Gas Prices a Living Lab for Economists – Hobart and William Smith Colleges \
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Gas Prices a Living Lab for Economists

Associate Professor of Economics and Chair of the Environmental Studies Program Tom Drennen recently spoke with Rachel Ward in the WXXI newsroom. WXXI is the public broadcast station in Rochester, N.Y. Drennen discussed the high gas prices as we approach the summer driving season and explained the annual rise in price comes from producers trying to “transition immediately from the high demand for home heating oil in the winter, to high demand for gasoline for summer travel.”

Drennen also noted the impact of the futures market on the price of gas, noting increases in futures prices directly impacts supplier pricing to consumers.

“Even if a company already owns the [gas], if prices on the futures market are 20 cents per gallon higher, they’re going to charge 20 cents per gallon more, because they’re thinking ‘OK, if I use this gallon, I’ve got to replace it and it’s going to cost me more’,” he said to host Rachel Ward. They also discussed consumers’ inability to “hedge against future price hikes,” and why prices this summer are rising as an aftershock to last summer’s high prices.

Among the most unique aspects of the gas price situation over the past several years is the opportunity it has presented to economists. Drennen called it a “living laboratory.”

“Economists have wondered for years, what would be the price at which the American consumer would actually say ‘maybe I won’t buy an SUV, maybe I’ll drive less, maybe I’ll consider where I live and not just assume that I that can drive there,’ and that price turned out to be $4 a gallon. It was like a magical point at which all of the sudden the American consumer said ‘that’s it, it’s too much’.”

He goes on to present possible solutions to the gas pricing issue, noting less reliance on oil and a federal gas tax.

The complete article from WXXI follows.


WXXI
Rising Gas Prices Offer Intro to Econ at the Pump

Rachel Ward• WXXI • June 8, 2009

It’s the same old summer story: as the Fourth of July travel season draws closer, gas prices climb higher. On Monday, AAA’s “Fuel Gauge” report showed the average price per gallon in the Rochester metro area was $2.67 a gallon, up from $2.26 a month ago.

Hobart and William Smith Colleges economics professor Tom Drennen says the phenomenon happens every year, as producers transition immediately from the high demand for home heating oil in the winter, to high demand for gasoline for summer travel.

But the cyclical strain on supply is only one of the many factors that underlie the volatile price of gas. Drennen says another big factor is the futures markets that traders use to hedge against price increases, or to speculate for profit.

“Even if a company already owns the [gas], if prices on the futures market are 20 cents per gallon higher, they’re going to charge 20 cents per gallon more, because they’re thinking ‘OK, if I use this gallon, I’ve got to replace it and it’s going to cost me more’.”

While the futures markets manipulate the prices that consumers pay, there’s no way for consumers to take advantage of their ability to hedge against future price hikes, like airlines do (though home heating oil or propane users can lock in rates during the summer in anticipation of winter price hikes). Drennen says he has no idea why gas stations haven’t yet come up with a similar concept.

Prices this summer are also rising because gas stations are working to recover from last year’s high prices. Drennen says when prices are high, suppliers don’t lay in as much gas, but now that prices are lower, they’re feverishly buying to replenish their stores. That can cause the price to rise at the pump, even though the underlying price per barrel isn’t high. Right now, oil is retailing for around $66 a barrel, but last summer, when gas prices climbed to over $4 a gallon, gas was at $147 for a barrel.

But while gas prices over the last year have been problematic for consumers, they’ve been a boon for economists. Drennen says the prices have provided a living laboratory.

“Economists have wondered for years, what would be the price at which the American consumer would actually say ‘maybe I won’t buy an SUV, maybe I’ll drive less, maybe I’ll consider where I live and not just assume that I that can drive there,’ and that price turned out to be $4 a gallon. It was like a magical point at which all of the sudden the American consumer said ‘that’s it, it’s too much’.”

Drennen says the only long-term solution for combating the cyclical and speculative nature of gas pricing is to reduce reliance on oil, by developing sustainable alternatives.

It can be tough though, to bring those technologies online, in a climate where consumers change their behavior and start seeking alternatives at $4 a gallon – but hop back into the SUV when the price drops back.

Drennen says a federal tax that would hold gas prices steady at $3.50 a gallon, no matter what the underlying cost of oil, could provide additional funding for the nation’s crumbling infrastructure, and for alternative fuels research. But he says the public outcry over fill-ups topping $4 a gallon last summer mean that idea would likely be unpopular and improbable, with politicians and the public alike.