This week will see the nation’s gasoline bill flirt with $1-billion per diem, but the pace of the increases has decreased, and barring catastrophic happenstance for U.S. refiners, we will soon be paying less than we were a year ago. That comparative milestone will be reached not because we’re about to see any broad price downswings. It will come because the March 20 through mid-May period in 2006 produced dramatic updrafts not likely to be repeated this year.
I’ll be departing this week for the arduous duty of delivering an intrepid price forecast as a keynote speaker for the Gulf Oil meeting in the Cayman Islands. I suspect there will lots of nonsense purveyed by oil price proselytizers in my absence, so I have put together a Twenty Questions summary, weighing in on what’s happened so far, and where the U.S. motor fuels market might be headed. This Q&A won’t be confused with anything that industry groups will publish, since it does not reflect an agenda, nor vested interests.
But before I get into seasonal predictions appropriate for this year’s vernal equinox, let me make a couple of quick comments on some recent pet peeves.
Public Citizen advocate Tyson Slocum was quoted in an MSNBC story that also featured some statements by yours truly. Mr. Slocum said “our energy trading markets where crude oil and gas prices are set aren’t transparent enough . . . there’s no government regulation there.”
I do not know Mr. Slocum and I am happy that we live in a country where entities like Public Citizen try to keep overzealous capitalists from taking our collective pants down.
But Slocum is way off base when he suggests that oil and gas markets are not “transparent enough”,
When I saw that quote, I felt the need to invoke a question many times posed by that 20th century philosopher and political aspirant Gary Coleman. Herewith:
“What you talkin’ about Willis?”
My contention is that oil price transparency has reached ridiculous scale. The amount of crude oil, gasoline, and heating oil transacted before our eyes in public markets has surpassed 1.5-billion bbl per day in some 2007 sessions. If anything, I would suggest that world oil markets now have the optics of funhouse mirrors, with an excess of transparency among financial players often distorting prices.
Now, on to my second peeve. If you google the term “driving season” in a news search in April or May, you may very well find as many search hits as if you googled, say “Cubs’ pennant chances.” But both references are largely mythical, particularly in recent years.
Contemporary America has no more of a “driving season” than we do a mating season, although I suppose Spring Break might qualify as the latter given what I witnessed last weekend in Las Vegas.
Gasoline usage is much more regular than it was decades ago, and there isn’t that much difference between how much gasoline is used in July versus December.
Gasoline demand has been running around 386-million gal per day for most of 2007. It may advance to about 400-million to 407-million gal per day in the ten weeks that precede Labor Day weekend. That extra 20-million gal or so per week should not represent a “War And Peace” challenge for U.S. and global refiners this Summer.
Twenty Questions On 2007 Oil Prices
Where are prices now and how do the numbers compare with recent years? Nationwide retail fuel prices average just under $2.56 gal, but the averages don’t tell the story of some of the recent extremes. California gas prices have advanced to about $3.15 gal and Midwestern pump listings that fell to $1.80 gal in mid-January have subsequently bounced back by 75cts gal or more.
Average prices are only about a nickel above where they were this week last year. But they are far higher than they were in previous years this century. The $1-billion per day threshold that we’ll see in the first Spring 2007 weeks compares with costs of about $440-million to $510-million per day in Spring 2001 and 2002.
Are we looking at another Summer of average prices above $3.00 gal? No, or at least, probably not. The price rallies that took nationwide numbers above the $3.00 threshold in 2005 and 2006 were special and not likely to be repeated this year. Prices hit $3.00 gal or more in 2005 because of Hurricane Katrina, and the legacy of Gulf Coast storm-inflicted refinery downtime was a major factor in sending prices to a $3.03 gal peak last year.
What is a reasonable expectation for fuel prices in the next six months? East of the Rocky Mountains, we’ll probably see retail prices peak at around $2.50-$2.75 gal within the next 30 days. By midSpring, most of the refineries that have struggled with Winter maintenance, or “event problems” should be back in action. I would not be surprised to see motorists pay more for their fuel on Easter Sunday than they pay on Memorial Day weekend.
