Fin - Daniel Gross - US

Why Gas Prices Should Be Lower Soon

Contrary Indicator

Oil markets were roiled today when the United States and the International Energy Agency jointly announced that they would release a combined 60 million barrels of oil into international markets over the coming month.

Where is the oil coming from?

The U.S. said it will sell 30 million barrels from the Strategic Petroleum Reserve, while other countries that are members of the International Energy Administration will provide the rest from their reserves.

But didn't President Obama tell you just a couple of weeks ago that he wasn't planning to do this?

Indeed he did. At a meeting with finance journalists on June 8, I specifically asked whether he was considering releasing oil from the SPR. His response:

"I won't make any news on that today. I will say that my general view is that the SPR is to be used where you don't have just short-term fluctuations in the market, but a significant disruption event. Libya has taken 1.25 m barrels per day off the market. We're examining broadly what that means in terms of the oil market."

So what's changed in the past two weeks?

A couple of things. First, the administration has apparently concluded that the situation in Libya isn't going to improve in the short term. As Energy Secretary Steven Chu put it today: "We are taking this action in response to the ongoing loss of crude oil due to supply disruptions in Libya and other countries, and their impact on the global economic recovery," said Energy Secretary Steven Chu. While Libya accounts for only a tiny portion of global oil production, its oil is the most cherished (and easy to process) light, sweet crude.

Second, an OPEC meeting two weeks ago ended in disarray, with members disagreeing about higher production. That suggests that the production we're losing from Libya won't be replaced anytime soon.

But why release the oil now? After all, oil prices have been falling since May.

It's true that oil prices have been falling. Since peaking at $114 per barrel in May, oil prices had fallen about 16.7 percent before today's announcement. (For a longer term chart, go here) Meanwhile, gasoline prices have fallen in the last two weeks, from a nationwide average of $3.78 per gallon to $3.65 per gallon. But that's still up 91 cents per gallon from a year ago, and the peak summer driving season is about to begin. Simply put, higher gas prices hurt the economy more in the summer than they do in the spring.

Cynics would say that politics are also coming into play.

As I discuss with my colleagues Aaron Task and Jeff Macke in the accompanying video, you don't have to be cynical to think that. While the economy is slowing, there seems to be little hope of further aid or stimulus. In his press conference yesterday, Federal Reserve Chairman Ben Bernanke indicated that the central bank was pretty much done with its efforts to boost demand. On Capitol Hill, talks are centering on anti-stimulative spending cuts and tax increases. And so releasing oil from the SPR is one way President Obama can stimulate the economy without action from the Fed or Congress. In theory, greater supplies of oil bring down the price. And cheaper oil functions as a tax cut for businesses and consumers.

Will gas prices come down as a result?

Yes. Crude oil prices have fallen more than 20 percent from their May peak. But don't expect a sharp decline in the price at the pump in the next few weeks. Gasoline station owners buy new supplies every couple of days. So when their costs rise, they feel compelled to pass along the higher prices to consumers instantly — as a matter of survival. The opposite dynamic takes hold when oil prices are falling. As wholesale gas falls in price, profit margins expand, and station owners are in no rush to ratchet down the price at the pump.

Of course, in the scheme of things, 60 million barrels isn't much. In 2010, the U.S. consumed about 19.15 million barrels per day, and the world ran through about 85.3 million barrels per day. Put another way, this 60 million barrels is about what the U.S. consumes in three days, or what the world consumes in 17 hours.

Even though it's a small amount, it seemed to have a big market impact. Why?

Right after the announcement, the price of oil fell about five percent, to below $90 per barrel.That's a pretty dramatic move. And it can be explained by a few factors. This represents new supply and takes away some of the worries about disruptions. In addition, speculation has played a role in keeping oil prices high. And some investors and analysts believe that this may be part of a concerted effort to fight speculators. The 30 million barrels the U.S. is releasing is equal to 4.2 percent of the total in the SPR, so there could be more to come. In addition, other economic news — the Fed ratcheting down its projection for economic growth in the second half of 2011 yesterday, and general concerns about a slowdown in China — point to lower prices.

Is this unprecedented?

No. When there are disruptions — a barge accident, a refinery explosion — the SPR lends out small amounts of oil to refineries, as it did in 2006. After Hurricane Katrina in the fall of 2005, the SPR offered to sell up to 30 million barrels to help keep the industry supplied. Ultimately, 11 million barrels were sold.

Will this move alone bring oil prices back to earth?

All things being equal, additional supply should lead to lower prices. But in the oil market, all things are never equal. The strength of the dollar, the pace of growth in China, politics in Iran, instability in the Middle East, new finds, OPEC decisions and more play into the ultimate price of oil.

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His most recent book is Dumb Money: How Our Greatest Financial Minds Bankrupted the Nation.

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