Gas prices seem near all-time highs and the summer driving season hasn't even started yet! A recent email presented a simple solution that will force gas prices back to the $1.25 a gallon range. Read on for details and to learn basic principals that may make investing more profitable.
Have you ever received one of those 'chain' emails-the kind where you are supposed to forward it to 10 of your friends? My wife received one this morning. The email contained the simple solution to the gas crisis. Supposedly, the solution was created by a high-level executive at a major U.S. corporation and an engineer that worked for an oil services firm. These guys should know their stuff, right? Wrong.
The solution proposed was that we should all decide to stop buying gas from ExxonMobil. If we stopped buying gas from them then they would be forced to lower gasoline prices to tempt us to buy from them again. The email said that we consumers need to teach the Big Boys that we are in charge, not them.
The Laws of Supply and Demand, the basis for capitalism, are taught in Economics 101. The law says that the market price of a good or service will be determined based on how much of it is available and how much buyers are willing to spend for it. This principle is one of the underlying reasons that bond, real estate and stock prices move up and down.
Let's look at salt as an example. In centuries past, salt was hard to come by and many people needed it. At one time it was so valuable, it was worth its weight in gold.
That's not the case nowadays. Salt is very inexpensive. The container it's sold in probably cost more than the salt inside it. Why? Because the supply of salt is high and the demand for it is low. Salt is easily mined in vast quantities. Also, refrigeration and the use of other preservatives drastically cut demand.
This supply and demand law is the reason the 'simple solution' to reducing the price of gasoline can't work. First, gasoline is a commodity product with a limited supply. If you only switch the outlet from which you purchase gasoline, you aren't reducing the demand. The same amount of gasoline will be sold, keeping demand, and therefore the market price, level. It may hurt ExxonMobil but will help someone else.
Reducing the price of gasoline by decreasing demand will require that people use less gasoline. That means we need to carpool, ride bicycles, walk or drive more fuel-efficient vehicles. In the last year or so we've seen that demand remains strong even when prices rise by a dollar or more. So demand probably won't change until prices are much higher than they are today.
Second, the simple demand solution doesn't take into account the fact that there is a global market for oil. Gasoline is produced by refining oil. ExxonMobil doesn't set the price of oil, the market does. Even if demand is reduced in America, the demand elsewhere continues to increase. The demand in China and India is growing so rapidly that prices will go up even if we cut back here in America.
Third, the supply of oil must be factored into the equation. There hasn't been a discovery of a major oil-field in decades. The amount of oil pumped from an oil-field doesn't stay the same. It will naturally decrease over time. There have been improvements made in getting the oil out of the ground, but overall, the number of barrels a day pumped is declining. For instance, did you know that the production of OPEC is lower today than it was in 2005?
So this 'simple solution' obviously won't work. I believe that there is little we can do in the United States to significantly lower the price of oil. There simply isn't enough oil to meet the needs of the world economy. Understanding that affects how I manage my clients' portfolios.
As an investor, understanding the Laws of Supply and Demand will help you select where you should invest. Avoiding industries where supply is increasing faster than demand will reduce your losses. Investing in industries where demand is growing faster than supply can increase your profits.
Nationally-syndicated financial columnist and Certified Financial Planner•® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA. He'll answer your financial question - FREE at www.guardingyourwealth.com.
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