Then, once summer “driving season” is under way, prices should be in the same $2.50-$2.75 gal neighborhood that I forecast for the next 30 days. They could go 10-25cts gal higher if it’s an early & active Gulf Coast hurricane season. But hurricane landfalls where refineries are clustered have to be viewed as rare and improbable, despite the memory of 2005.
Without hurricane landfall, gasoline prices should drop substantially in the last 100 days of 2007. That period has a tradition of ebb tides that feeds the cynical public yearning for a pre-election conspiracy. Note: there are no major federal elections in 2007, but prices will ebb even as the Washington puppetmasters take the year off.
This forecast is appropriate for most of the country. But California and other states that border the Pacific Coast have a different dynamic - - prices in these states could move as high as $3.50 gal or dip back into the $2.50-$3.00 gal range, all contingent on whether western refineries run without incident.
How much of the 2007 price rally can be blamed on crude? Not all that much, although it’s fashionable for oil company CEO’s and industry apologists to cite crude, and conveniently blame OPEC and anti-American countries for our ills. The price of light sweet crude (benchmark West Texas Intermediate or WTI blend) fetches about $57 bbl as Spring beckons. There are 42 gallons in each barrel, so that works out to be about $1.36 gal in raw wholesale cost.
The price of heavy sour crude is much cheaper, with those blends recently bringing about $42 bbl, or a tidy $1.00 gal in wholesale cost.
Wholesale gasoline prices have spent most of the past week at about $1.90 gal east of the Rockies, and above $2.25 gal in California.
A decade ago, the price that gasoline fetched at wholesale was probably within 12-25cts gal of the price of crude. Nowadays, the relationship is much more distant –some 2007 weeks have seen gasoline trade some $25-$40 bbl above the price of crude.
Crude may indeed play more of a factor in the remaining nine months of 2007, but anyone who says that crude costs are the driver of the fuel price rally so far is being disingenuous.
Who is making money on this surge? Crude oil producers are doing quite well. During the 80’s and 90’s, producers might sell crude for “only” two to five times the cost of bringing that crude oil to market. In the last few years, these multiples have swollen to as much as ten to fifteen times wellhead-to-market costs. Current numbers are far more lucrative than what most multinational or wild cat producers might have envisioned five years or even five months ago.
Refiners are doing splendidly. Some leading refinery executives accurately predicted that processors would see a “refining renaissance” this decade, and for the most part, that has certainly been the case. Publicly traded refiners will release first quarter earnings at the end of April. Those companies that did not have extensive downtime this winter will report numbers that may appear “Caligula-like” to onlookers. But some of these companies were one step away from the “Repo Man” as recently as 2002.
Gasoline retailers have been the messengers blamed for the message of high fuel prices. Most of the companies that sell gasoline on the street depend on other income streams (beverage sales, deli items, Slim Jims, Horny Goat Weed, etc.) to make a profit. Many have watched on in horror this Winter as fuel profits have been negligible.
Note: Myth suggests that service stations make a mint when prices rise. The reality is that rising prices bring misery to the fuel vendor. The occasional sweet spot for making money on fuel comes when wholesale prices plunge (e.g. September 2006).
Another less talked about segment of this business deserves special mention. The trading companies – investment banks, some hedge funds, and brokerage concerns – are beneficiaries when fuel prices vacillate wildly.
Why are oil prices so volatile? Expressed via one of those old SAT analogies, volatility is to oil in the 21st century as Elvis was to tabloids in the 1980’s. Oil has incredible cache as an international commodity, and it’s not uncommon to see dozens of single days where it moves by an amount equal to what it takes most financial markets months to accomplish. The “action” in the publicly and privately traded financial instruments for crude oil and other energy products would make a Las Vegas bookmaker swoon with envy.
Traditional analysts might chalk this volatility up to ever-changing fundamentals, and the impact that geopolitical headlines can have on prices. I disagree. The physics of oil price movement are remarkably similar to the physics of crowd behavior at a European soccer match.
What’s the worst thing that can happen for oil prices down the road? On the crude oil side, there is always the risk that Mideastern oil flow could be interrupted or that unstable governments in Venezuela and Nigeria put raw feedstock contributions from those countries at risk. On the refined products’ side, the 2007 hurricane season represents a possible, although not probable calamity that can knock out U.S. fuels’ output.
