Friday, May 30, 2008

Why is gas so expensive?

Simple answer: it's because oil is expensive, right?

Pretty much. But why is oil so expensive?

There the answer gets more complicated. Are we running out? Is someone hoarding? Are India and China drinking it all? I'll leave those answers to others. But here's one answer that may make things slightly more clear.

Oil is always traded in dollars. No matter where you buy a barrel of oil in the world you have to pay the man in greenbacks. That means the value of our dollar has a direct effect on how we perceive oil's price. When the dollar devalues the price of oil goes up for us because it takes more cash to buy a barrel. Similarly, when the dollar increases in value the price of oil goes down for us.

As we know, the dollar has devalued--like crazy! Let's go back six years. In 2002, oil cost $25 per barrel. The Euro and the dollar were at parity (one dollar bought one Euro). Fast forward to 2008. Oil costs $125 per barrel. But it now takes $1.60 to buy one Euro. The dollar has devalued. The price of oil had to go up. How much of the oil price rise can be explained by the devaluation? Well, you can just look at Europe. They only pay 75 Euros per barrel. If we were still at parity that's what we'd pay, too. In other words, $125 - 75 = $45 of the price increase of oil--almost half the $100 increase--can be explained by the dollar's devaluation.

Removing dollar devaluation, the price of oil has tripled in six years. Sounds bad, sure. But historically it's not unique.

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