Why are gas prices so low now?

I was asked this question today and found that the more reasons I gave, the more reasons I thought of.  I think this speaks to the perfect storm elements that have put us where we are.

Traditional Supply and Demand

1. Two million American jobs have been lost so far this year.  I saw an estimate that 10 million people are under-employed, which the government defines as working part-time when they want to be working full time, rather than the more logical problem of working as a bartender when you have proven ability to run the joint.  If 2 million have actually lost jobs, there have to be a hundred million at this point who are nervous that they might.  These folks drive less and use less gas.  That reduces demand, which makes the price go down.  Some.
2. They also buy less, which means fewer trucks are needed to move goods around the country.  More fuel savings.
3. Whatever fuel and energy went into supporting these 2 million jobs gets reduced.  Factories have been shut down, machines idled, and office buildings emptied out. Air conditioning and heating of these facilities is gone.  Fed-ex shipments have been reduced, restaurant food deliveries have been reduced, office supplies have been reduced.  All of this reduces demand, which lowers the price.
4. Oil is still being pumped out of the ground pretty quickly.  OPEC has voted to reduce supply, but to some degree the reduced price is encouraging member countries to cheat, sell more, and recoup some of the revenue they’ve lost.  It turns out OPEC can’t usually just turn off the spigot over night.  So supply hasn’t fallen as quickly as demand, tanks and tankers are filling up, and the oil companies have no choice but to lower price to stimulate demand so they don’t end up having to drink it.

Supply and Demand That’s Less in Our Faces

There have been huge, gigantic, almost unfathomable tidal waves of money sloshing around the globe and bouncing off markets for over a year now.  These waves of money turn entire markets into competing products that have their own supply and demand.  This isn’t new, but the size and drivers of the money movements, to a degree, are new.

1. Zillions of dollars, apparently, had found a happy home in all the mortgaged backed securities we keep hearing about.  As the risks of those securities became known, they outweighed the returns they offered.  Investors sold these securities en masse.  That money that had been parked in mortgaged backed securities had to go somewhere.  Some of it, over the last 18 months or so, went into equities or stocks.  The infusion of money into the stock market pushed it to record highs.  But with stock prices so high, yields were relatively low and those who could see the storm clouds on the horizon saw greater risks there than those low yields warranted.  So a lot of money got “parked” in commodities.  Which bid up the price of commodities in a way that had nothing to do with actual production and consumption of commodities and everything to do with the supply and demand of commodity based financial instruments.  The distortion this caused made commodities “hot”, which created a brand new speculative boom as giant investors started gambling on commodity futures.  This is a lot of what caused the enormous spike in oil prices and the spike in corn and rice prices that threw several developing nations onto the brink of mass starvation.  It wasn’t that people were suddenly eating too much rice or had stopped making enough of it.  The problem was that too many people wanted to own the rice for its investment potential instead of its food potential.  But now.the economy has been in recession, technically, since last December.  As per the traditional supply and demand issues above, consumption has been reduced which has, finally, popped the latest bubble that had driven up commodity prices.  So where is that money going now?  I’m glad you asked.  Debt is seen as too risky, the equity markets have been killed and remain extremely volatile, commodities are crashing… what’s left?  Investors are basically down to two options.  Mattresses and US Government Treasury bills and bonds.  The demand for US Treasuries has gotten so intense, as these untold billions of dollars smash around the world looking for a safe place to land, has pushed yields on them so low that at times they have actually gone negative.  That means that some investors have been willing to pay the US Government to hold onto their money for them in exchange for the gaurantee that only the US Government can make that their losses will be limited to only a small amount.
2. The giant hedge funds and many other investors had been taking advantage of the debt and equity markets by leveraging their investments many times beyond what was safe.  When it got harder to borrow money, they had to start “de-leveraging.”  So, say a hedge fund had $1 billion of investor dollars in it, but had used that as collateral to get $30 billion in loans, which is what it actually invested in the markets.  If now they can only borrow $20 billion, they have to sell $10 billion of various financial instruments.  This dynamic is largely what was behind the stock market crash in October.  To some degree investors were predicting lower profits due to recession, but to a large degree, the crash had nothing to do with the “real” economy and everything to do with investors refusing to lend money to these hedge funds and, instead, putting their money into Treasuries.
3. The hedge funds also have lost a lot of their luster to the giant investors because they did not provide the degree of protection against market risk that they were supposed to be able to do.  They got swamped instead and to a degree became a failed experiment.  So investors have been pulling their investments out and the expectation has been that much, much, much money will be pulled out of them by the end of this year.  If that hedge fund knows that it is going to have to fork over $250 million of its $1 billion in investment capital, it A) has to raise that cash, and B) means that it can no longer support the $30 billion it had borrowed.  So it has to liquidate investments, which means, it has to sell stocks.  Hedge funds haven’t wanted to get to December 31st and suddenly all of them sell trillions of dollars of equities and commodities at once, so they have been dumping stocks since about August or September. Most people seem to believe that they are done now, which, all else being equal, means that we are less likely to see catastrophic stock market crashes again, for now.
4. All of this has led to huge deflationary pressures, which have further reduced prices of things and increased the value of cash… see the next post for some thoughts on this.

So… that’s why gas prices are lower.