Money Mondays: Gas Prices Heading Downward

Mellody Hobson is President of Ariel investments, a Chicago-based money management firm that serves individual investors and retirement plans through its no-load mutual funds and separate accounts.

Additionally, she is a regular financial contributor and analyst for CBS News.

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TOM: Good morning, Mellody!

MELLODY: Good morning, Tom!

TOM: This morning we are talking about lower gas prices, and that is welcome news.

MELLODY: it certainly is, Tom. After experiencing some of the highest gas prices on record in recent years, prices at the pump have dropped to their lowest levels in 5 years. That is not only a boon for all of us, but it is also likely to give our economy a boost as well.

TOM: That is great to hear, Mellody! Can you tell us what is causing prices to drop?

MELLODY: Well, Tom, for the most part this is basic supply and demand, and there are a few big factors that are helping to keep the price of oil, and therefore gas, low. First things first: demand. In the past few years the global economy has driven demand for oil, even in the dark days of the great recession. That was primarily the result of oil-thirsty economies in emerging countries like China, Brazil and India. However, these economies have slowed in the past 12-18 months, and European economic growth has remained weak as well. This, coupled with less reliance on foreign oil in the US, and you have a recipe for prices to dip. This dip in demand has also been helped along on the supply side. The big name in oil supply worldwide is OPEC, the Organization of Petroleum Exporting Countries. This cartel of countries accounts for 40% of the world’s oil supply! Generally, OPEC nations coordinate their production levels to keep oil prices higher than they are now.

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However, due to recent disagreements this process has been rockier, so there has been more oil on the market, allowing the price to fall. Two other reasons we are seeing prices go down? A big one is the strong dollar. Because oil is priced in US dollars, when the dollar is strong, it means that oil is cheaper. As the dollar has strengthened dramatically since early summer, the price of oil has dropped from over $100 per barrel to under $85 per barrel. Finally, the last piece of this is that we have seen the switch to winter-grade fuel, which is cheaper to produce. Every year, refineries switch their production between winter and summer-grade fuel, and summer grade is more expensive. Now that we have changed over, that has contributed to the price you pay at the pump going down.

TOM: We have also heard about U.S. energy production too.

MELLODY: That is another big, big factor, Tom. The United States has experienced a renaissance in its energy sector in recent years that is turning past predictions on their head. You may have heard about the new fields in North Dakota and Texas. Because of these finds, American oil production is up 45% over the past five years, from 1.83 billion barrels of oil to 2.7 billion barrels annually. Natural gas production has exploded, with new sources – particularly shale deposits – being tapped across the country. Both of these developments have helped to more than halve energy imports as a percentage of GDP, from 2.8% to 1.3%. But it isn’t just about production.

It is also a result of policy. Under this president, we have seen a huge increase in America’s fuel efficiency standards, which were raised in 2011, and which will continue to rise dramatically over the next 11 years to 54 miles per gallon for cars and light trucks. Additionally, with natural gas expected to continue to be cheap and abundant, more and more companies such as ups and FedEx, as well as municipalities, are converting to natural gas fuel vehicles. So America’s changing automotive fleet is helping change the demand equation.

TOM: What can our listeners expect on the gas front?

MELLODY: More money in their pocket, for one! Lower fuel prices are always great for consumers. Right now, Americans are paying about 20 cents less per gallon than this time last year, and since July the prices have come down about 50 cents a gallon on average. Because of this, the average person can expect to save a little over $300 on this year when it comes to their gasoline bills. And that is not just good for consumers, but for the economy, as 70% of our economy is driven by consumer spending! It could mean a little more cheer for the Christmas season, or better yet a little more money in that retirement account! You know what I always say about unexpected financial windfalls, Tom.

TOM: I do. Thanks for joining us this morning, Mellody!

MELLODY: You are welcome, Tom!

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