Crude Oil and Gasoline Prices

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Crude Oil and Gasoline Prices
June 2009
Axia College/University of Phoenix

Crude Oil And Gasoline Prices
Since the early Seventies, energy consumers have been on a roller-coaster ride of wild and woolly price swings, producing a kind of economic whiplash. Petroleum and gasoline prices are especially prone to price volatility. Sometimes the cause of a price increase is obvious and dramatic, like an oil embargo or hurricane. Other times less so, as when a refinery goes offline for periodic maintenance, thus tightening fuel reserves. Taxes at the federal, state and local level must be factored into the calculation of gas prices. There are also recurrent charges of “price-gouging” (alleged collusion between oil companies and gas stations to artificially inflate retail gas prices) whenever supply disruptions occur and prices rise at the pump. Despite numerous hearings at the Congressional and state levels to investigate price-gouging, no evidence of such practices has ever been shown (Federal Trade Commission, 2006). To blame price spikes and fluctuations on a shadowy individual or cabal belies the complexity of the processes involved. But one of the foremost contributory factors of increased costs is the impact of environmental regulation at the state and federal levels. Though government policies are intended to protect the environment and consumers, they often interfere with supply and demand, producing price instability in the markets. Many of the same regulations and policies that regulate oil production apply to natural gas production and costs (natural gas and oil fields are often located in the same geographical area), this discussion will be confined to gasoline and crude oil prices. Though there are innumerable components that figure in the price of gasoline, the focus of this essay will deal with the following factors: supply and demand; oil futures; environmental regulations and mandates; research and development (R&D); and tax policy. To understand how oil (specifically crude oil) is priced, a review of some basic economics would be useful. Oil is subject to the same rules of economics as any other product. Economists define prices as a function of the laws of supply and demand. Basically they work the following ways. The law of demand specifies: “If all other factors remain equal, the higher the price of a good, the less people will demand that good. In other words, the higher the price, the lower the quantity demanded,” (Investopedia, Economic Basics, 2009, para. 1); and the law of supply: “Like the law of demand, the law of supply demonstrates the quantities that will be sold at a certain price. But unlike the law of demand, the supply relationship shows an upward slope. This means that the higher the price, the higher the quantity supplied,” (Investopedia, Economic Basics, 2009, para. 2). According to Trench, (2009) the global market determines supply and demand conditions and establishes the price of crude oil, from which gasoline is produced. There are other variables involved, like time and supply, but exploring all the different variables would expand this essay enormously. The commodities market, where oil futures are traded, is another primary factor in oil pricing. Basically a future is a “financial contract obligating the buyer to purchase an asset (or the seller to sell an asset) such as a physical commodity or a financial instrument, at a predetermined future date and price,” (Investopedia, Futures, 2009, para.1). They are called futures because they are an educated guess, a “bet”, as to what the price of a commodity at a future date. A futures contract is usually of three-months duration and the prices are based on estimated supply and probable demand. Speculators who purchase commodity contracts have been maligned as having undue influence in the oil markets. But the funds they use to buy the contracts are their own, and if they guess wrong on the timing or price, they lose their...
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