The cost of a gallon of gasoline is probably the most recognized price we encounter. Most of us drive, and it is something we buy on a frequent basis. Even those who don’t drive can see the price posted at the many stations throughout our area.
By commenting that the price of gasoline has come down, I’m not really saying anything that most people don’t already know. What I will try to do is add is some analysis, as to what this price drop might mean for the overall economy and financial markets.
As with most items, the price of gasoline has tended to rise over time. However, unlike many other goods the price increases for gasoline have often been quite dramatic. Up until the early 1970’s the price of gasoline was only about $.30 per gallon. Then came the Arab oil embargo in 1973, as OPEC became a dominant player in world oil markets, and the price of gasoline just about doubled. This led to a major recession in 1974/75.
Since that time the price of gasoline has had several other dramatic price increases, which have had detrimental impacts on the economy. Over this time frame there have been times when the price of gasoline has fallen quite significantly. Therefore, the price drop we are currently seeing is certainly not unprecedented.
It should be noted that the price of gasoline is primarily determined by the cost of oil. Oil is a commodity that is traded on a daily basis, and oftentimes has wide price swings. For most other goods the cost of the raw material normally doesn’t impact the price we pay that significantly. For example when the price of wheat changes, it has only a minor effect on the price of a loaf of bread.
When the price of oil or gasoline is coming down it could be either a good or a negative sign for the economy. For example in late 2008 the price of oil fell dramatically, as the economy was falling into a deep recession. This price drop was due to a lack of demand, which is a bad sign.
When the price of oil is declining due to an increase in supply that is a more positive sign. Oil production in the U.S. has increased significantly in recent years due to increased extraction from shale deposits. This has helped to increase the global supply of oil helping to keep prices down.
While increased supply has helped to lower prices recently, global demand has also been less than expected. This is because growth in many countries is falling below expectations. In addition the U.S. dollar has been very strong, which tends to be a negative for commodity prices.
For the U.S. economy overall the decline in gasoline prices would be a net positive. While oil production in the U.S. has increased, we still consume more oil than we produce. Clearly the energy sector has been hurt by the recent fall in oil prices, but there has been a greater positive offset to consumers.
The decline in the price of gasoline tends to have a greater impact for lower and middle income consumers. That is because the amount people drive tends to be fairly uniform among income groups. The one exception might be some low income people who don’t have a car and take the bus.
With regards to financial markets the drop in oil prices, at least in the U.S., has been a positive. In other countries the drop hasn’t been as significant because their currency has weakened against the dollar. Not surprisingly energy stocks have been weak and airlines have done very well.
At this stage I would not recommend someone buy the airline stocks. This has traditionally been an industry that has faced many problems with a number of bankruptcies. While the environment for airlines is currently favorable, it can easily change.
As long as the global economy doesn’t weaken much further, oil prices probably won’t drop much more. When OPEC meets, they might try to limit production, but it is questionable how effective they might be enforcing cuts. On a seasonal basis gasoline prices do tend to fall this time of the year. At the start of the year in California the cap-and-trade bill takes effect, which will likely cause gasoline prices to rise.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.