Tuesday, May 24, 2011

Why Gas is Expensive and is Only Going to Go Up

For my readers who depend upon gasoline, I’m sorry for my depressing title this week. I remember growing up in Ontario and gasoline was cheap. In my earlier years gas prices were typically below 50 cents a litre. I cannot find conclusive evidence through casual searches, but I believe I recall 30 cents a litre being not unusual.

Since the late 1990s the price of gasoline has been going up. The price has not gone up consistently, it has fallen, for a variety of reasons and the growth in the price of fuel has leapt forward and crawled upwards. However the trend is clear, ever upward. But why? Why is gasoline more expensive today than it was fifteen, twenty or thirty years ago?

As any economist can tell you the price of an item is determined by two factors: supply and demand. We’ll begin with demand because that one makes sense and is easily explained. Demand is the market (or desire for) a product. When we switched in the 90’s from compact cars to SUVs the demand for gasoline went up across the country, and the world. But we are not alone. As the nations of India and China industrialize and create a middle class they too need more fuel. This growing demand pushes prices higher and higher.

Steps can be made to reduce demand. We can switch to alternative fuels, conserve, use public transit, carpool, etc. Though even if we all took those steps and kept the demand to the level it is at presently the price would still rise. The problem isn’t demand.

The problem is supply. The first oil discoveries were laughably easy. A person would literally find oil bubbling to the surface and set up a drilling facility to extract more product. Eventually the process was refined and we developed methods for discovering oil pockets elsewhere. We have used up virtually all of the easy oil. The oil left in the world is in difficult locations, such as the bottom of the ocean, in the Arctic or Siberia, or in unstable regions of the world. It is easy to imagine why it might be more expensive to set up an oil rig in the Gulf of Mexico than to build a pump in Petrolia, Ontario.

The oil left in the world is increasingly difficult to get to, or is in increasingly unstable parts of the world, which amounts to pretty much the same thing. There is a larger problem that looms over all of this though, that is peak oil. Peak oil is a theory that was developed in the mid-twentieth century. Given that oil is a finite resource there will come a time when we produce less and less. One day, and some predict it already has occurred, we will cross a line when we will produce less oil one year than the year before it. In short the world supply is diminishing. With our demand continuing to rise the competition and price of oil will grow.

Oil is used to make gasoline, and so there is a direct correlation in price. Gas prices first rose to over $1.00/litre in 2005, and sank back down. During the height of the Great Recession gas prices remained under $1.00. With the economy on the rebound and demand for gasoline on the rise again prices have started to spike. $1.35, or $1.40 per litre are not strange sights today. Over the summer as the driving season gets underway prices will likely shoot over $1.50/litre for the first time, and perhaps higher. But as autumn comes prices will fail to recede.

Prices may sink below $1.00/litre again, but I am doubtful that would last long. Within the decade we will likely see $2.00/litre, in my opinion. What will we do to respond to this as time goes on? We can try switching to other energy sources, and that may help. The short term prospects look good, and the end result means that we will be paying more to move around and do the things we like. It’s time to start thinking about the coming world to be.

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