What Should We Do About Higher Gas Prices?

Posted by Jeff Carter
on February 19th, 2013

Why the heck are gas prices going up again?

It’s not the speculators. Speculators can’t influence a market. Despite the protestations of people who totally misunderstand why markets exist, the market reacts to information and allocates resources accordingly.

The rise in gas prices are tied to other factors. It’s simple microeconomics. There is a supply curve for energy, and a demand curve for energy. Unfortunately, the demand curve for energy is inelastic. That means small changes in either supply or demand can influence the price.

Since demand is inelastic, meaning no matter what the price is we will demand to consume it, we need to focus on supply. If you don’t think demand is inelastic, what would you substitute for the energy sources you use today in your life to keep your lifestyle at a similar level its at currently? If you weren’t using gas to propel your vehicle, what alternative would you use?

Supply is influenced by a lot of factors. The first one is production. No matter how much crude oil there is, there are only a certain number of refineries to process it. This creates a bullwhip effect in the supply chain. Long term, we can build more refineries to cushion the economy from supply shocks and price should become less volatile. It’s been a long time since America has built a refinery. No one wants to hurdle the EPA and OSHA to try and get one built.

Another factor influencing supply is exploration. We aren’t exploring for more oil. Most of it has been shut down on federal lands due to a highly restrictive permitting process. Critics will say Obama has opened up more land than anyone for exploration. However, the opportunity costs to exploring compared to other uses of that capital don’t incent companies to drill for oil.

Obama has been one of the most unfriendly Presidents ever to energy companies.

A factor that no one really considers is the monetary policy of the Federal Reserve. The world uses the US dollar to benchmark the price of oil. The value of the dollar has been continually cheapened through virtually all the policies put in place by the Federal Reserve. Cheapening the dollar makes the price of oil go up. If the Fed raised interest rates, the price of oil would drop.

The answer to higher gas prices is more exploration and increasing production capacity, lower regulation, and increasing the value of the dollar. If you want to know the source of higher oil prices, it resides at 1600 Pennsylvania Avenue, or on a golf course.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.