Tuesday, August 5, 2008

Gas prices will fall with oil

I am not surprised to see that the New York Times, the paper that exploits the most negative news that it can, does not headline the sharp reduction in oil and gas prices. The biggest news regarding the economic outlook: Gas prices are falling with oil.

The markets certainly agree: The Dow closed at +2.94%; the S&P 500 closed at +2.87%; the Nasdaq Composite closed at +2.81%; the Russell 2000 closed at +2.4%; the dollar was up against the Yen; the 10-year treasury yield rose to 4.02%; oil closed below $120/barrel at $118.58/barrel.

Finally, some truly good news! The interpretation of the data is infallible: oil prices are falling. The West Texas Intermediate spot price closed today at $118.58/barrel, which is a $26/barrel drop since the beginning of July (1 month), when oil was eking toward the $150/barrel mark. You will only read this in papers like the Wall Street Journal because it is good news.

What happens to gas prices?

I know that you all remember the beginning of July when the national gas price hit $4.10/gallon. Well, as of August 4, 2008, gas prices have relaxed a bit, 22 cents/gallon to be specific. Gas refineries have seen a sharp reduction in the price of oil and are passing some of the reduction in cost to the consumer with lower gas prices.

Where will gas prices be next week (August 11, 2008 as measured by the Energy Information Administration)?

The chart shows that there is a strong and positive correlation between the price of oil and the price of gas. This means: Rising price of oil → rising gas prices, and falling price of oil → falling gas prices.

I estimate the exact relationship using weekly data on the price of oil (WTI) and the price of gas spanning the years 1994 to 2008. Statistically, for each 1% change in the price of oil, the price of gas will go in the same direction by 0.6%.

For measured prices (the latest data point is August 4, 2008), gas prices this coming Monday (August 8) will register around $3.86/gallon. However, in current time, this means the following (which is slightly off, given the lag in gas price measurements): If oil falls another 1% from today’s reading, $118.58/barrel, to $117.39/barrel, the national gas price will fall from the current $3.88/gallon to $3.76/gallon. Go oil! This certainly reduces the strain on consumers and the outlook for the economy!

Please leave comments. Best, Nontruths

1 comment:

  1. Love the summertime when the refiners are at full throttle! We have $3.81 gas here at the moment and dropping fast. As long as Americans don't increase their driving miles (demand), this could be a great Labor Day weekend. Utah went to a four day workweek. It is interesting that BBL goes hand in hand with Gal. Always thought the refining capacity had something to do with it (California).


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