News-Bangla - নিউজ বাংলা - Bangla Newspaper from Washington DC - Bangla Newspaper

Rightly or wrongly, motorists outside the US think that we in America are spoiled by low gasoline prices. Two days ago, I paid $4.10 per gallon (1 US gallon = 3.786 liter) at Plymouth, Michigan. Across the country, average price was $3.70/gallon a month ago and just below $3.59 a year ago.

 Depending on various taxes and fees, gasoline price/gallon ranged from $3.79 to nearly $4.65 across the US Even at these prices, we pay less than half compared to motorists in many other developed countries. Canadians, for example, pay more than US consumers ($4.96/gallon) — even though Canada is the biggest foreign supplier of oil to the U.S. 

According to a survey conducted by AIRINC — a Cambridge, Massachusetts-based firm, even Canadian prices are bargains compared to what drivers pay in Turkey ($9.63), Eritrea ($9.59) and Norway ($9.63). Greece, Denmark, Sweden, Belgium, the UK and the Netherlands are also among countries with some of the world’s highest gasoline prices, with drivers paying at least $8 a gallon. These high prices are due to exorbitantly high domestic taxes.

 The US imports from OPEC declined 20 per cent in the last three years. In 2011, the country imported just 45 per cent to meet its oil — down from a record high of 60 per cent. It has now become a net exporter of refined petroleum products like gasoline for the first time since the Truman presidency of early 1950s. Although domestic oil production declined from 9.6 million barrel a day in 1970 to 4.95 million in 2008, it has risen to nearly 5.7 million a day over the last four years. Given the country now sees supply exceeding demand, everyone is asking, why oil prices at the gas station are reaching their near historic highs? Let’s do the math. 

The Iron Law of Gasoline Prices:

Price of Gasoline = (World Price of Oil) + $1.00/gal 

Prices at the pump will vary significantly depending on domestic taxes, surcharges and fees. 

Obviously the lopsided share of the gasoline price accrues from crude oil cost which recently ranged between $105 and $125 a barrel depending crude oil type. At $125/barrel, an EIA estimate show that a standard 42-gallon barrel translates to $2.98 a gallon at the pump. Add an average 15 per cent for refining, transporting, and selling the gasoline at retail outlet and then add $0.67/gallon for tax (note: taxes vary from state to state ranging from $0.264/gallon in Alaska, to as much as $0.674/gallon in New York). The total adds up to $4.10/gallon — close to the Iron law of gasoline price. Then there could be county and municipal city taxes and fees. 

The blame for rising gasoline prices has no consensus target; partisan politicians blame it on sitting president — even though oil a global commodity — beyond any control of Presidential. Many point fingers and rightly so at oil sales embargo imposed on Iran, and the looming preemptive Israeli bombing of Iranian nuclear facilities and the potential outbreak of a full-blown war in the Gulf region — yet others find excuse on increasing demand by ever growing demand from China, India, and Brazil. 

Another common scapegoat is the speculative positions being held by investors on oil futures. Well, there is some element of scapegoat in each of these but according to the US Energy Information Administration (EIA), a composite of ever- changing confluence of seven key factors contribute to gasoline prices:

 • Non-OPEC production trends;

• Oil inventory levels;

• Demand from developing, non-OECD, countries;

• Demand trends from more mature OECD economies;

• Market-altering events from bad weather to political upheaval;

• OPEC production targets and trends; and

• Financial market activity (and, yes, this would include the dreaded “speculators”. 

In the West, oil prices trend higher usually in the summer, mostly driven by high vacation-driving demand for gasoline. However, during mild winter prices tend to drop because of weakened demand for home heating oil. For example, in tune with the wild price swings in 2007 and 2008 average retail price for regular gasoline also hit a peak in July 2008 of $4.10, rising as high as $5 a gallon in some areas. By December, it had also dropped to $1.68 a gallon. 

In recent weeks and months the biggest risk to oil supplies is the impending threat of an Israel engineered war with Iran over the nuclear issue. Then there’re domestic unrests in some of the oil producing countries such as Nigeria. The constraints in Libya’s oil production are also adding to the supply limitations.

 The fall of Libya’s autocrat Gaddafi forced the other autocrats in the region to squander away billions of dollars in subsidies and salary hikes to their citizens to avert potential “overthrow” movements of their autocratic rulers— resulting in budget deficits. These countries now need higher oil revenues to support deficit spending. 

All these factors create an uncertainty about production and supply of oil. Uncertainty implies risk. Understandably, commodity traders are always on alert to cover both anticipated and unanticipated risks. So, they speculate prices on crude oil which—by some recent estimate—adds about $0.56 to $0.85 to crude oil price.

As an example risk-averse behaviour by oil traders, refer back to the 2008 oil price spikes. The initial explanations were ascribed to higher demand in China, India, Brazil, and Japan. Subsequent analysis attributed the sudden jump in oil prices to increased investment by “hedge fund and futures traders” – the speculative price inertia. According to some estimates, speculation is adding $0.56 to $0.80 to a gallon at the pump. Well, how does it work?

An oil future is simply a contract between a buyer and seller, where the buyer agrees to purchase a certain amount of a commodity — in this case crude oil — at a fixed price. Futures offer a way for a purchaser to bet on whether a commodity will increase in price down the road. Once locked into a contract, a futures buyer would receive a barrel of oil for the price dictated in the future contract, even if the market price was higher when the barrel was actually delivered.

In the Wall Street vocabulary, another name for “future contract” is “betting” which takes the market to strange and unchartered new highs. In the 19th and early 20th centuries the Wall Street used to bet on grain. In the 21st century it’s the crude oil. But what’s wrong in price speculations as some people make a big fuss about it? Isn’t how all markets work — be it financial market (stock market), commodities market and so on? In the US price speculation on any commodity or financial asset is illegal if such activities are collusive — maneuvring price by a syndicate.

 Past evidence of speculative price inertia forced President Obama to create an Oil and Gas Price Fraud Working Group to investigate price manipulation of the oil market and price-gouging at the gas pump. The task force is also looking into American oil refiners and “conducting other, nonpublic investigations” into the oil and gas industry.

 The concerns about speculative price inertia are heightened because of the observed supply demand imbalances:
 US petroleum reserves are at an eight-year high, domestic production increased; demand declined but the price of crude oil is rising — pushing higher prices at the pump. This means that the conventional supply -- demand model can no longer explain oil price movements satisfactorily — raising the specter of a new artificial oil market in operation. Hopefully, the task force will unearth criminal activities — if they’re any.

 The writer, formerly a Physicist and Nuclear Engineer, is a Professor of Economics at Eastern Michigan University, USA.