Analysis on how gasoline prices are determined - Term Paper Example

Since the past couple of years, the world economy has been on a delicate stage, and growth has been pretty slow. In fact, American and the rest of the world has faced a severe recession and financial turmoil, which has left many unemployed and struggling to live. One of the main reasons for a global recession is gasoline prices, which has seen wobbly fluctuations. In this paper, we will look into the economics of gasoline, and how has it turned into a crisis. Introduction This paper would provide a complete analysis on how gasoline prices are determined, and how are prices influenced. The paper would introduce the determinants of gasoline prices. Furthermore, this paper would examine the problems that America and the rest of the world would face in a severe gasoline crisis. Also, the role of the Organization of the Petroleum Exporting Countries (OPEC) would be discussed to give an overview of their importance. At the end of the paper, I would provide alternatives that could prove to be life saving for the world, and the role of the government in reducing America’s dependence on oil. Our topic structure would look as follows: Rationale for Gasoline Crisis The factors of the gasoline crisis (St. Louis Journal) that we face today are as follows: Supply The role of the government The public Supply has played a major part in the wake of today’s gasoline crisis. World data suggests that there is currently no shortage of gasoline, but being the bellwether of the world economy, the U.S. itself consumes 25% of the world’s fuel. America, as a whole, consumes around 21 million barrels a day, and imports 62% of its daily consumption. This fact is sufficient to prove that an oil crisis is inevitable, given our consumption. Furthermore, the role of the government has been an advocate of the gasoline crisis. The government has set policies and laws that do not give tax incentives for oil exploration and development. America is a huge fuel consumer, but it can be a ground of huge fuel production, provided that investors are given the proper environment and support by the government. Support in the form of tax incentives and exemptions would attract the biggest investors. The past few years have seen investors dried up, and in order to cover the revenue which foreign investors bring with them, the government started to put a gasoline taxes on the final produce, thereby contributing to a increase in gasoline price to the final consumer. Moreover, the public is also to blame, since the people have consumed extra gasoline. When I say extra gasoline, I mean to say that the people have been forgiving to the automakers who have delivered powerful, yet inefficient vehicles, and consumers have relied on those vehicles. According to an article in WashingtonPost, ‘Americans should control greed by paying for what is needed, or should pay more of the real price for using more than what is needed.’ Demand and Supply (Price Determinants) In the international market, price for every good is determined by market forces. The capitalistic system gives freedom to the market forces, and prices are determined by demand and supply. Demand is the willingness of the consumer to buy at a particular price, whereas supply is the willingness of the producer to produce at a given price. For instance, an increase in demand for gasoline would increase prices, and an increase in supply of gasoline would contain or reduce prices. During the past few years, the world economy has seen significant growth, particularly in emerging economies such as China, India and Brazil etc. This has resulted in optimistic growth prospects, and has dramatically increased demand. Thus, gasoline prices are on a steady rise. Moreover, gasoline prices are affected by the negative relationship of the U.S. dollar and crude oil. Crude Oil and Gold are traded in the international market in U.S. dollars, and this has been agreed by OPEC. Usually, an increase in dollar value causes a decrease in crude price, and vice versa. Before 1971, the U.S. dollar was backed by gold, and changes in price of oil didn’t have an effect on producer profits, as gold had intrinsic value. However, after 1971, dollar was made a fiat currency, and was printed without gold backing. This made it easy for the American government to print money, and hence increase supply. In the last 35-40 years, dollar value has declined significantly amid ever-increasing money supply in the U.S. economy. Therefore, when dollar falls (real value decreases), producers ask for more money to compensate the loss in their real value assets, which are based on U.S. dollars. Besides these factors, the OPEC, which holds two-thirds of the world’s fuel reserves, plays a vital role. Refining is done on a large scale in these countries, and they accumulate a lot of the world’s oil production. For instance, Iraq is