As we approach Memorial Day, the traditional start of the U.S. summer driving season, there's bad news and good news for motorists.
First, the bad news: Early in the summer, gasoline prices will be considerably higher than they were a year earlier -- in some areas, more than 30% higher. A price bump that large cuts into budgets, and sometimes changes vacation plans. On Friday, the average U.S. price of unleaded regular was $2.83 per gallon, according to data collected by gasbuddy.com. A year ago, it was $2.38.
Now, the good news: The recent plunge in the price of oil means that later in the summer, gasoline prices are likely to drop considerably, provided crude prices remain at or below current levels. Some regions of the country may see price drops of 25% or more, returning gasoline prices to near last year's levels.
Oil prices have plummeted 20% during the past two weeks, from about $88 per barrel to about $70 on Friday, due to concern that measures being taken by debt-plagued European countries to cut their budget deficits will slow Europe's economy, decreasing demand for crude.
Further, if Europe's economy does slow, the U.S. economy -- with which it is deeply intertwined commercially -- will likely be affected, as well, reducing oil demand further and putting additional downward pressure on its price.
Oil: A Vital but Volatile Commodity
The past two weeks have witnessed a remarkable turnaround in sentiment regarding crude oil. In March, Goldman Sachs reiterated its forecast that oil would hit $95 per barrel in early 2011, and for a while this spring, that analysis looked prescient: Oil pushed though $87 and appeared poised to clear the $90 level.
But then the Greek debt crisis became the focal point of investors' concerns, and shortly thereafter, word of government debt problems in Spain, Portugal, Italy, and Ireland surfaced. The European Union did pass a $1 trillion stabilization package of aid, loans, and loan guarantees, but even that wasn't enough to reverse the shift in sentiment, which now foresees slower GDP growth in Europe, the U.S., and globally, reducing demand for oil.
"It's all about the EU debt crisis and whether it's leading Europe into another recession, with a negative impact on oil demand," Andy Sommer, an analyst at EGL AG in Dietikon, Switzerland, told Bloomberg on Friday.
Thanks to the fall in oil's price, gasoline prices are declining, and will continue to do so unless oil's price rebounds. Every $1 drop in crude oil's per-barrel price deceases the cost of gasoline made from that crude by about 2.5 cents per gallon. Hence, a $20 drop in oil should lower gasoline prices by around 50 cents per gallon, if refiners and gasoline stations pass on those savings to consumers. Lower gasoline prices also boost U.S. economic growth: Each 1 cent drop in gasoline increases U.S. GDP by about $1 billion per year. In that sense, a dip in gas prices is like a tax cut.
So far, wholesale gasoline prices -- the cost of gasoline from the refinery -- have declined in lock-step with the plunge in oil prices. Two weeks ago, wholesale unleaded gasoline sold for $2.46 per gallon -- a two-year high. On Thursday, it had fallen 50 cents to $1.96 per gallon.
Will Gas Stations Lower Prices?
The obvious question is how quickly gas stations will pass along their wholesale savings to their customers. As motorists probably know from personal experience, many gas stations tend to delay lowering their prices for as long as possible.
But history also shows that eventually, market competition forces gas stations to reduce prices, and the nation is already starting to see signs of price cuts. Prices in Huntington, W.Va., had fallen six cents this week to an average of $2.87 per gallon. In metro Los Angeles, the average had fallen four cents to $3.09 per gallon.
Hence, assuming oil's price drop to about $70 holds, gasoline prices should drop in most regions of the U.S. by at least 30 cents to 40 cents per gallon. Some areas could see even larger price declines, though some high-demand areas might see smaller ones.
True, gasoline prices would have to fall about 45 cents to return to last year's $2.38 per gallon spring average, but after a string of cost increases, American motorists will probably be glad to know some good economic news is just down the road.
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