Oil and Gas Prices Are On the Move Again

Recently, the rise in retail gasoline prices has been a cause of concern for many consumers and market-watchers. A steep rise in gas prices would likely result in a decline in discretionary spending by. Market watchers are concerned that higher gas prices will raise the cost of production and along with the impacts on discretionary spending the higher gas prices could slow down the economic recovery that may be underway.

First it is unlikely that we will see $4.00 per gallon in the near future. In fact, the recent rise in gasoline prices look very similar to the rise we see around this time of year every year. Around this time of year there is an increase in demand that typically boosts gasoline prices. For the years 2004-2009, the figure below shows the (cumulative) percent change in average gasoline prices from the first week of year to the middle of May.

By early May, gasoline prices were roughly 30 percent higher than they were at the beginning of the year. From 2004-2008, the average increase in the price of retail gasoline over this time period was nearly 25%. Thus, the increase does not look too different from the previous five years. If we use the past behavior of gasoline prices as a guide to where gasoline prices will be throughout the remainder of the summer a reasonable guess would be that the national average gasoline prices will range between $2.55 and $2.75. South Carolina typically is below the national average and so I would expect midgrade gasoline prices to be between $2.35 and $2.65. One factor that may cause gasoline prices go outside of this range depends on the speed at which the world economy recovers from the recession. The release by the IMF today indicates that the world GDP will be 2.9% lower in 2009 than it was in 2008. What really will matter for gas prices is how quickly the Brazil, Russia, India and China (the BRIC’s) bounce back. Unlike the United States and Western Europe, these countries spend a large fraction of increase in income on petroleum consumption. In the vernacular of pointed headed economists, for every one percent increase in income in the BRIC’s petroleum consumption increases by one percent. If these countries begin to grow at a pace of eight percent a year, similar to the pace before the recession, it would have big impacts on gasoline prices. Of course gas prices could climb if there are supply disruptions in the oil producing countries.

The extent to which the higher oil and gasoline prices act as a drag on the economic recovery depends on the factors that are causing the increase in these prices. If the price increases are due to disruptions in the supply of oil and gas, then this will certainly act as a drag on economic growth. If, however, the increase in prices is due to a rise in world demand, the negative impact on the economic recovery in the United States may be muted. Intuitively, if the BRIC’s starts to grow more rapidly then their rising incomes will lead to more consumption including goods produced in the United States. Thus, if the higher energy prices are due to rising incomes and increased this tends to boost the demand for our exports and helps raise our Gross Domestic Product (GDP). The increased exports helps to partially offset some of the negative effects of higher gasoline prices. Another factor that may push up oil prices in the United States is weaker dollar. If the exchange rate depreciates broadly, a barrel of oil becomes relatively more expensive in the United States and this may lead to higher gasoline prices and, as a result, lead to a slower economic recovery in the United States. Again the weaker dollar would help boost exports so this would partially offset some of the negative effects of the rising oil prices due to dollar depreciation.

As an aside, during the run-up of energy prices in 2007 and 2008 much of the price increases could be attributed to the economic growth in the fast growing developing countries (Brazil, India, China, and Russia) and a depreciating dollar. Supply disruptions and speculators had a limited role in the price increase.