Why gas prices are so low

Global crude oil prices have sunk dramatically, falling to nearly $80 a barrel – a 30 percent drop from June. Unleaded regular gasoline prices are now under $3 a gallon. Falling prices are a boon to industrialized nations, but they shouldn’t make the mistake of assuming that oil will remain cheap indefinitely.

If you ask 10 experts why oil prices are so volatile, you are likely to get 10 different answers. But they all boil down to supply and demand.

In recent years, the ranks of major economic achievers were swelled by the emergence of formerly developing third world nations – especially population giants like India and China. The result was a significant increase in the number of middle- and upper-class consumers eager to enjoy a more lavish lifestyle. Such a lifestyle inevitably meant higher consumption of oil products, which generated upward price pressure.

The reason crude oil prices have been falling since early June is the global economic slowdown, especially in Asia and Europe. Demand is down at a time when oil is abundant, especially with substantial increases in U.S. production, which is at its highest level in 30 years thanks to shale oil drilling in North Dakota and Texas. United States crude oil production has climbed to just over nine million barrels a day and is projected to approach 9.5 million next spring. Adding to the excess supply, production is up in Russia as well.

As a result, imports from the 12 OPEC countries responsible for about a third of global production have been cut in half. OPEC members who rely on higher oil prices to balance their budgets wanted to announce production cuts at their Thanksgiving Day meeting in Vienna and are looking for Saudi Arabia to take the lead.

The decline in crude oil prices accelerated last month when the Saudis, the world’s largest oil producer at 9.6 million barrels daily, cut the price of exports to the United States in an effort to retain its shrinking market share and, some speculate, undercut America’s oil shale bonanza. The thought is that the Saudis can push the price of crude oil below $50 per barrel and still make money.

In the past, oil producers struggled to respond to the problems of letting supply run wild by developing “gentlemen agreements” to control supply in “rational” ways. The most notorious of these producer cartels is OPEC.

The difficulty with the cartels is that many of their members aren’t gentlemen. They can’t resist opportunities to make hay while the sun shines by sneaking extra oil onto world markets to take advantage of temporary price spikes or marching to the beat of their own drummer and cutting prices, causing other members to wrinkle their noises in disgust- before joining the party so they don’t get left behind.

One of the few economic laws that’s truly ironclad is the practical impossibility of enforcing cartel supply and price restrictions without the kind of outright physical violence that is generally only acceptable among New York’s Five Families.

Falling oil prices are providing a boost to the U.S. economy with lower costs for consumers and energy­ sensitive industries. It has been estimated that the cut in crude oil prices to $80 a barrel is the equivalent of a $600 tax cut for every household. This should be music to the ears of retailers who had been bracing for a slow-growth holiday shopping season.

originally published: November 29, 2014

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