Podcast: The trend for gas prices

Gas prices have been easing downward in the last few weeks, welcome relief for consumers. But what is the outlook going forward? Will prices continue to fall? Dennis Hoffman, director of the L. William Seidman Research Institute at the W. P. Carey School of Business, discusses the forces at work in the market and says yes — at least for the short term.

Gas prices have been easing downward in the last few weeks, welcome relief for consumers. But what is the outlook going forward? Will prices continue to fall? Dennis Hoffman, director of the L. William Seidman Research Institute at the W. P. Carey School of Business, discusses the forces at work in the market and says yes — at least for the short term.

Transcript:

Knowledge: Will consumers soon be seeing some relief at the gas pumps? Dennis Hoffman, professor of economics at the W. P. Carey School of Business says yes. In the last two weeks we have seen a consistent drop in the price of a barrel of oil. Is this trending towards something the consumers are going to see at the gas stations?

Dennis Hoffman: It absolutely will result in lower prices at the pump. The question is when. And the way to assess that is to think about the way the supply chain process works in gasoline distribution. What we see is the wholesale prices of gasoline, oil, natural gas, etcetera, quoted on the NYNEX daily in New York. And prior to the romp of gasoline at the pump, we saw wholesale prices skyrocketing.

What we have seen in a dramatic fashion over the last approximately two and a half weeks now is a precipitous decline in the price of wholesale gasoline. The price decline in gasoline, I believe in percentage terms, is easily as steep as the decline in the price of crude oil. For perspective, using today's quotes, I believe that the price of wholesale gasoline is down approximately 60 cents a gallon from its peak.

So what we would expect to see from fuel at the pump over the next several weeks is continuing declines in the price of retail fuel. So consumers might ask, "Well, wait a minute. If wholesale prices have come down 60 cents a gallon, why don't I see 60 cents or more down at the pump immediately?" And the answer of course is some of that fuel was purchased at higher wholesale prices and some of that fuel is still in a distribution system, some of that fuel is still in the tanks at local gasoline stations.

And that is why the price has not come down as much as wholesale fuel has come down. But barring changes in this trajectory of wholesale price declines, people at the pump, in Arizona for example, could expect a price of in the $3.50 a gallon range for regular unleaded I would anticipate within the next month or so. Certainly things can change. If wholesale prices spike, those higher priced fuels will get in the pipeline again and this decline in prices will be abated.

But right now it looks very good. And it couldn't come at a better time for the U.S. economy or the Arizona economy in particular. We have been looking at the pace of consumer confidence in the U.S. and in Arizona over the last several years. And we saw consumer confidence indices plummet pretty much coincident with this accelerating cost of fuel.

We saw retail sales and sales consumption fall off pretty much dramatically in Arizona as fuel prices spiked. This won't solve all of the problems with the Arizona or the U.S. economy, but it certainly comes as welcome relief for consumers who have been feeling really pinched by the prices at the pump.

Knowledge: One question to ask is what is driving the lower oil prices right now?

Hoffman: There is considerable debate in the economics profession about what is at the root of, first of all, the run up in oil prices and now this rather abrupt decline. Much of the short-run movement in fuel prices is driven by anticipation. It has been labeled speculative behavior. Behind that speculative behavior is the anticipation or the fear of geo-political shock, events in the Middle East, disruptions in the supply of fuel that caused the buyers to bid up the price of these fuels.

Fundamentally, of course, we have increased pressure from around the world in terms of demand from China, from India, China especially, and from all countries now in terms of the demand for fuel products. And those increased pressures certainly have put upward pressure on the prices of fuel over the last several years. They do not explain, however, the rampant run up over the last few months.

The short-run movement is certainly due to concerns over geo-political events and the speculative activity that takes place as a result of those concerns. So tensions may be easing slightly in the Middle East. Another interesting explanation is China, interestingly, is powering down in anticipation of the Olympics. It is a country that is very, very highly polluted. And one way to deal with the pollution issue, at least in the short run, is to shut down a lot of industry and commerce in China.

I believe that they are doing that. That may certainly have some implications in the short run for fuel. The concern there is that as China powers back up, that demand will re-emerge. Again, that is just simply one aspect of this demand scenario. Other people have pointed out to the fact that people are switching to alternative modes of transportation as gasoline eclipsed first $3 and then $4 a gallon.

And so the question remains: will they continue to use that alternative means of transportation, be it carpooling or mass transit, public transit? Will they continue to do that as prices decline somewhat? Finally, we have seen a sharp decrease in the demand for (high) fuel-consuming vehicles — SUVs for example. Sales of trucks and SUVs are at historically low levels, certainly in comparison with anything in the recent past.

Knowledge: For consumers, realistically, how far are gas prices going to drop?

Hoffman: Time will tell in terms of actually how far prices will fall and how long they will stay down. But it is pretty simple arithmetic right now. If wholesale prices have gone from $3.60 a gallon to … they traded below $3 a gallon just this morning. If wholesale prices can fall 60 cents a gallon, prices at the retail level will fall as well.

The question is what is going to govern those wholesale prices going forward? It is going to be the same factors that have prevailed in recent months? Concerns over the Middle East? Demand issues? Responsiveness to higher prices? Speculative concerns? All of the above will be putting pressure on gasoline prices. And we will simply have to watch and wait and see.

But the only thing that we can know with pretty good predictability is if there is upward pressure on those wholesale prices, if they start climbing back to $3.10, $3.20, $3.30, the relief that consumers will be seeing at the pump will certainly be short-lived. On the other hand, if we continue the trend down in wholesale prices, who knows? Three bucks a gallon may be within our sights. It would have been unthinkable even a month ago. But a 60 cent move is a pretty dramatic move in wholesale prices.