National Commentary

The Peak Oil Crisis: Gasoline Prices Revisited

It has been 18 months since we all worried very much about high oil prices. Starting in July 2008 gasoline prices took an historic plunge dropping from a U.S. average high of $4.11 a gallon all the way down to $1.70 in January 2009.

In retrospect this price drop was a good thing for it did more to slow the downward spiraling recession than most people realized. In the last 12 months however, the situation has reversed and the average price for gasoline is pushing $2.80 a gallon. An increasing number of commentators are starting to talk of the return of $100 oil and $3+ gasoline.

The problem of course is by now everybody knows gasoline prices always rise in the winter and spring leading to a peak around June. In 2008 and 2009 we had unusually large increases with average gasoline prices going up $1.20 a gallon in 2008 and 90 cents a gallon in 2009. These increases, however, took place under unusual circumstances and as yet there is no reason to believe that we will see gasoline pushing $4 a gallon again this summer. In fact some are arguing the case that gasoline prices are currently too high and will be going down shortly.

A drop in oil prices in the next six months seems unlikely without a major development.

There are numerous factors that will affect the balance of forces determining gasoline prices six months from now – the economic situation in the OECD nations, the pace of economic growth in China, India, and several other Asian countries, the stability of the U.S. dollar, the weather, stability of Iran, and perhaps even an OPEC decision to increase oil production if prices get too high.

While it is difficult to foresee clearly the interaction of all these factors, the conventional thinking is that U.S. and OECD oil consumption will remain flat, the Saudis will continue to withhold a couple of million barrels a day (b/d) from the markets, and China will continue to grow rapidly in 2010. Many believe the Chinese are coming up on a massive real estate bubble-burst one of these days, but this still seems to be a couple of years away and is unlikely to have much to do with gas prices next July.

While it is impossible to predict whether Iranian or Iraqi oil exports will be disrupted by political developments in the next six months or whether another six weeks of unusually cold weather in the northern hemisphere is really in the offing, there are several key events scheduled that could have some sort of impact on where gasoline prices are next July.

Perhaps the most important of these are the announced plans of the U.S. Federal Reserve and Treasury to stop supporting the financial industry, the housing industry, low interest rates, and whatever else they are overtly or covertly subsidizing by the 1st of April. The idea would be to let the U.S. economy try to stand on its own feet prior to the November mid-term elections without the help of hundreds of billions in government subsidies. Whether this plan actually comes to pass is problematic, another couple of months worth of bad economic news may lead to a decision to continue the programs.

The greatest danger from hasty removal of government intervention is the likelihood that interest rates will increase substantially and that the U.S. dollar will fall thereby sending dollar-denominated oil prices higher no matter what happens to supply and demand.

At the minute, a substantial drop in oil prices in the next six months seems unlikely without a major untoward development. Shortages from insufficient global oil production are still a few years away, so for the time being the value of the dollar and the demand for oil will be the controlling factors. A Chinese economic meltdown still seems to be some years off. A better bet is the collapse of the U.S. equities markets which have been disconnected from reality for the past nine months.

We are already getting some numbers showing that the demand for gasoline in the U.S. is slowly dropping – this probably has something to do with the unemployment rate is which is realistically over 20 percent. As gasoline is so important to the average person in the U.S. reductions in automobile use will likely be slow and undertaken reluctantly. The inconveniences of less driving still outweigh the cost of gasoline for most.

While global oil supply has some room to grow in the next six months, much more cheating on OPEC quotas is unlikely as the cheater countries don’t have much more room to cheat. The Saudis and their Gulf brethren have some more productive capacity, but continue to maintain that they are happy with $70-80 oil and there is no need to increase production. There are a number of looming problems in the next six months one of which is Venezuela. It seems to be on course to lose about 75 percent of its electricity supply due to a massive drought emptying a hydro-electric reservoir.

Unless there is a major geopolitical upheaval in the next six months, oil prices are likely to creep up as they have been doing since last May. Gasoline prices will continue their tradition winter/spring climb likely passing the $3 per gallon mark which seems to be psychological point that impedes the sale of large cars.

How much further prices will go is impossible to responsibly forecast for there are simply too many unknowable variables involved.

The only thing we can be sure of is that this increase is going to damage, perhaps fatally, prospects for a U.S. economic recovery. With more and more money being sent away to pay for “essential” gasoline supplies, there is going to be less and less to pay for everything else.

Tom Whipple is a retired government analyst and has been following the peak oil issue for several years.