Why is Gas so Expensive?

People often ask, "Why is gas so expensive?" and the answer I hear usually has something to do with greedy oil executives. The real answer comes in three parts, loss of production, speculation and demand. Let's look at all three in some level of detail to see how they influence the price of gas.

We'd all like to blame the big oil companies for raking us over the coals when it comes to the price of gas, but the reality is much different. They have much less to do with the price of gas than the "supply and demand" equation.



Let's look at what has happened, but first, let's look at the old familiar pattern to help us keep things in perspective.

All my life I'd see the price of gas go up on weekends. Why is gas so expensive on the weekends? Because more people are out using it. There is higher demand, and the gas stations (not the oil companies) raise the price to snag a little more profit.

I'd also see gas prices drop in the winter and go back up during the summer. Why is gas so expensive in the summer? Because that's when America takes it's driving vacations, and there is more demand for fuel. A higher demand on steady production makes the commodity worth more, so the fuel suppliers raise the price.

Whether gas prices go up or down, remember that production largely remains the same. The refineries can't afford to start up and shut down - they have to maintain a steady operation. It's less costly that way.

With that as background, let's answer the question "Why is gas so expensive?"

Loss of Production

When hurricane Katrina hit in 2005, we suffered a loss of production capability. I got word from a friend one night that had heard from another friend who worked at a fueling station that the price at the pump was going up about 40 cents the next morning. Indeed it did.

This was in reaction to insufficient supply because of a loss of production. If you can't produce enough product, then relatively speaking, the demand is all the larger and that drives the price up. Here is an example.

There is an upside down airplane on a 1918 airmail stamp with a face value of 24 cents. A man bought a sheet of 100 of these stamps back in 1918 at the post office. He paid $24 for the stamps. The clerk at the post office noticed the misprint and demanded the stamps back from the customer.

The customer stood his ground and sold the plate of stamps the next day for more than one thousand dollars.

This story shows adequate supply at the post office (which sells the stamp at face value), and then a cut back on the supply (to zero), and a huge and immediate price spike (because of zero supply but great demand by collectors). This is essentially what happened with gas prices. Because there was a reduction in supply, the price went up because the demand was still there.

By the way, in 2005, less than 90 years later, a single stamp of this upside down airplane sold for more than a half a million dollars.

At the time of hurricane Katrina, I tried to get filled up with gasoline in my bulk fuel storage tanks. I contacted an independent carrier, not to ask him why is gas so expensive, but to ask him to fill up my tanks because the regular fuel suppliers in the area weren't providing fuel to anyone except the gas stations. Even farmers couldn't get fuel.

The independent fuel supplier told me that this was the first time in his long career that he couldn't get gas. He was turned away at the refinery more than once. He was also told that if he supplied fuel to anyone except the retail outlets, he would no longer be provided fuel - at any price.

Does that answer "Why is gas so expensive?" Not entirely, there was also speculation.



Speculation

The stock market and the futures markets are funny things. Sometimes you can predict what the market reaction will be, and sometimes you can't.

With a recovering production capability, a war ongoing in the Middle East, threats of war with Iran, and people talking about peak oil, there were many who believed that the future price of oil would be much higher, and so lots of money was dumped into oil futures - way more than what normally would be placed there by energy companies during their regular trading.

The speculation essentially created a huge future demand in the marketplace, even though there was a decline in demand (that should drive prices down) and an increase in supply (that should drive prices down). The enormity of the demand for oil, on paper at least, turned the market on its head and caused the price of oil to go up - way up.

This is the primary answer to the question, "Why is gas so expensive?" It was artificially elevated, not by oil companies, but by speculators in the same marketplace as the oil companies.

Demand

There were two agents at work in the area of demand - the marketplace and the trading floor. The trading floor had the greatest effect on the price of gas.

With many investment banks and managed funds moving huge sums of money into the oil market, it made oil companies look like small players. This demand was a key factor in sending oil prices to record highs, and with it went gas prices.

There wasn't a demand by the public, in fact, public demand was reduced primarily by the high prices. As the threat of war with Iran melted away, so did many investors who pulled out of the market. This is what really made the price of oil drop, assisted a bit by reduced demand.

The rise and fall of gas prices was a clear indication that it wasn't influenced just by supply and demand. Americans didn't stop driving their cars. Truckers didn't stop delivering goods. There was a reduction in fuel consumption, but not anything that would account for the extraordinary drop in fuel prices. Something else was at work, and that was the withdrawal of speculative investment in oil futures.

Here is a good video, but rather long, that offers an answer to, "Why is gas so expensive?" It's well done and gives good supporting evidence.

Summary

The bottom line is that the overwhelming majority of Americans are consumers, and that means we are on the end of the whip while the marketplace plays "crack the whip." We can nudge the price of goods up and down a bit over time by our buying habits, but we can't make the market turn upside down like it did.

Other forces make the marketplace turn upside down.

Why is gas so expensive at the pump? Small to moderate increases shown as market trends are due to our habits as consumers. Large and fast increases or decreases in pricing are attributable to factors that are outside our control as consumers. When it comes to gas prices, we've seen the effects of both a natural disaster and a man-made disaster.



Done with Why is Gas so Expensive, back to Are You Frugal

There certainly is a broad scope of topics here at Frugal Living Freedom. When you think about it, money permeates so very many activities in our lives, therefore, being frugal encompasses a wide range of interests, from being employed to taking a vacation, and just about everything in between. Enjoy the variety, pick up some new ideas, and start making frugality a part of your signature.



I'm a big proponent of being debt-free, and I mean entirely debt-free - no mortgage payment. It's not essential for financial freedom, but you'll love the feeling once you get there. If you didn't have a rent or mortgage payment, how much more could you do for yourself with your current level of income? I suspect plenty.











If you ever hope to see an abundance of wealth, you need to plug the hole in your boat. The wealthy don't necessarily make lots of money, instead, they know how to hang onto what they make, and make it work for them.