What’s the best thing that can happen for oil prices down the road? High prices might promote a true renaissance in energy technology. There is also the possibility that the public might realize that there is no downside to conservation.
Who or what determines the price that I pay? The price of crude oil and the wholesale price of gasoline is determined in the hugely successful and highly liquid financial markets each business day. Thousands of commercial and financial investors, speculators, and market-makers establish prices nearly 24 hours though bourses such as the N.Y. Mercantile Exchange and InterContinentalExchange. One could say that the price of oil is not determined each day in Houston or Tulsa, but instead in New York, London, or in the ether world of electronic trading throughout the globe.
Why are California prices often so high? California uses a very clean, but very specialized gasoline that only the most sophisticated refineries can manufacture. California Air Resources Board, or CARB gasoline, can be made by West Coast refineries, as well as a few plants at the U.S. Gulf Coast. Only a half dozen or so foreign refineries can make this California blend of gasoline.
The U.S. East Coast regularly receives 1-million bbl/day of gasoline from foreign refineries. In contrast, the West Coast rarely sees more than a trickle of imported gasoline move in to Pacific Ocean ports.
Also, California and other West Coast states have seen greater demand growth that has outpaced supply capability, and this trend may well continue through the rest of the decade. More motorists, longer commutes, and no real increase in refining construe a recipe for high prices in the region.
Are there other U.S. hot spots? Supply in Rocky Mountain states as well as Arizona and New Mexico are other states to keep an eye on. These states need local or regional refiners to run without incident to keep the system functional. A refinery incident in Wyoming or New Mexico can have dramatic consequences, particularly during warm weather months. There is no global gasoline cavalry for backup.
Many oil “experts” and investment analysts talk about the prospects for $100 bbl crude oil. Should I believe them? No. It’s been my experience that most of the “thought leaders” on this issue have a vested interest. The most measured analysts who talk about $100 bbl oil, believe it might happen for an instant and recognize that such a surge would hamstring global economies.
Boone Pickens is perhaps the highest profile individual that talks about $100 bbl crude. You must ask yourself whether he would be a beneficiary of such a move, and factor disclosure into his motives.
Are gasoline prices a bargain when adjusted for inflation? It depends on the baseline for your perspective. Industry executives often cite 1980-1981 as a base period for defending the non-apocalyptic nature of $3.00 gal prices and when 2005-2006 fuel price numbers are compared to that spike, prices are quite tame.
But if one were to use 1998 or 1999 as a baseline, much different comparisons can be garnered. Gasoline prices are three or four times as high as they were, for example, when the Spice Girls were touring U.S. concert venues.
U.S. gasoline prices are much cheaper than most other industrialized countries, but that’s because U.S. citizens pay much less in taxes that European, Asian or South American counterparts. (Note: Washington makes up for this light touch in many other areas).
What about ethanol? Will it help? A virtual cannery of worms opens when one discusses ethanol, particularly from the perspective of cost benefits and federal subsidies. I’ll avoid that polemic. Sky high ethanol prices contributed to the 2006 retail surge, particularly in metropolitan areas that phased out MTBE. At one point, spot (or cash market) ethanol surged to about $6.00 gal.
Ethanol prices are relatively tame in 2006 and should remain so. Absolute prices are around $2.50-$2.60 gal as Spring begins, which means that the inclusion of ethanol might add a couple of pennies to the price of finished fuel blends in some markets.
But a lot of additional ethanol production will be coming on line in coming months. Those gallons should swell the U.S. motor fuel stocks by another percentage or so. A single digit percentage swing in supply (or demand) fundamentals can have dramatic consequences in U.S. markets.
Does a world of $50-$80 bbl crude and a U.S. landscape with $2.25-$3.50 gal fuel prices represent a new normal? No. The one thing you can count on in the U.S. oil industry is that “abnormal is the new normal.”
People ask me whether I would bet on crude oil prices going below $45 bbl or above $70 bbl in the next 18 months, and I would reject both bets. Gasoline prices as low as $1.50 gal or as high as $4 gal are both possible through the rest of the decade.
