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Gasoline prices will achieve a balance

Like a seesaw, gasoline and oil prices go up, and gasoline and oil prices go down. During the last 12 months, Americans have seen gas sell for the incredibly low price of 80 cents to 90 cents per gallon — as well as what seems like an astronomically high price of $1.80 or more for premium. Prices are now settling down and moving toward the $1.20 to $1.40 range for a gallon of unleaded and are likely to fall to less than $1.20 per gallon.

The high prices made us mad; the low prices made us hit the road in our gas-guzzling vehicles. But to those who live in oil-exporting countries during these fluctuations, particularly in Latin America and the countries of the former Soviet Union, the high prices bring joy to the heart and food to the table, whereas the low prices ensure another year of declining living standards.

Even when gasoline prices were at their highest this year, when adjusted for inflation, the prices U.S. consumers paid were lower than they were in the 1970s.

When our gasoline prices are judged in relation to the gasoline prices in other parts of the world, they seem incredibly low. In much of Europe, where gasoline can sell for $6 or more per gallon, consumers simply do not understand why Americans are complaining. In their eyes, we have a terrific deal. And we do — at least relative to most of the world.

Why do oil prices go up and come down? The answer is relatively simple. Oil is a commodity, produced in dozens of countries and thousands of locations. Although there are different grades of oil, some considered "smelly" and others "sweet," all oil has essentially the same properties, the most important of which is its ability to produce energy — whether in an electric plant, in an automobile or in some other way. To a large extent, one barrel of oil is very much like every other barrel of oil.

When a commodity like oil is traded in relatively free markets, its selling price is almost exclusively a function of supply and demand — creating the seesaw effect. When two 50-pound kids are on a seesaw, one on each side, the seesaw is in balance and both kids are the same distance from the ground. This is similar to the way the oil markets determine price. The price fluctuates until a balance is achieved. When governments (or large businesses) impose constraints on supply, such as the constraints imposed by the Organization of the Petroleum-Exporting Countries and some individual countries last year, supply and demand become unbalanced, and prices rise and fall until the balance is re-established. OPEC decreased the oil supply, causing prices to go up and demand to go down, thus re-establishing balance.

Since the supply constraints imposed by OPEC have been relaxed, we can expect prices to go down and Americans to complain less. However, OPEC and other producers will try to prevent any significant price declines. If the price falls to less than $22 per barrel, producers will likely decrease supply yet again by withholding oil from the market. They may be successful a second time, although it can be difficult to regain the discipline to constrain supply once it has been allowed to increase.

What should we expect? Your answer is probably as valid as any market expert's answer. My prediction is that oil prices will moderate and settle in at around $22 to $24 per barrel, with unleaded gas selling between $1.10 and $1.40 per gallon in the middle and latter part of the summer.

One caveat — most people who predict oil prices turn out to be wrong.

Teddy Coe (coet@unt.edu) is the COPAS/PDI Professor of Accounting and director of the Institute of Petroleum Accounting.

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