a oil rich country, but the war in Iraq has closed many refineries. Therefore, supply has been disrupted and prices increase as a result of supply shortfall. Also, refineries across the world keep inventory level to cope with emergencies, such as strikes. The level of inventory that is kept at refineries in the Middle-East and the U.S. is an important price setter, owing to production stoppages. Furthermore, America sees a change in gasoline prices due to seasonal demand. Usually, people tend to drive more in the summer months, and price increases a bit in the summer (US Department of Energy). Moreover, the price of gasoline is also affected regionally and locally through competition. The more difficult it is to get gasoline in an area, the higher the price. You might have noticed that two neighbor gas stations might have a different price. These prices are a result of the owner’s profit margin. After paying for production costs, government taxes, distribution and franchising costs, the owner adds a margin for carrying out the operation of the gas station. Sustainable Development and Innovation The existing oil refineries of the world have to be more efficient, and utilize their full capacity to gain economies of scale. The refineries should also invest to establish temporary facilities for oil refining and production, in times of maintenance for the existing production facility. This would keep supply intact with demand, and would keep prices constant. Furthermore, automakers around the world should produce hybrid vehicles which are relatively efficient. The big automakers should invest in R & D to develop vehicles with newer technologies, and the government should offer support in the form of tax exemptions. Alternative Sources, Challenges and Solutions The only way to control gasoline prices is to reduce our dependence on it, and hence reduce consumption. There are several ways to do this, but some of the most common are: drive less and when needed, use public transit more often, and use another fuel as an alternative (Gorski, George).First, reducing consumption is what America and the rest of the world needs. Crude oil is a non-renewable resource and everyone should consume it, but in limits. Second, we should use public transit more often to reduce traffic on expressways, and save millions of barrels of consumption annually. Furthermore, only few public vehicles would use fuel instead of numerous private vehicles. Last, we should consider using other fuels as alternatives. Some of the alternative fuels are Liquid Petroleum Gas (LPG), diesel, Compressed Natural Gas (CNG), solar energy etc. CNG and LPG are much cheaper than gasoline, and they are much more environmentally friendly. Use of these fuels would not only save countless bucks, but would also preserve the environment of excessive pollution and depletion of oil sooner rather than later. Conclusion In short, the world’s challenges are to keep production going at a constant rate, and try to increase. At the same time, producers, with assistance from OPEC and respective governments have to keep high inventory levels to offset a period of zero production. Furthermore, the governments of various countries should consider allocating a heavier budget to oil exploration. In my opinion, the price of gasoline would increase, at least in the foreseeable future. Although the world is undergoing a severe recession, the prospects for recovery and growth are high, and consumers would be confident of a quick recovery. Furthermore, the proposed changes such as full capacity utilization would take time to accomplish. Also, the political tensions in the Middle-East look to intensify in the near future and that can disrupt supply. Even with the technology that is available, adapting to other forms of energy would be a difficult task for businesses and individuals alike. For instance, if CNG is used, it would take some time before America and other countries have easy access to CNG, since investors won’t take a risk of opening too many retail locations. All in all, I feel that the future can be bright and crude oil can be utilized to the fullest cheaply, but extra effort would have be exerted by governments to regulate the price of gasoline. Works Cited 1. Brown, Warren. A Gas Crisis 30 Years in the Making. WashingtonPost Online. 27 May. 2007 < http://www.washingtonpost.com/wp-dyn/content/article/2007/05/24/AR2007052401121.html> 2. Gasoline Crisis has been Building for Years. St. Louis Business Journal Online. 21 Oct. 2005 < http://stlouis.bizjournals.com/stlouis/stories/2005/10/24/editorial2.html> 3. Gorski, George. An Alternative to America’s Gasoline Crisis. Article. 22 Jun. 2008 4. Gasoline Price Fluctuations. US Department of Energy. 14 Jul. 2009 http://tonto.eia.doe.gov/energyexplained/index.cfm?page=gasoline_fluctuations 5. The Price of Fuel. < http://www.thepriceoffuel.com/whataffectsfuelpricing/> Read More