Why Gas Prices Are Falling

By Nomi Prins, TheNation.com. Posted October 19, 2006.

When gas prices were high, the Bush administration blamed the Iraq war. But now that they’re sinking, it’s clear that theory doesn’t hold up.

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Plummeting gas prices have been good news for the motoring public. They also raise the questions: Why? How? Since their August highs, oil prices dropped from $77 to $60 per barrel. Gas prices have fallen from an average of $3.04 to $2.25 per gallon. In a September USA Today poll 42 percent of Americans thought there was a direct connection between the Republicans wanting to keep control of Congress and gas prices falling.

Free-market types went to town. Oil is set by market forces, not Washington, rang the unified voice of analysts. "If only Bush had that kind of control," mused White House spokesman Tony Snow. But subtle manipulation is a form of control.

Let's back up. In July, legendary investor Jim Rogers -- who got his start with George Soros -- and other Wall Street analysts were saying that within the scope of the bull market, oil prices would head over $100. This would translate to roughly $4.00 to $4.50 per gallon at the gas pumps.

Meanwhile, the White House was evading blame for gas prices having doubled like Olympian dodgeball champions. It's not us. It's unrest in Iraq. Nuclear threats from Iran. Growth in China. Economists said, It's supply and demand, stupid.

Following their logic, and given the second-fastest drop in gas prices ever, we'd expect a noticeable reversal of those factors: an end to the war in Iraq, perhaps; India and China halting production; the Iranian president warmly embracing Bush and the home team. None of this happened. As far as supply goes, this spring US crude oil inventories were at their highest point since May 1998.

Manipulation can be physical or psychological. No, Bush wasn't calling his broker to short the market and Cheney probably wasn't conversing with oil execs to back it up. But long-term mutual back-scratching relationships are potent. An overly speculated market like oil (the most traded commodity in the world) picks up on subtle signs. Just as traders push the market up, they can take it down, depending on those signs.

If detectives from CSI were investigating the plummet in oil prices, they'd look for motive and method. Motive's obvious: strategically important midterm elections. With Iraq and swarming allegations that the Administration has created more terrorism than before, there's not a lot the GOP can control. According to Doug Henwood's Left Business Observer study, there's a 78 percent correlation between the direction of gas prices and approval for the GOP.

Republicans have been pleased to focus on what they can manipulate, if not overtly control. Big Oil gave the GOP 81 percent of its $63 million in campaign contributions since Bush took office. Republicans are giving Big Oil a $5 billion helping of tax breaks. Last November the Republican-led Senate Commerce Committee, headed by Alaska Senator Ted Stevens, gave oil companies a post-Katrina break to keep their exorbitant profits. Democrats called for windfall profits. Republicans didn't.

After Katrina oil companies like Exxon, which also happen to own the major oil refineries in the country, increased their refining profits, which had direct implications on the price of gas at the pumps -- that made them higher than the rising price of crude oil would dictate.

In September the difference between the cost of crude oil and the price of gas after the refining process (called the "crack spread" in the markets) has narrowed substantially, meaning oil refiners are extracting less profit because they're charging proportionately less at the independent gas station pumps.

Just as Enron and others could manipulate, if not directly control, California prices by closing power plants at will, so can oil companies reduce refining profit margins (which were gigantic) to keep their friends in power. That's easier to control than futures where other players are in the market, and it's something retailers pass on to drivers. This is not conspiracy, but self-preservation.

Other strong messages came from Washington. My favorite is the one that came directly from the Federal Reserve. For two years, the Fed has been raising interest rates due to inflationary pressures (such as the high cost of gas). Then, it stopped -- the day after gas prices reached their August 7 peak of an average $3.04 per gallon. The next day, the Fed said that despite high energy prices, inflationary pressures would "moderate."

The market slide started that day, not a sudden change in supply or demand. On September 20, the Fed again left rates unchanged, saying energy prices were in check, causing a further slide. Global crude oil prices fell, but gas prices fell faster.

Wall Street analysts, traders and hedge funds don't care about any of these reasons. They just don't want to be caught behind the ball, so they sell the market, causing further price drops. Yes, those are market forces -- but they are market forces with a lot of push from Washington-related signals. Why now? To say the election has nothing to do with it would be naïve. To say gas prices won't be up again afterward would be wrong.

Nomi Prins is a senior fellow at the public policy center Demos and author of Other People's Money and Jacked: How "Conservatives" are Picking your Pocket (Whether you voted for them or not).