For the first time in 2008, the price of gas at pumps throughout the United States is lower than than what it was about an year ago.
This is obviously in line with the global oil prices, which have fallen more than 25% in the last month. While OPEC decided to cut production by 5%, starting Nov 1st, the oil prices still kept falling.
The more popular reason given for this is that global demand is likely to fall even more, but, the real reason, probably is that the price rise was more speculative in nature to start with, in any case.
As anyone who fills gas at a pump knows that prices of oil and gas do not have an exactly linear relationship and while oil prices obviously do impact gas prices at pump, there are some interesting factors at play here.
Price of Oil
A large part of the fall in the oil prices is being attributed to the global slowdown, and the anticipated slowdown in demand for oil in the coming months. The speculation in oil futures is not talked about at all. It may be because deleveraging is taking such a toll on the stock markets of the world that it is hiding its impact on oil derivatives.
Like last time when the oil prices rose, the real demand for oil in the world had not risen, but rather the position in the global derivatives had risen. Similarly this time deleveraging has taken its toll on oil prices. Like I said in my post on July 20th, the oil price bubble will burst and so it did.
I mistook the time it took to thought it will take to burst though. I was expecting the bubble to last much longer than just a few months, but it did prove to be a speculative bubble after all.
What that means is that the price fall in oil was sharp and rapid. But the price fall is not so sharp and rapid for gas pump prices.
Price of Gas
The gas pump market is more competitive in United States than in any other country in the world (where the government doesn’t keep the prices artificially low).
This means that when the oil prices were rising, gas pump owners were watching their competitors and keeping an eye on competition, so that they don’t end up raising prices too soon and losing out to competition. This meant that gas pump owners raised prices at a slightly later time than they should have actually done it.
While this is a real phenomenon, people who are used to filling up their tanks under 40 bucks will probably be too angry to notice this, when gas prices move upwards, slowly but steadily.
And also because, as the chart on this great page shows, gas prices move upwards much faster when oil prices move upwards, but they don’t quite come down as fast, when the price of oil falls.
The same phenomenon plays out when oil prices go down. Gas pump owners see who blinks first. Basically they see how long can they keep their own prices higher. As long as both of them keep prices high, they will not eat into each other’s customers.
Due to the competitive pressures, the prices at both pumps do eventually come down. But due to natural human tendencies, the upward journey takes place much faster than the downward journey.
Conclusion
The world is much more connected now than it has ever been and complex financial instruments like derivatives impact real gas prices all across the world. Even the price of oil and gas which are fundamentally thought to be the same are impacted by various other factors that makes their price behavior seem erratic.