MEDIA CONTACT: Dr. Mike Walden, 919.515.4671 or michael_walden@ncsu.edu

YOU DECIDE: What's behind the good news on gas prices?

By Dr. Mike Walden
North Carolina Cooperative Extension Service

I've noticed something recently that I haven't seen in a long time. When I fill up my vehicle at the neighborhood gas station, I see people actually smiling! They're happy because, since early August, the price-per-gallon of gasoline is down 40 cents, and many experts think more reductions are to come.

To drivers so accustomed to rising gas prices, the recent drop is certainly good news, but it does bring up one big question: why? Does it have something to do with the recent discovery of new oil reserves in the Gulf of Mexico? Is the drop related to the upcoming November elections? Or is it simply the season for lower gas prices?

I'll dismiss the first two explanations. It will take years to get oil flowing from the new Gulf strike, so there should be little impact on gas prices now.

Likewise, the argument that lower gas prices have been engineered to coincide with upcoming elections assumes elected officials can rapidly move the oil and gas markets. Although political decisions about gas taxes, environmental regulations, drilling and refinery construction can affect these markets in the long run, impacting these markets in the short-run is another matter. Plus, none of these factors has been in play in recent weeks.

Instead, the good news on gas prices comes from the economist's old standby -- the fundamental forces of supply and demand. On the supply side, several positive things happened in the last month. First and foremost, with the end of the active hurricane season approaching, the number and severity of hurricanes have been far fewer than originally predicted, and none moved through the oil production- and refinery-packed Gulf of Mexico.

Recent Middle East events have also seemed to calm oil supply jitters. The ceasefire in Lebanon appears to be holding, Iran has made some conciliatory statements and Iraq's oil production is at a two-year high.

Then there's the Organization of Petroleum Exporting Countries' just-concluded meeting at which the oil ministers said collective production would not decline in coming months. While what OPEC actually does can be different than what OPEC says it will do, the announcement was still viewed as a green light for more price declines.

Demand-side forces have also pressed down prices. One is the typical seasonal effect of driving, gas consumption and resultant decreasing gas prices in fall and winter compared to summer. But beyond this seasonal effect is the fact that drivers have been more frugal gasoline users even during the summer. In three of the last four months, gas consumption was lower this year than for the same month last year.

The net result of these basic economic forces — more supply and less demand — means gas inventories have risen and are now 8 percent higher than last year. This is an automatic recipe for lower prices.

But will the good news on gas prices last?

Probably, for at least a few more months, and they may even go lower. I've seen some widely variable forecasts, from a modest drop to just above $2 per gallon to a plummet to near $1 a gallon. Much depends on the kind of winter we'll have and the demand for home heating oil, which competes with gasoline for crude oil.

We've learned two clear lessons about the gas market in the past couple of years: (1) gas prices can turn rapidly, both up and down, and (2) gas prices are very difficult to predict.

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Dr. Mike Walden is a William Neal Reynolds Professor and extension
economist in the Department of Agricultural and Resource Economics of North
Carolina State University's College of Agriculture and Life Sciences. He
teaches and writes on personal finance, economic outlook and public policy.
His You Decide column is provided every two weeks by the Department of
Communication Services. Earlier You Decide columns are available on the Web
at http://www.cals.ncsu.edu/agcomm/writing/walden/decide.htm
Related audio files are at
http://www.ces.ncsu.edu/depts/agcomm/writing/walden/index.html