Summer Gas Prices to Spike, but Not to Record Highs

Oil prices reached a year-and-a-half high last week, but there is hope for consumers.

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Last week, global crude oil prices hit an 18-month high. This week, in the United States, the average price of a gallon of regular gasoline reached $2.85, the highest it's been since October 2008. [See a slide show of the 10 states with the highest gas prices]

This is both good news and bad news. The bad news is that the economic recovery could slow if gas prices rise too fast. And because refiners have to make costlier blends to meet summertime emissions limits, gas prices usually rise as summer approaches anyway, meaning Americans could soon find themselves paying $3 a gallon or more for gas.

The good news, though, is that the United States is almost certainly not headed toward another summer of $4-a-gallon gas. That's because the world economy—and oil markets—are at a very different place than they were two years ago. Right now, the United States and many other countries are just crawling out of the recession. In recent days, there has been a flurry of positive, if less-than-glowing, signs of recovery. The United States created some 160,000 jobs in March, the first month of major job growth since 2007. Home sales are up, and a growing number of CEOs say they are planning to hire in the next few months, according to a recent survey. Other western countries, including the United Kingdom, are showing similar, if still tepid, gains.

The rise in oil prices is tied to this rosier outlook. "What's really driving a lot of this are the expectations about new demand growth and the optimism around the world," says Ruchir Kadakia, the global oil program director for Cambridge Energy Research Associates, a Boston-based consulting firm. As economies improve, more people buy cars and drive more, and the markets are signaling their expectation that oil demand will pick up. Meanwhile, some developing countries all but waltzed through the recession and have seen a continued growing demand for cars, and thus more oil. China in 2009 alone saw a more than 40 percent spike in the number of cars sold there, overtaking the United States as the world's biggest car market.

This last point may sound troubling because it was precisely the rising oil demand in China, India, and other developing countries that was blamed for the price shock in 2007 and 2008. But that was only part of the explanation. "Everything that could go wrong went wrong" in 2008, says Lucian Pugliaresi, president of the Washington-based Energy Policy Research Foundation, which studies global oil markets. "It was like a perfect storm of bad outcomes." Not only was demand rising, he says, but there were major problems with expected oil supplies not showing up. In the early 2000s, forecasters had predicted significant oil would flow out of Iraq, Nigeria, Kazakhstan, and many other countries as the decade progressed. But political instability, technical problems, and other issues kept much of that oil in the ground. As a result, demand was rising, supplies were failing to materialize, and among traders a new attitude of fear had set in that oil would be much harder to find in the future.

Fast forward two years, through the recession, and the situation is different. OPEC, according to experts, is sitting on spare capacity, in part because demand fell off last year. Saudi Arabia has the potential to pump more oil, but it's not, because, at the moment, the world doesn't need it. In other words, there's extra oil out there that can be put on the market to help keep prices down, if need be. For Saudi Arabia and other oil producing states, that's in their best interest. The global economy is still weak; any surge in oil prices would hurt not only consumers but also industries that rely heavily on energy. If push comes to shove, "I would expect Saudi Arabia to move to put more oil on the market," says Pugliaresi.

The Saudis also have a longer-term worry. They know that when crude oil hit its records in 2008, it gave a huge boost to renewable energy efforts. So they want to keep oil attractive. With today's weak economy, they're in an especially precarious position. The year-and-a-half high that oil hit last week was $86 a barrel. At this point, "for the Saudis, $90 is really testing the limits," says Kadakia. Anything too far above that could send gas above $3 a gallon in the United States, creating unhappy, cash-strapped consumers and industries.