Features


Hot topic: Skyrocketing prices at the pump by Sherry Bithell


As of mid-June, the average price of a regular-grade gallon of gas was $2.16, and prices have been climbing, with the occasional dip, over the past few years. According to the U.S. Department of Energy, the same gallon of gas was $1.49 on May 18, 2003, $2.06 just a year later, and $2.12 this past May.

Is there any relief in sight? Virginia Tech Magazine consulted Virginia Tech finance expert G. Rodney Thompson to learn more about the current situation--and what lies ahead.
G. Rodney ThompsonA professor of finance in the Pamplin College of Business, G. Rodney Thompson is a winner of the Wine Award for Teaching Excellence and two-time winner of the University Certificate of Teaching Excellence. In addition to teaching finance courses at both the undergraduate and graduate levels, he teaches every fall at Virginia Tech's study-abroad center in Riva San Vitale, Switzerland, and leads study-abroad groups to Asia and South Africa during the summer. Thompson is actively engaged in finance research on company equity and debt and on foreign direct investment and privatization.



WERE HIGHER PRICES INEVITABLE?

Yes, says Thompson, gas prices were going to rise "sooner or later." This inevitability is due in part to the faster-growing economies of such countries as China and India, which are increasingly demanding more of the fixed world supply of oil. It is because of the seemingly infinite global need for a finite supply that Thompson doesn't anticipate the situation changing anytime soon. "Prices may appear high now, but in my opinion, they will be much higher in the not-so-distant future. This is not a passing phenomenon."

However, the shortage the U.S. currently faces is due primarily to refining capacity--or, specifically, the lack thereof. Simply put, regardless of the amount of crude oil there is, it must be refined. But Thompson notes, "Firms have not invested in refineries in the immediate past, and with the higher profits coming in from the gasoline shortage, they are unlikely to make a major investment in the future."

Both the demand for oil and the dearth of refineries have led prices to where they are today. Still, why is there such a range in gas prices across the country? As of May 23, consumers in Massachusetts were paying an average of $2.13 for a gallon of regular grade while those in Ohio paid $1.99 and those in California paid $2.43. Thompson says that it's pretty much the luck of the draw depending on where consumers live or where they buy their gas. There are no laws governing what a gas station can charge, so "if a major food store wants to sell gasoline at cost so that you might come in and buy a gallon of milk, it is the store's right to do so."

oilIS THE U.S. SIMPLY "CATCHING UP"?

One theory bandied about recently is that our rising gas prices are simply a matter of the U.S. catching up to what everyone else already pays. Not so, says Thompson, who points out that the price discrepancy between what the U.S. pays for gas compared to the costs in other countries is merely the fact that other nations are taxed at higher rates on their purchases.

Those taxes, he explains, go toward better highways and public transportation, such as Europe's well-known and reliable railway system, as well as investments in alternative energy research. "We in the U.S. have chosen a path of low taxes and minimal public transportation. We want lower taxes and less service. We believe that makes us 'better off.' The people in Europe would not tolerate the quality of our highways or our lack of public transportation. It is a simple question of what taxpayers wish." In short, the United States already pays the world price for gas, just not the higher taxes.

WHAT ELSE DO HIGHER GAS PRICES SIGNIFY?

In comparing the current oil shortage to the energy crunches of the late '70s, Thompson says that each has been a sign of necessary structural changes to the world's economies. However, he adds, "This is a stronger signal. We ignored those signals for the most part and I see no indication that we will react to current signals any differently."

Today's increasing gas prices indicate more than a lighter wallet--they also show that the value of the U.S. dollar is falling. Thompson explains this decline by contrasting the U.S. situation with current gas prices in Europe. "Given the rise in the value of the Euro, the price of oil has not risen significantly in Europe. One Euro cost $.86 in November 2000. Today, it costs $1.30, which is a 34 percent decrease in the value of the dollar. That same percentage change in the value of gasoline makes what would be a $1.50 gallon of gasoline rise to over $2.00. That is to say, while the European buyer has to bid the same price for a gallon of oil--or gasoline--in Euros, we have to bid 34 percent more to stay even."

As a result of this discrepancy, the potential cascading effects of rising oil prices are less harmful to Europe than to the U.S. However, for most Asian countries--particularly China, which has strong ties to the U.S. dollar--the declining U.S. currency means that they're also paying more for oil, which in turn dampens the growth of their economies. That slowed growth, in turn, will lead to rising costs for everything that the U.S. buys, transports, or manufactures.

Thompson describes the potential consequences that may result from a worldwide, long-term devaluation of the U.S. dollar as "frightening." Taking into account that the international price of oil is currently calculated in U.S. dollars, he explains, "Imagine if the world moved to a Euro-based price for oil and let the dollar float away from oil? Add that to a Euro peg to the Chinese yuan, as opposed to China's current peg to the U.S. dollar, and Americans would be living in a very different world."

gas pump

WHAT DOES THE CRYSTAL BALL SHOW?

For the short term, Thompson says that he wouldn't expect much of a decline in prices during the travel-heavy summer. Indeed, consumers don't seem to have limited their travel plans based on higher gas prices; according to the Department of Energy, the four-week average for U.S. gasoline was up 2.9 percent from last year.

And for the long term? "There is nothing pretty in the long term," he claims. Although he paints a grim future, Thompson does note that there are options--it's simply a matter of how the U.S. chooses to respond to the oil shortage.

"There are lots of things we could do. Fuel-cell technology. Hybrid cars. More and better public transportation. But we have not been very forthcoming with taxes to fund research in these areas. Also remember, Amtrak appears to be on its last leg.

"Truthfully, we have known about this problem for more than five years, but there is no leadership to move us to the next level."

Were it up to him, Thompson says that he would challenge America's leaders to look ahead. "Do we not have the scientific capacity to move beyond our petrol-dependence? That is a question worth asking, especially when we hear of the limited investment in science education in the U.S. And will the Chinese, Japanese, Germans, or East Indians develop that technology [see Message from the President] and leave us to the dwindling pools of oil remaining in the ground? That might be the more probing long-term question."