices.”
Moors said it's time to think beyond the daily price changes.
“Up and down price fluctuations are almost beside the point,” he said. “We have 30 to 35 years of crude oil left. If we don’t have energy alternatives by 2030, we’re in significant trouble.”