Just six years ago, national gas prices hovered around $1 per gallon. Today, even the average six months ago ““ $3 per gallon ““ is sounding good.
Gas prices are continuing to tick upward, and national averages today are approaching $4 per gallon, a rapid increase experts explain as a combination of simple economics and external factors.
“I don’t really know if anyone knows the reason (for the rising prices), but we can take some educated guesses,” said Avanidhar Subrahmanyam, a professor at the UCLA Anderson School of Management.
Demand for oil has increased in recent years, especially with India and China becoming more economically powerful, Subrahmanyam noted.
Still, he said he does not believe demand has risen enough to fully explain the price spikes.
“I do not believe there has been an increase in demand. … Nothing that could explain an increase of $1 a gallon,” he said.
Instead, Subrahmanyam suggested that market speculation may be to blame.
Hedge funds are increasingly betting on commodities, such as crude oil, rather than on stocks as they have in the past, he said.
Hedge funds make money by investing in futures contracts for specific commodities; essentially, they bet that the price of a commodity will increase over time.
Right now, oil is an attractive commodity to bet on because current conditions make it unlikely the price will collapse, Subrahmanyam said.
“From their standpoint, there’s turmoil in the Middle East. … Gasoline is essential; supply is sort of finite,” he said. “Demand for oil will stay fairly constant.”
Michael Intriligator, a professor of political science, economics and public policy, said other outside entities such as the Organization of the Petroleum Exporting Countries can also affect gas prices.
“A lot of this is set by monopolistic interests,” he said. “OPEC is a major control mechanism of oil prices. OPEC is a cartel, basically. They play an important role in determining how much oil gets onto the market.”
OPEC is comprised of 13 member states, mostly countries in the Middle East and Africa, which coordinate their oil export activity and therefore are able to exercise considerable influence over the world oil supply.
President Bush is currently in Saudi Arabia, the de facto leader of OPEC, meeting with officials about ways to curb rising gas prices.
A recent report by the Congressional Research Service suggested that a combination of demand increases and supply shortages was largely responsible for the spiking price of crude oil.
It found that world demand for oil has increased between 1 percent and 4 percent during each of the past four years, and it pointed to violence and terrorism in the Middle East as possible causes of supply destabilization.
But some experts doubt that the war in Iraq and the war on terror are primary causes of rising gas prices.
Subrahmanyam said he believes the connection between war in the Middle East and higher prices is mostly psychological.
“Most of us associate higher prices with some world event,” he said. “That’s sort of keeping the prices propped up, in my opinion, because people are more willing to accept gas prices in a time of turmoil.”
Though Intriligator acknowledged that the war has likely increased American demand for oil and may have destabilized supply, he maintained that OPEC and other major oil producers play a more important role.
Because those producers reap such significant profits, prices are unlikely to drop anytime soon, Intriligator said.
“Some people are predicting a steep decline. I don’t see that happening,” he said. “If there’s some falling out among the members of OPEC and Russia, that could stop it. But at this point they’re in sync ““ they like these high prices. Unless there’s some structural change, I don’t see why prices won’t just keep going up.”
Subrahmanyam said he was not as sure prices would continue to rise.
Instead, he said he suspects this may be a “speculative bubble” ““ entities like hedge funds are betting prices higher than they should, and eventually they must come back down.
“My guess is that this price is too high. I would expect to see a flattening out,” he said. “This is similar to what was happening with the technology bubble. People were betting on dot-coms, and it all collapsed.”
In the meantime, though, Intriligator and Subrahmanyam both said rising prices could have significant impacts on the overall U.S. economy.
“The people who drive their cars to work every day are going to pay through the nose,” Intriligator said. “On the other hand, the major oil companies have made out like bandits.”
Subrahmanyam said the situation has the potential to get much worse before it gets better.
“There’s definitely going to be a ripple effect. I think it hasn’t trickled through yet,” he said. “But my best guess is that maybe it won’t come to that. Maybe the bubble will burst.”