A Few Questions We All Ask

With gas prices on the rise and no foreseable end in sight, there have been many of us who have been wondering how the gas/oil industry works. So, to educate ourselves a little on this topic, a kindly reporter from Knight Ridder Newspapers put an article together for the masses in a question and answer format that even the least intelligent of us can understand. Remeber these answers when you are at the pump, bemoaning the unfairness of it all.

Why Gas Prices are Soaring

Q. Why are gas prices so high?

A. Global demand for oil has grown quickly in recent years, driven especially by China's and India's fast-growing economies, although the United States remains by far the biggest oil consumer. Global demand for oil is now about 84 million barrels per day. That almost equals the entire supply available; global oil production capacity exceeds demand by only about 1.5 million to 2 million barrels oer day.
In such circumstances, anyone who needs oil soon must pay what the market asks, since there aren't many sellers with excess oil available to seek bargains from. In addition, with the supply demand balance so tight, markets fear that a single terrorist attack, a natural disaster such as a hurricane or earthquake, or even an accident at a major refinery could spark shortages. So buyers are willing to pay higher prices today to ensure that they'll get what they need tomorrow if supplies are short.

Q. Why did oil prices rise so fast?

A. The price of crude oil jumped dramtically in recent weeks in part of heightened fears of shortages. Oil traders are particullary nervous about forecasts of a busier than usual hurricane season. Hurricanes disrupt deliveries by oil tankers and can halt production at offshore rigs in the Gulf of Mexico. They also threaten refineries on the U.S. Gulf Coast. Other factors included temporary shutdowns at some U.S. refineries and U.S. government warnings of possible terrorist attacks in Saudia Arabia, the world's biggest oil producer.

Q. Oil contracts typically are for delivery a month out, so why did gas prices jump along with oil prices instead of a month later?

A. Gasoline retailers say wholesalers are raising costs to gas stations almost immediately as oil prices rise. Dealers pass on that cost to customers as soon as they take delivery from tanker trucks.

Q.Prices in my neighborhood are higher than just a few blocks away. Is this price gouging?

A. No. In a free market, gas stations can charge what the market will bear. Today gas prices are set through "zone pricing." Wholesalers of gasoline have complex software programs that gauge the income and population density of neighborhoods. They set higher prices for retailors in areas with higher income and population density. Essentially, they're charging the most they can get where they can get the most, just as many restaurant chains, shoe stores and grocery stores do. It's just more visible with gasoline.

Q.After rising last week to more than $67 per barrel, oil prices are falling this week to $63.59 on Thursday. Why didn't gas prices drop too?

A. Rockets and feathers. It's an industry expression to say prices rocket up but drop slowly as a feather. Economists have documented this. One dealer said privately that it was simply profit-taking on the way down to make up for the loses when consumers bought less gas because of higher prices.

Q. Aren't oil cartles to blame for the high prices?

A. Today's high prices are driven by demand, not supplier-imposed shortages as in the 197-0's and `80's. The Organization of Petroleum Exporting Countries says its members are pumping oil at almost full throttle and that developed nations should build more refineries. Refineries are working at near capacity and can't keep pace.

Q.So refineries are to blame?

A. Critics allege that refiners avoided addding capacity in order to create a tight market that gives them greater profits. The industry says environmental regulations and local opposition from homeowners make it impossible to site new refineries. Financial experts say low return on investment is the real reason that refineries, which cost billions of dollars, haven't been built for years in the United States.

Q.Is this the peak?

A. Oil analysts have said prices may well exceed $70 a barrel, and a shock event could drive them over $100 a barrel. Gasoline would rise proportinately.

Q.Is relief in sight?

A. Historically, gas prices tend to dip after Labor Day, when the peak summer-driving season ends. But as reifneries shift their mix to produce home heating oil, they'll produce less gasoline, which could keep supplies tight and prices low.

Q. Will prices ever fall significantly?

A. Experts are divided. Award-winning oil historian Daniel Yergin, thinks global production capacity will expand by 2010 to yield another 16 million barrels of oil per day. He suggests there could be an oil glut that causes collapse in prices.
Matthew Simmons, an investment banker who specializes in oil, wrote a contoversial new book, "Twilight in the Desert," suggesting tht Saudi production has peaked and soon will shrink, putting a big dent in world productionn. To Simmons, $3 a gallon sounds cheap compared with what's coming.

Q. Are financial speculators getting rich at the expense of motorists?

A. Speculation clearly plays a part. Oil is sold in contracts for delivery of 500 or 1,000 barrels, so most investors are larger players. Only 5 percent of oil contracts trading on the New York Mercantile Exchange are delivered as oil; the rest are contingency bets, mostly canceled, so there's a lot of paper trading hands.
If you have a company-sponsored retirement plan or invest in a mutual fund, chances are your portfolio is doing well thanks to commodity index funds, energy stock indexes and hedge funds that are active in the oil futures market.

-- Kevin G. Hall, Knight Ridder Newspapers-Thursday, August 18, 2005