Gas Pains: Can We Stomach Even More?

Illustration by M. Ryder

Gas prices: Where's the cost increase coming from?

In mid-May, crude oil, which accounts for 55 percent of the price of gasoline, surged to an all-time trading high of $135 a barrel. Accordingly, gasoline prices, which for months lagged the big run-up in oil, accelerated upward, fueled by the summer travel season.

High gas prices are just the tip of the iceberg. The rising price of oil, up 25 percent in the first quarter of 2008, negatively affects macroeconomic variables from real GDP growth, inflation, and employment to exports/imports and interest rates. In fact, the Energy Information Administration estimates that every $10 per barrel increase in the price of oil will reduce U.S. GDP by approximately $6.9 to $13.8 billion in current dollars.

What's causing high oil prices?

According to High Oil Prices Have Significant Effects on Consumers and the U.S. Economy, published by Congress' Joint Economic Committee, rising prices are the result of "decisions made by OPEC and other oil-producing countries, stagnant production in Iraq, and ongoing concerns about political and supply stability in a number of oil-producing countries."

What's more, since oil is denominated in U.S. dollars, the dollar's 40 percent decline in the last six years has put additional upward pressure on oil prices. And because oil prices are affected by oil futures, which are traded on the commodities futures exchange, prices have also been driven up by the increased speculative buying by institutional investors from pension funds to university endowments that own the largest share of outstanding commodities futures contracts.

Yet the most significant, long-term factor driving oil prices higher may be the greatly increased demand for oil in developing countries, such as China and India.

While experts believe the combination of our nation's increased energy efficiency and the changing composition of output means that the U.S. economy is less vulnerable to high oil prices than it was during the oil crisis of the 1970s, high prices still can have a negative impact on economic growth because of their effects on producer costs. For example, as the price of oil drives the cost of gasoline higher, transportation costs rise, thereby increasing the prices of goods and services.

If those costs can't be passed along to the consumer, unemployment and subsequent decreases in production may result.

As Raymond L. Orbach, under secretary for science at the U.S. Department of Energy, noted in a recent keynote address, because global energy consumption is expected to double -- perhaps triple -- by the end of the century, we should find ways to supply new energy.

To adequately meet the energy demands of the future, Orbach says that "transformational breakthroughs" are needed to provide a foundation for novel, alternative technologies. He believes major advances could be on the horizon because of the emergence of nanotechnology.

Just as the rise in oil prices in the 1970s led to significant breakthroughs in energy efficiency and alternative fuel production, so, too, will today's oil spikes foster scientific exploration and innovation. In fact, because the supply-and-demand curve may drive prices higher throughout the 21st century, we likely will see significant developments in the field of alternative energy sources, many of them driven by the cyclical nature of the oil industry.

Michael L. Schwartz, RFC, CFS, CSA, is a wealth manager and investment advisory representative of First Allied Securities, Inc., and president of a Jenkintown-based wealth-management firm. He can be reached at: mike@schwartzfinancial.com.