Stronger Dollar, Waning Demand Should Cause Gas Prices to Retreat

According to the AAA's Daily Fuel Gauge Report, the national average price of gasoline just hit a record $3.72 per gallon, up 35 cents per gallon in just one month. Many consumers now believe the $4.00 mark will be broken very soon.

I am absolutely convinced that the run-up in oil and gasoline prices has more to do with the weak U.S. dollar than it does with supply and demand considerations. To a large extent, Federal Reserve policy decimated the dollar and caused inflation in dollar-denominated commodities. The Fed felt a need to aggressively loosen monetary policy because of the U.S. financial crisis and the slowing economy. However, it went way overboard by slashing the target fed funds rate from 5.25% in September all down to 2% where it stands today. Although the dollar had been weakening against the euro since 2002, the Fed's recent actions contributed to the dollar sell-off and the rush toward oil and other commodities.

This is not to say, however, that supply and demand played no part. Most oil producers are running close to full output and there isn't as much slack in the system as there was in the past. Furthermore, several oil-producing nations have serious problems. In Nigeria, it seems there is a new attack on production facilities almost everyday. Iraq, which has among the largest proven reserves in the world, is still mired in conflict and isn't producing anywhere near its full capability. And Venezuela has hampered its production by nationalizing assets and driving out foreign companies.

As for demand, it continues to climb in China and India. However, demand is actually falling in the U.S. We are currently consuming close to a million barrels of gasoline a day less than we were during last summer's peak. While demand is likely to climb as a new summer season dawns, it is unlikely to rise as much as it usually does if prices remain at elevated levels.

Now that it appears the Fed is through (or almost through) cutting interest rates, there is hope that the dollar will soon start to strengthen. With a stronger dollar and waning U.S. demand for gasoline, it is hard to believe that prices won't ease off a bit from current levels.

Comments

[paultaut]

The Dollar has been stable...stopped dropping but oil continues to rise...Dream on.

There is plently of unrefinable oil, it sits in storage...WTI has peaked...Tar sands, shale oil...so what...where is the refining capacity for this sludge?

[lefty]

The only way for oil to be guided by supply and demand is remove it from the commodity market. Plus, stop selling our oil internationally.