Editor’s Note:  A small retreat in gasoline prices at some pumps recently delivered hope that fuel costs this summer might ease. However, Dr. Cullen Goenner, a UND economist who closely observes the global economic scene, says "no such luck." In fact, nationwide average gasoline prices at the gas station have hit new records, even accounting for inflation. Moreover, the latest government statistics show that inflation led by fuel price hikes is on the rise even as worker pay slips.

Goenner, a macroeconomist and assistant professor in the College of Business and Public Administration , says the nightly news is the place to grab the real facts fueling prices at the pump. In the following interview, Goenner explains some of the dynamics of the oil market and what we can look forward to.

Q. First, let’s deal with some possible good news: Americans still are getting a gasoline bargain at the pump when compared with, say, prices in westernWestern Europe, which now average more than $5.50 a gallon.

A. In comparison, U.S. gasoline prices today may not as painful as they appear. We remember the “good old days” of cheaper fuel, but gasoline in 1950 actually averaged an inflation-adjusted $1.51 per gallon (2005 dollars); in 1980, at the peak of the oil embargo era, gasoline at the pump averaged over $2.50 per gallon. The price of crude oil in Cushing, Oklahoma, the bellwether market for U.S. prices, last week was in the $72 per barrel area, significantly off the record, inflation-adjusted $86.99 set in January 1981, but up from around $26 at the turn of the millennium and about $55 per barrel a year ago.

The current advance in gasoline and other fuel prices is led almost entirely by the rise in the cost of petroleum, which accounts for roughly half of the price of gasoline. Over the last couple of years, this is taking a toll. The problem is the fundamental law of economics, that is, supply v. demand:  there’s a lot of worldwide demand chasing dwindling supplies.

Q. What does that mean for America’s working families?

A. I believe that oil prices will likely stay high because the supplies that we expect to find are very close to where demand is; there’s very little room to maneuver. So any disruption in supply, whether we’re talking political instability in the Middle East or, say, another weather-related disaster, could easily send prices even higher. Since fuel costs are tied to just about everything in our economy, that means we’re likely to see more price hikes across the board, something that the Federal Reserve (Fed) clearly is worried about.

In economic terms, higher energy prices not only lead to higher prices for other things, they also feed a fear of inflation, and that drives the Fed to raise interest rates in anticipation of future inflation; the idea would be that as energy prices rise, transportation costs to go up; we’d see higher prices at the pump, and we’d pay out more cash at Wal-Mart and other stores that we purchase things from.

Thus we’re likely to see the Fed continue to raise interest rates.

Q. Tell us about the demand side of the equation—aren’t people likely to try saving on fuel costs?

A. Yes, but it’s more complicated than simply trying to drive less. Higher petroleum prices already are being factored into the economy, and as petroleum prices will continue to rise, they’ll be a growing factor behind the apparent slowdown in other sectors of the economy. And, of course, demand from people getting on the roads for family summer vacations will mean that prices will continue to go up.

Q. So the supply-demand equation is tight—which side of this equation is the greater power in the upward-spiraling price of petroleum?

A. I believe that most of the increase, perhaps 30 cents or more, of the hike from $2.50 towards  $3 per gallon and more will be supply-related. Expectations about supply are making the market nervous. Though there are many geopolitical factors behind the uncertainty, I continue to believe that the biggest current worry concerns Iran's nuclear intentions and political instability in Iran and Nigeria, two of the 10 largest producers and exporters of oil.

Because of Iran’s nuclear intentions, the market is unsure whether the United States and/or Israel will consider armed aggression against Iran; if that occurs, it will greatly destabilize the Middle East and, consequently, oil prices. In Nigeria, production is down some 20 percent as terrorists disrupt the flow of oil through weekly kidnappings and bombings targeting the oil industry. So a large part of this potential increase in fuel prices is directly tied to uncertainty about what’s going to happen on the supply side.

Q. Do you see anything mitigating, or limiting, the potential petroleum price inflation?

A. So far, Saudi Arabia, the world’s single largest exporter of crude oil, and other producers have been relatively liberal in terms of providing consumers such as the United States with lots of oil. That is the good news. But here’s a caveat: there’s no assurance that such a generous flow will continue from those producers. Really, there’s not a lot of good news out there.

Q. North Dakota is an energy producer—maybe there’s good news there for us.

A. Well, of course, people in the Williston Basin and surrounding regions are benefiting as petroleum extraction has increased beyond 100,000 barrels a day for the first time since May of 1998; the number of rigs operating has doubled in the last year. But when folks remember the large influx of cash that came in following the last run-up in petroleum prices in the 1980s, they also have to remember that, at that time, oil and gas extraction contributed about 13 percent to the state’s economy. Today, that’s less than 1 percent.  And there's fewer oil rigs out there now than there used to be. There just hasn't been much U.S. investment domestically in drilling because oil prices have been relatively low since the late 1980s.

The bottom line is that North Dakota accounts for only 2 percent of U.S. oil reservcesreserves. We have an asset that’s relatively small, and we have moved more to the manufacturing sector.

Another part of U.S. oil story is that refining capabilities are actually down over last year; Hurricane Katrina took out 10 to 15 percent of those capabilities, and the stock of finished gasoline is down. Suppliers are having a tougher time getting gasoline, and that also is pushing prices up.

Q. So how did we get into this fix? Didn’t the country experience dramatic shortages and price hikes during the Arab oil embargo of the 1970s?

A. People have very short memories, and they don’t remember the effects. What we remember are the mid 1980s, when oil was cheap and energy prices overall were low. Plus, I don’t think there’s been any real initiative at the federal level to mandate things such as more miles per gallon.

Overall, Americans have chosen to drive gas-guzzling large vehicles and have thus chosen to disregard the past. And we haven’t paid that much attention to other economic lessons. For example, in the late 1970s early 1980s, there was a concerted move to smaller Japanese cars. Japan practically took over the U.S. market for smaller, more efficient vehicles. But the U.S. auto market was taken over by SUVs as people got used to gas under $1.50 a gallon. They figured that if gas prices go up, it was a temporary thing.

Q. So you’re telling us that we’re not changing our habits with respect to gasoline consumption.

A. That’s right—in economic terms, we’d say that there’s not a lot of substitution that goes on as it relates to gas. The price goes up, and people complain, but they drive just as much as they before. We now consume about 20 million barrels of oil daily and about 65 billion gallons of gasoline and diesel fuel each year, and that number is projected to increase by 2.6 percent each year. We (Americans) drive more than 2.5 trillion miles annually in automobiles, light trucks and SUVs, the equivalent of about 14,000 round trips to the sun, and almost twice as much as we did in 1980.

Maybe after two to three years of sustained higher gasoline prices, we’ll see some changes. But until then, we won’t see much change as far as how and what we drive.

Q. Some folks tell us that one way around this predicament is to opt for alternative fuels such as ethanol. Do you see that as a real choice?

A. The big concern about ethanol is that it’s costly to transport; currently, there’s no infrastructure to get large quantities—I mean the quantities that you’d need to make an effective substitution for gasoline—from the Corn Belt of Iowa, Minnesota, Nebraska, and Wisconsin, to other parts of the country.

We’ve got that infrastructure— the large port terminals for receiving crude oil from overseas and all the refining facilities—in place for crude oil but not yet for ethanol. What we’re seeing is that ethanol is mostly being used relatively close to where it’s being produced. It’s not likely that we’ll change substantially in the near future. That being said, I believe that the long-run potential for ethanol is good. As gasoline prices rise, here’s a much greater likelihood of ethanol becoming competitive.