Gas Prices 2012: What Next?

The price of gas is a big question mark in the monthly budget of millions of Americans. Will it go up? Will it go down? If it spikes, will I be able to afford to get around and get to work?

The good news is that the outlook on gas prices is fairly stable over the rest of the year. The bad news is that long-term, we shouldn’t expect any significant price drops.

You might notice that the price of gas plunged considerably in early 2009 and has spent the last three years slowly rising back to close to its previous highs. And that actually brings us to the most important factor in gas prices…

Crude Oil

Crude oil is, of course, what gasoline is refined from. So the price of the most crucial part of the process pretty much dictates the price of gas. In fact, the huge highs followed by the crashing lows you see in that chart was caused not by outside economic factors, but by commodities speculators.

Crude oil, like many products, is bought on commodities markets; and like any market, it’s prone to speculation. That’s what happened in 2008, as a nasty spiral was triggered by commodities speculators.

At the start of the year, crude oil was sitting at $100 a barrel and gas prices were steadily rising. Speculators saw the chance for major profit as gas prices were rising, yet there was still strong demand. They began bidding up the cost of crude oil, and the gas price debacle of 2008 was on. People remember the days of $4 gas all too well.

The whole incident was a spiraling mess that was only derailed by a larger economic crisis. Suddenly, all the demand for gasoline dried up at once and one of the most basic laws of the universe kicked in: what goes up must come down. Oil companies tried desperately to reduce the supply to meet the lower demand as the cost of a barrel of crude dropped to under $40, from highs of $140.

The cost of crude oil has risen ever since as oil producers and refiners have narrowed in on a good amount of supply for the amount of demand available. The good news is that the government expects the price of oil to average $106 a barrel through 2012 and to drop slightly over the course of 2013 to an average of $98 a barrel, meaning that gas prices in your area should stay largely stable.

Which brings us to the next factor…

Supply and Demand

This actually has two scales we need to consider: the micro scale and the macro.

Oil refining and gasoline are a tricky industry in many ways. Oil has to be imported, refined into gasoline, and shipped to gas stations. All of that takes time, and during that time the value of the product can vary wildly. Similarly, the overall supply of crude oil is limited, and it’s not just America that’s thirsty for it: China needs oil so much that it will happily import from anybody, even Iran.

The micro scale comes into play in the competition between your local gas stations. Sure, there’s a floor established by the cost of gas and other expenses, such as marketing and taxes, but they’re still competing for customers. They’re trying to raise their prices as high as possible while avoiding losing any business.

Fortunately, there’s a limit to that competition, so don’t expect it to drive up prices more than a couple of cents. Gasoline is a volume business, after all, and one penny per gallon adds up fast when you sell thousands of gallons of gasoline a day. But part of the cost is what goes into your gas, and that’s where the states come in.

Regulations

Gasoline varies from state to state. That’s because of regulations. For example, California has some of the most expensive gas in the nation because its efforts to reduce air pollution have led to very specific regulations in how that gasoline is formulated.

Each state has different rules about these formulas and what can and cannot go into your gas. These laws, however, are unlikely to change much: state legislatures have more pressing issues to deal with than the chemistry of your gasoline.

Another government issue unlikely to change is…

Taxes

We all know that state and local governments collect a tax on gas. It’s factored directly into your price. Unfortunately, prices aren’t really high enough and state budgets are squeezed enough that it’s unlikely gas prices will be moved one way or the other based on tax changes.

Finally, there’s the wild card in any oil market…

Geopolitical Unrest

If you pay attention to the news, this is not a surprise. Oil tends to be located in places that aren’t exactly politically stable. While plenty of oil comes from the United States and Canada, lots of it also comes from countries like Iran, Iraq, and Nigeria. And whenever some violence breaks out in one of these areas, it affects the price of oil.

For example, when Iraq was being investigated for having weapons of mass destruction back in 2002, it drove up the price of crude oil internationally.

It doesn’t necessarily have to be any sort of accident in an oil producing country. The Japanese tsunami and earthquake of 2011 drove down oil prices as it reduced demand by a considerable degree. Even relatively mild events like Hurricane Irene can drive up oil prices, especially if they shut down oil refiners or cause other problems in the oil supply.

And this is the real problem with the oil market. We can’t be sure that some sort of disaster won’t happen. Geopolitical unrest and natural disasters are the big question mark in any financial market, but especially oil. It’s so heavily dependent on supply and demand that the slightest tweak in the market can shake prices.

So, as far as we know, things will be mostly stable for the rest of 2012. But be ready for instability; just like life, really.

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