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Slowing economy helps keep down gas prices

With the economy slowing sharply, consumers are pulling back. But they're also  catching a break from an unlikely source — the gas pump.  By's John W. Schoen.
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With the U.S. economy slowing sharply, American consumers are pulling back. The Bush administration and Congress are handing out tax rebates worth hundreds of dollars per person to help blunt the slump. But consumers are also catching a break from another, unlikely source — the gas pump.

Last year's surge in energy prices came as a booming global economy helped fuel demand, especially as rapidly developing countries like China paid whatever it took to keep their growth machines humming. Now as that growth is slowing, especially in the U.S., energy consumers are taking their foot off the gas. One result is a drop in demand and a buildup of inventories — factors that have sent prices falling.

The slowdown in gasoline demand was one of many topics discussed at a gathering here of oil executives, investors and the media hosted by Cambridge Energy Research Associates.

John Hess, CEO of independent oil producer and refiner Hess Corp., told reporters his company began to see demand for gasoline ease — and in some cases decline — beginning in the fourth quarter of last year.

“I think that speaks to the serious economic downturn the U.S. economy is going through,” he said.

Forecasters are divided on just how rapidly the economy is slowing, or how long the downturn will persist. Oil executives here noted that any drop in demand will be temporary as the world’s thirst for oil continues to grow. In the short term, though, Energy Department data confirms that as demand has softened, inventories have been building. That has produced a drop in prices of 12 cents a gallon since the first of the year, to just below $3 on average nationwide.

On top of the seasonal decline in driving, businesses are also cutting back on gasoline consumption as the economy slows, analysts said.

“We tend to think of commuting or vacation,” said Geoff Sundstrom, a spokesman for the American Automobile Association. “But when you think about the various tradesmen out on the road, the salespeople, the short-haul deliveries that get made, as the economy weakens, particularly in the construction sector, there’s just less gasoline consumed."

Refiners, meanwhile, have seen inventories build. Some have cut back production during the slack winter months to complete annual maintenance and finish repairs on a series of outages that crimped supplies last year. Those unplanned outages came after several years of overhaul to meet new low-sulfur refining standards and the phaseout of a clean fuel additive, MTBE. With those modifications behind it, the refining industry is in better shape that it has been in a while, according to Tom Kloza, publisher at the Oil Price Information Service.

“It’s tough for me to come up with a scenario that matches the supply problems last year,” he said.

Pump prices also have been coming down as dealers rely more heavily on ethanol, which is finding its way to more parts of the country in larger quantities. (Because the corn-based biofuel can’t be shipped by pipeline, transportation bottlenecks have slowed the flow of ethanol outside the Farm Belt.) Heavy government subsidies have helped spur a surge in production, keeping ethanol prices below the cost of gasoline. So every gallon of gasoline that is cut with ethanol is cheaper to produce.

Some consumers may be using less gas because they can’t afford it. But even as prices have surged, motor fuel still consumes a relatively small portion of most household budgets. Still, slumping SUV sales — while bad for car makers’ bottom lines — are gradually increasing the overall mileage of the fleet of vehicles on the road. And that’s beginning to have an impact, says Sundstrom of AAA.

Lower gasoline prices have taken a bite out of record high profit margins for refiners, who are still paying $90 a barrel for crude, roughly 60 percent more than they were paying a year ago. Profit margins collapsed by some 70 percent in the second half of last year.

The drop in energy prices — due in part to the weakening economy — could help blunt the downturn, especially if pump prices remain tame and consumers feel more like spending. But the impact may be limited. As the global economy boomed earlier in the decade, and oil prices went from $25 to $100 a barrel, the impact of the surge was muted by the fact that the economy uses about half as much oil per dollar of gross domestic product as it did in the 1970s. Now, with demand slackening, the impact on the downside may be muted as well.

“Oil prices dropping are going to be a help and probably a bigger help than the stimulus,” Harvard University economist Kenneth Rogoff told reporters at the CERA conference. “But it’s not going to untangle the subprime mortgage mess.”

Unless the economic downturn gets substantially worse, seasonal demand for gasoline is expected to pick up again this summer. But forecasters have been scaling back estimates of just how high prices will go.

Gasoline is now expected to peak at a record $3.40 a gallon in the spring, according to the latest forecast from the Energy Information Agency. That is less than the $3.50 spike the EIA predicted in last month’s report.

Crude oil, pegged by the EIA last month at an average price of $87 a barrel this year, is now expected to average $86.46 a barrel. Prices are expected to fall next year.

Few here expect the softening in energy prices to last once the economy gets back on its feet. Oil executives spent much of the conference discussing how and where they hoped to find enough new crude production to both replace the decline in output from aging fields and meet the expected increase in demand over the coming decades.

Despite major advances in technology, the industry faces a series of problems keeping markets supplied — from an aging workforce to geopolitical turmoil in oil rich regions. Beyond looking for ways to boost oil supplies, this year’s conference found greater consensus on the need to reduce demand by boosting auto mileage and speeding research into fossil fuel alternatives like fuel cells.

So while the current economic downturn may offer the industry a bit of breathing room, any softening of demand is only temporary, said Hess.

“An oil crisis is coming in the next 10 years,” he told his industry colleagues. "That means we have to act now.”