Different River

”You can never step in the same river twice.” –Heraclitus

June 19, 2008

Why is the price of gas so high?

Filed under: — Different River @ 10:20 am

Part of the reason for the increase in the price of gas is increased demand from China and India, and supply problems in Nigeria, Venezuela, and Mexico. But the demand increases have developed over many years, and the supply problems over several months — so why the rapid increases on a week-to-week basis?

One reason is the falling value of the U.S. dollar relative to other currencies. Bryan Caplan wrote this up very succinctly, with some good back-of-the-envelope calculations:

Oil is sold on world markets, and the dollar is now very weak. What would the dollar price of gas be today, if the dollar were as strong as it was back in 2002? Here’s a back-of-the-envelope calculation (gas price data are here; exchange rate data are here):

Today a dollar buys you .6451 Euros, and it takes $4.134 to buy a gallon of gas. Suppose the dollar were still at parity with the Euro, as it was on 11/23/2002 (actually 1.0030, but who’s counting?). In that case, a dollar would buy you (1/.6451)=1.55 times as much. So a gallon of gas would be only $2.667.

The actual price of gas back in the third week of November, 2002 was $1.451. So to a first approximation, if the dollar had been stable, gas prices would have risen by about 80%, instead of 280%.

Admittedly, the U.S. is a big player in world oil markets; if the dollar had been stronger, it would have partly raised the world price of oil, and thereby the domestic price of gas. So maybe a stable dollar would have left gas prices 100% higher rather than 80%. If you adjust for the fact that some costs of gasoline (refining, taxes) are purely domestic, maybe gas would have been 150% more expensive even given a stable dollar.

Note that this has nothing to do with “price-gouging” or even with the oil companies at all. Granted, oil companies that own their own oilfields are making a lot of money now — but those that buy oil on the open market and then refine it into gasoline are not necessarily making money at all.

One Response to “Why is the price of gas so high?”

  1. LooseKannon Says:

    We’re going to get what we deserve. An economy that looks a lot like the rest of the scorched earth that Dubya will leave behind. The Emperor will eventually be seen to have no clothes.

    If Obama’s elected, he’d be wise to trot out his supporter Paul Volcker to explain to the nation that there’s some pain to be gone through while the excesses are wrung from the system. Volcker can refer to his success in the ’80s in which he, as Chairman of the Federal Reserve, inflicted relatively short term pain on the nation (around 5 years worth) in order to have it followed by long term (20 years) prosperity.

    This may well make Obama the best one term president in American history.

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