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Will Worse Gas Prices Raise Mortgage Rates?

Gas prices are rising in the US and it makes you wonder: will mortgage rates soon be rising as well?

The questions are not unrelated. In basic terms the price paid for gasoline at the pump has very little to do with the actual cost of production, refinement and distribution. However, the price paid at the pump is a universal tax of sorts, raising the cost to commute and move goods. In other words, higher energy prices add to inflationary pressures.

Mortgage Rates

When inflation hits economies then mortgage investors want to preserve the buying power of their capital. They do that by seeking higher home loan interest rates. If enough investors will hang onto their funds until rates rise then, as a self-fulfilling prophecy of sorts, rates go up.

Many think that higher gas prices are now the result of supply shortages or excess demand. It’s not true.

“It’s not a supply problem,” says Brian Williams on the NBC Nightly News. “Right now there’s plenty on hand and it’s not a demand problem we’re using much less gas than we do during the summer months. The problem is that prices are largely set by commodities traders, also known these days as speculators.”

According to the US Energy Administration (USEA), “U.S. dependence on imported oil has dramatically declined since peaking in 2005. This trend is the result of a variety of factors including a decline in consumption and shifts in supply patterns. The economic downturn after the financial crisis of 2008, improvements in efficiency, changes in consumer behavior and patterns of economic growth, all contributed to the decline in petroleum consumption. At the same time, increased use of domestic biofuels (ethanol and biodiesel), and strong gains in domestic production of crude oil and natural gas plant liquids expanded domestic supplies and reduced the need for imports.”

If US dependence on foreign energy has declined then why do prices increase? Some possible reasons include:

  • Less refining capacity (Actually, the country has excess refining capacity — we hit a 29-year high in 2011)
  • Shipping interruptions (think of Iran) and
  • Increased consumption caused by an expanding economy both in the US and abroad. (An expanding economy would make higher energy prices both tolerable and politically acceptable.)

Speculation

There is another reason gas prices rise and fall: speculation, bets that prices will move one way or the other. As Warren Buffett explains in his 2011 letter to Berkshire Hathaway shareholders:


“A few years back, I spent about $2 billion buying several bond issues of Energy Future Holdings, an electric utility operation serving portions of Texas. That was a mistake – a big mistake. In large measure, the company’s prospects were tied to the price of natural gas, which tanked shortly after our purchase and remains depressed. Though we have annually received interest payments of about $102 million since our purchase, the company’s ability to pay will soon be exhausted unless gas prices rise substantially. We wrote down our investment by $1 billion in 2010 and by an additional $390 million last year.

“At yearend, we carried the bonds at their market value of $878 million. If gas prices remain at present levels, we will likely face a further loss, perhaps in an amount that will virtually wipe out our current carrying value. Conversely, a substantial increase in gas prices might allow us to recoup some, or even all, of our write-down. However things turn out, I totally miscalculated the gain/loss probabilities when I purchased the bonds. In tennis parlance, this was a major unforced error by your chairman.”

As I read his letter, it appears that Buffett bought his notes from the originating company and thus they could employ his cash digging wells and improving their system, but many investors simply buy and sell commodity and derivative interests in oil, gas, propane and such with no thought of delivery. For them commodities are simply a gamble that does not result in a single new well, refinery, efficiency or job.

Three Steps To Hold Down Gas Prices

So, how do we deflate energy speculation and thus hold down mortgage rates?

First, we get supply-rich Saudi Arabia to increase crude production — as they already have done!

Second, we learn how to jawbone, how to make bets against the US more risky. The way to do that is to follow the suggestion of Sen. Charles Schummer (D-NY) who says it’s time to open the strategic oil reserves just a touch.

Given that this is a political year and high gas prices hurt incumbents, it’s hard not to imagine that the strategic energy reserve will soon be opened just enough to drive down the high prices caused by speculation.

Third, we keep buying cars with better mileage, whether gas, electric or diesel.

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