Have consumers changed their buying habits so far in 2007? If you merely interpret government data, you might conclude that there has been a 2007 fuel buying binge. I think that conclusion would be in error, however.
Demand for gasoline this year is likely to be about 1 percent to 1.5 percent higher than it was last year. Government data until now probably suggests a rate of “lift” about twice as high. In any case, price hikes so far have had little impact on demand – there is a threshold where consumers begin to complain about prices, but it is perhaps 50cts gal shy of the threshold that actually changes behavior.
At what point, do drivers change their habits and use less? Well, last year, we saw gasoline demand ease on the West Coast when prices moved north of $3.25 gal. You can’t find regional figures to confirm my observation, since they don’t exist.
But one has to view this behavior through a holistic prism. Wall Street analysts may speak of personal disposable income thresholds that would trigger real conservation, but one needs to factor in the pace of a price upswing, and a myriad of other stimuli that impact consumers.
I’ve heard about these European vehicles that can get 40 or 45 miles per hour on diesel fuel. Can we expect to see these vehicles in the U.S. and where might U.S. diesel prices be headed? Europe has definitely embraced diesel as a preferred fuel and that trend there could continue. But no such movement seems likely in the U.S., and indeed, diesel fuel demand may outpace diesel supply growth in all corners of the globe this decade. The good news is that U.S. diesel has become a much cleaner fuel, but the bad news is that no surpluses of this fuel are in sight. Hence, prices above $2.50 gal may be the norm and there will be many months where retail diesel prices will be higher than gasoline.
Many generations remember the coupling of higher oil prices and global recession. Is it possible that we are looking at a reprise? No. While politics and headlines get blamed for oil price spikes, many of the petroleum price gains this decade are classically intertwined with economic growth. There is a myth that suggests that stock markets move up when oil prices move down and vice versa, when the opposite has been true for most of the 21st century energy bull market. Oil prices and the trading community that determines the same are counting on reasonably brisk economic growth through the decade’s end. A recession or “mini-slowdown” would throw a monkey wrench into the entire pricing structure. Oil prices above $50 bbl are probably not possible against the backdrop of recession.
If you were anointed King of the petroleum world and sought to cure some of the 21st century oil price ills, what would you do? First, I would name Scarlett Johansson as my special assistant. Then, I would do the following:
- I would raise the legal driving age to a minimum 17 years of age throughout the country. Research has shown the teenage brain to be undeveloped when it comes to assessing risk, and we have a problem with too much demand, cluttered roads, and most of all, with a high prevalence of young people involved in tragic accidents. Why haven’t regulators connected the dots?
- I would get rid of the nine tenths designations on the price pumps. It’s been my experience, that the vast majority of gasoline retailers are honest businessmen, but this legacy of a bygone era keeps motorist cynicism at a peak.
- I would require SUV’s of a certain excessive size to burn 89 octane or 92-93 octane gasoline. Motorists would have the right to drive the vehicle of their choice, but the higher fuel price would rightly observe that those choices can have consequences on others. The Pope could get a pass for the Popemobile.
- I would mandate that the President and Congress be required to occasionally ask their constituents to make personal sacrifices with their fuel use. Okay, maybe I’ve been inhaling the vapors around the gas pumps too often.
- I would require that all rental cars have a fuel efficiency that meets a tougher-than-normal standard. You don’t need to be renting that huge Suburban or Escalade.
- I would encourage anything that results in the construction of more U.S. petroleum bulk storage, particularly at coastal U.S. ports. The country doesn’t have enough storage of oil. Just-in-time policies work with widgets and computer parts, but with a lifeblood product like petroleum, it translates into “just intolerable.”
- I would retain full service only gasoline rules in my home state of New Jersey, but only if some new commands were required for ordering the various grades. In homage to the hardest working man in show business (James Brown), “Fill it up with regular” could be replaced by the simple command “Hit Me”. Midgrade could be “Hit me Again” and a full tank of Super could require the consumer to request “take it to the bridge.”
(Okay, I included that last bullet just to determine who might still be with me.)