Economy: The Oil Conundrum

(Drivebycuriosity) - The economic development these days is puzzling. Oil is much cheaper than last year, but the economy doesn`t respond much and US retail sales are still sluggish. Why did cheaper oil not rekindle the economy?

I think there is at last a partial explanation for that: The oil price reduction did not arrive at the consumer yet - at least not fully. The price of oil (Brent Crude) fell 50%, from $116 to $58. But the gasoline price at the pump dropped much less. According to the US automobile association AAA the average US gas price is today $2.751 (last year: $3.574) (fuelgaugereport.). This is just a reduction of 23%. In California, where most of the US car drivers live, is the situation worse (aaa): The average gas price there is $3.872 (last year: $4.044). This is just a minus of 5%.

The meager gas price reduction is not just disappointing. According to the bank Morgan Stanley consumers ignore the gas price drop, because they believe that the price reduction is just temporary (businessinsider).

Why did the gas price fall less than the price of oil? There are a lot of explanations for that: A part of the gas costs at the pump are tax payments, which didn`t fall and are caused by regulations, like the mandatory admixture of ethanol. Both, taxes & regulation, are especially strict in California (latimes).

But, I think there is an additional explanation: The stickiness of prices. Refiners & gas stations are reluctant to reduce prices. It needs time that the competition forces them to adapt their prices to the lower costs. The rising seasonal gas demand in the summer time also stood against price reductions.  There might also be some speculation that oil prices (their costs) will rise soon.

I believe that the price for Brent Crude will stay around $60 - and might even fall below $50 - because the global oil production is much higher than the demand for oil (driveby). Today the refiners enjoy high profits because of the huge difference between crude oil and gas prices. The high profits will motivate them to produce more gasoline which should squeeze gas prices down.

Therefore I expect that gas prices will go down sharply in the coming months - faster than seasonal usual. Next winter the average gas price at the pump could fall below $2.00 - which would conform to the oil price reduction.

Hence falling gas prices should stimulate consumer spending in the coming months and rekindle the sluggish economy.