Since peaking in late June, gasoline prices have fallen more than 13% in many places and are easily at their cheapest this year:
US Retail Gas Price data by YCharts.
Many markets are seeing gas prices below $3 per gallon now, and for consumers, cheap gas is great -- especially if you drive a lot of miles. Furthermore, lower gas (and diesel) prices lower shipping costs, and theoretically, these savings should lead to lower prices at the store. Combined, that's more money in your pocket, right?
There's another side to the coin, though, and it's one that deserves a hard look. Cheap gas could be indicative of bigger problems, and these problems might not be so good for us. Let's take a closer look at the bigger picture.
What drives gas prices?
Gasoline prices are largely related to the price of crude oil. There are two key "spot prices" that are used to measure the relative market price of oil: West Texas Intermediate (WTI) Crude, and Brent Crude. Over the past few months, both have fallen sharply:
WTI Crude Oil Spot Price data by YCharts.
But like other goods, the basic economic drivers -- supply and demand -- are also at work here. U.S. crude oil production has been growing significantly in recent years, reaching a point last November where the country actually exported more crude oil products than it was importing for the first time in nearly two decades. However, that one-month result wasn't sustainable, and the country still consumes more oil than it produces. In 2012, the U.S. produced over 11 million barrels per day of crude, but consumed more than 18 million barrels per day of oil and oil products. The U.S. is expected to pass Saudi Arabia in production of oil this year and continue growing production for the next five years.
The problem? Demand for oil isn't keeping up with the pace of production growth.
Europe a mess; Asian growth slowing
Earlier this month, the International Energy Agency cut its forecast for oil demand growth by more than 20%, citing a slowing pace of growth in Asia, and the continual bad news coming out of Europe, which has yet to gain any traction since the recession ended. In reality, there are growing fears that Germany -- easily the most stable economy in the eurozone -- may actually be entering a recession.
What does this matter? The concerns are twofold, actually.
First off, there are many more ties between the U.S. economy and Europe and Asia than most people realize. Lots of U.S. companies generate significant amounts of their business overseas, and chances are, your personal wealth is exposed to this through your retirement holdings. If you own a mutual fund -- which you probably do -- then what happens with Europe and Asia's economies matters to you.
Second, the U.S. energy boom has been one of the bright spots in our economic recovery over the past five years. While cheap gas is nice at the pump, if oil prices continue to decline, American businesses -- many of which aren't "Big Oil" -- will suffer if oil producers are forced to cut production.
US Oil Consumption data by YCharts.
The result? This could impact our economy, too.
Big picture: Is cheap gas here to stay?
While it's hard to predict exactly what will happen and when, it's fair to say that -- barring an unforeseen economic event like the housing crisis -- oil prices will probably start to rebound in the next several months. U.S. producers aren't the only ones exposed right now. Saudi Arabia and other OPEC producers may have access to the cheapest oil in the world, but the major social commitments that have been made to their citizens add significantly to their cost of production.
There may appear to be discord between OPEC producers right now, but there's a solid chance that there will be a consensus from the group by the end of its next meetings in November. This is likely to be some form of production cut, a necessity in the face of declining demand growth. This would lead to prices stabilizing, if not increasing in the short term, while the weak spots in the global economy work through their malaise.
So, while cheap gas is nice, and it could last for a while, it's important to remember that it's often an indicator of bigger problems somewhere in the world. It's just as important to remember that those problems -- in a very small world of commerce -- have an effect on you, too.
