Professor of Finance Edgar Norton talks about the current decline and future of gas prices.
If you don’t like the weather in Illinois, some say—wait a while. It will change. The same holds for gas prices at the pump. Fortunately, in recent months, the trend of the price at the pump has been drifting down for those of us in Illinois—and elsewhere in the U.S.
There are many reasons why gas prices have been declining and reasons why, at least in the short-term, we should expect prices to drift down a bit more before stabilizing. Like most topics in economics, the explanation for price changes is “supply and demand” and so it is in this case.
On the demand side, global economic growth is sluggish. The U.S. recovery from the Great Recession is slow and plodding, at best, with unemployment still above pre-recession levels and consumer spending still hesitant. Europe’s central bank—equivalent to our Federal Reserve Bank—is trying its own version of quantitative easing to stimulate European economies. And China, which enjoyed robust growth in recent years, is experiencing slower growth of late. Slower demand growth is helped, too, by technology over time that has increased fuel efficiency in cars, trucks, and other machines that use petroleum products.
On the supply side—supplies of oil are quite high. U.S. crude oil inventories are at record highs. The U.S., thanks to innovations in extracting oil and natural gas via “fracking,” is becoming more energy self-sufficient. U.S. oil production has doubled in the past six years, greatly adding to U.S. and global oil supplies. Saudi Arabia, which as the main force in OPEC (Organization of the Petroleum Exporting Countries) in the past has reduced its oil production to help maintain global oil prices, has instead maintained its production in the face of falling oil prices to keep its “market share” of customers buying its oil. No major supply-line disruptions, such as an active hurricane season or long-term refinery shutdowns, occurred.
Although short-term trends are favorable for consumers, lower global oil prices will result in future declines in oil production as high-cost producers leave the market; we’ve already seen this in the U.S. with some fracking operations closing down as they can’t make a profit with $40 per barrel oil. And as economies show more strength, demand will rise and so may oil prices.
But forecasting oil prices is not easy. The U.S. Energy Information Administration (EIA), a division of the U.S. Department of Energy, collects and analyzes much data about energy supplies, demand, and price trends. One year ago they were predicting retail gas prices would average $2.94 in 2015—and gas has averaged quite a bit lower than that over the year. Right now, the EIA is predicting gasoline prices to average $2.33 per gallon in 2016. One Wall Street firm that predicted a price of $200 per barrel for oil in 2008 is now predicting its price may fall to $20 per barrel. One thing about predictions—they are variable and easy to change.
Similar to trying to predict the weather 6-9 months ahead of time, the oil price forecasts leave much to be desired. So keep your eyes on the road, a firm grip on the steering wheel—and try not to fill the gas tank right after the price bounces up 25 cents a gallon.
Norton can be reached via MediaRelations@IllinoisState.edu.
