The High Cost of Driving Part 2: How Futures Markets Affect the Price of Gas

Learn how financial speculation fuels prices at the pump — and impacts the overall American economy in the process.

Percentage of household income spent on gas and transportation

Last week, we discussed how the law of supply and demand and world events affect the price of gas. But, as we noted then, those aren’t the only pieces of the gas price puzzle. Today we’ll look at a third force: futures trading.

As the graph below shows, the law of supply and demand isn’t sufficient to explain fluctuations in gas prices. Since 1980, demand has risen steadily, as has production (though U.S. production currently outstrips demand). Of course, the U.S. isn’t the only country in the world. Demand’s a worldwide phenomenon, and emerging markets like China have a sizable impact.

Gasoline onsumption, production, and price 1980–2012

Click to enlarge!

Yet the cost of gas has been erratic. That’s partially due to the wars and natural disasters we discussed last week. But there’s another big reason for fluctuating gas prices: speculation.

Futures trading: gas pricing happens on Wall Street

Speculation is now part of the DNA of oil prices. You cannot separate the two anymore. There is no demarcation.”

—Fadel Gheit, analyst at Oppenheimer & Co.

A more recent entry in the debate over what really drives gas prices through the roof is futures trading. And it’s an argument that’s gaining a lot of steam due to oil corporation head honchos and outspoken politicians.

What exactly is futures trading?

Futures trading is a type of speculative economic transaction in which a seller strikes an agreement with a buyer to deliver an agreed-upon quantity of an item at an agreed-upon date in the future. The buyer hopes that a product’s price is going to increase by the time of delivery (making the past purchase a savings), while the seller hopes that it will decrease (making the past sale a bigger profit). The factors driving buyers’ and sellers’ hopes are varied, but current events — and presumptions about events to come — play an important role. And that explains why the very murmur of any potential war in the Middle East can drive serious increases in price.

In a May 2011 Congressional hearing, Exxon Mobil CEO Rex Tillerson acknowledged financial speculation’s power in determining gas prices. In fact, according to the New York Times, Tillerson suggested that as much as 40 percent of the current high cost of oil arises from speculation. At the time, Tillerson said that, “If you were to use a pure economic approach, the economist would say … [the price per barrel’s] going to be somewhere in the $60 to $70 dollar range.”

That week, the actual cost was about $98 a barrel.

The extra $30–$40 is pretty significant when you consider the current average cost of extraction is just $11, on average.

Gas is the lifeblood of the American economy

It’s important to realize what a key role gas plays in the health of the American economy. For many Americans, driving is less of a choice than a necessity, and having to plunk down $60 to fill the tank can make the thought of other purchases less savory. In other words, big spending at the pump means little spending … well, everywhere else. And the less consumers are spending, the less money is getting pumped into the economy.

Thankfully, there are many ways for you to save at the pump and still give the local economy a shot in the arm. You could try our top 5 tips for improving fuel economy. Or try riding a bike around town, taking more walks, or hopping on the bus. Or better still, take a look at some of these gas-sipping cars.

Related link

Learn how supply and demand and world events also influence the price of gas.

 

One Response to “The High Cost of Driving Part 2: How Futures Markets Affect the Price of Gas”

  1. Micah
    December 29, 2012 #

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