There is plenty of media coverage right now about rising gas prices. According to some projections, the national average of the price of a gallon of gas will be over $4 by the start of summer. In fact, it is already above that level in Alaska, Hawaii and California.
Unfortunately, no one seems to have a concrete explanation about why gas prices are spiking.
At a speech at the University of Miami Thursday, President Obama said there are no quick fixes to the problem. He said America needs an energy program that includes oil, [natural] gas, wind and solar power. What he did not mention is that wind and solar generally cost more than oil. And he did not give any specific explanation about why gas prices are going up now.
Some attribute the increase to growing global demand, pointing to increasing auto usage in places like China and India. But that explanation doesn’t really pass muster because there has not been a significant increase in demand over the past month and long-term U.S. demand is declining.
After peaking in 2007, gasoline usage in the U.S. in 2011 was about the same level as in 2004. In other words, domestic demand for gas is falling, not increasing. That means one would expect a softening of prices.
In fact, because of weak demand, the U.S. industry is exporting gasoline, diesel and jet fuel. Here is a quote from an article by Ron Scherer in the Christian Science Monitor:
“Compared to a year ago, exports of gasoline have tripled – at a time when the price of gasoline is 42 cents a gallon more expensive at the pump. On Thursday, for example, the price of crude oil remained elevated at $107 a barrel because of fears over the Iranian nuclear situation, and the price of gasoline rose 3 cents a gallon compared to Wednesday, according to AAA.
“The oil industry maintains the exports are necessary because domestic demand is weak. The industry says if refiners could not send American-made gasoline to China, India, Europe, and South America, the refineries would have to close as several have already done on the East Coast. Yet, other energy observers say exporting gasoline at a time of rising prices is sort of like throwing flammable liquid on a fire.”
Based on a historical perspective of oil prices, there is no reason for gas prices to be approaching record levels. The chart below shows the price of USO, a domestic exchange traded security designed to track the movements of light, sweet crude oil, over the past five years. While the oil price has risen recently, it is still below its highest levels of 2011 and well below the highest levels of 2007 and 2008.

The next chart shows a comparison of the price of USO and the U.S. dollar over the past three months. The value of the dollar has been falling since mid-January. That is at least partially responsible for the rise in oil prices.

Oil is a global commodity priced in U.S. dollars. That means the price of oil automatically rises any time the dollar loses value. However, the increased oil price is disproportionately large when compared to the drop in the dollar.
The best explanation for the current price spike is likely speculation in the oil futures markets. An article about this possibility by Dan Burrows on CBS Money Watch, references research by Ed Yardeni, president of Yardeni Research.
“Oil futures traded on the New York Mercantile Exchange have leaped above $106 a barrel. The current national average for a gallon of regular gas stands at $3.61, up from $3.19 a year ago, according to AAA’s fuel gauge report. That’s the highest price at the pump ever for this time of year.
“But speculators in the gas futures markets are largely to blame, according to Yardeni, not demand. ‘Large speculators and small traders were net long a record 101,926 [gas futures] contracts on February 14,’ Yardeni writes in a note to clients.
“Since each contract is for 42,000 gallons, or 1,000 barrels, of gas, and gasoline inventories in the U.S. stood at 232 million barrels, ‘speculators and traders, in effect, held a record 43.8 percent of U.S. inventories,’ Yardeni says.”
What all that really means is that because speculators control almost half of the U.S. supply of oil, a speculative bet that the price of oil is going to rise becomes a self-fulfilling prophecy.
Unrest in the Middle East is the likely cause for speculators betting on higher oil prices. If war breaks out and disrupts the supply of Middle Eastern oil, then crude prices are likely to skyrocket and the speculators who have already locked in supplies of crude at higher prices will see a substantial increase in the value of their contracts.
All of this is bad news for the U.S. economy and likely for investors. Rising gas prices act like a brake on economic activity. Higher fuel costs impact virtually every aspect of the economy and get passed on to consumers rather quickly. That will lead to a decrease in consumer spending, which makes up about 70% of U.S. economic activity.
Right now the U.S. stock market is in the midst of its longest and strongest advance in many months. If the price of gas keeps rising watch for this rally to come to an abrupt end fairly soon.
Flint Stephens