News item: Retail gasoline prices for regular gasoline rose in the last five days by about two cents per gal to $2.777 gal, according to the data OPIS compiles for the AAA FuelGauge (www.fuelgaugereport.com)
(The Energy Information Administration yesterday reported a 1.4cts gal increase for the last seven days, but our numbers are better, and represent something close to 90,000 stations).
Labor Day is less than two weeks away. The teeming masses of business journalists will be asked by their editors if they can work up a gas price story, in most cases for their local newspaper. I’m a step ahead of you all - - here are ten questions, some of which most reporters will ask, and some that should have been asked all along, but were not. All are answered with the candor that can only come when one does not have a vested interest in the outcome.
1. Q. What can the U.S. consumer expect between now and Labor Day weekend?
A. You can expect to see prices drift lower. For the most part, that has been a trend witnessed all Summer long, with the exception of a small rise that occurred in the ten days following the 4th of July. Prices bounced back above $3.00 gal at that point, thanks mostly to a cluster of some very serious refinery problems in the Midwest.
The certainty is that retail prices will dip this week, as wholesale prices Monday retreated by more than 10cts gal in most markets. They are already down another 2-3cts gal Tuesday morning. Retail follows wholesale, so I’m making a safe bet.
Next week might see a continuation of the downtrend unless another tropical system develops. Hurricane Dean won’t impact U.S. refining, and its wrath may be confined to Mexican offshore crude oil production in the southern Gulf. An awful lot of traders “bought the hurricane” last Thursday and Friday, and that’s why oil markets were toasted in the last 36 hours. But one should still cross one’s fingers and hope that other major storms don’t threaten production assets through the remainder of the season.
2. Q. Looking back, why did some consumers pay $3.25-$3.50 gal or greater, earlier this year and will we see that again in 2007?
A. Without a hurricane, it’s not likely that we’ll see prices approach those Memorial Day levels again this year. They may indeed flirt with similar numbers in Spring 2008, however, although it’s too soon to render a 2008 forecast that is more advanced than say, witchcraft.
Gasoline prices raced to record retail numbers thanks to a price surge at the wholesale level that preceded the pump spike. In retrospect, most analysts have to concur with my belief that the wholesale spike was excessive. It had less to do with fundamentals and typical seasonal behavior, and everything to do with emotional excess and the tremendous inflow of financial investment into energy futures.
Thanks to those factors, gasoline margins for refiners in many key bulk markets reached numbers $30-$50 bbl above the price of crude. A more typical long term margin for refiners might be $5-$15 bbl. Even the believers in a 21st century refining renaissance concede that $30-$50 bbl differences (where wholesale gasoline trades at 71cts gal to 119cts gal above the raw cost of crude) are aberrations.
3. Q. We heard in May and June that U.S. refineries were broken down and couldn’t match the production levels of previous years, or, that the new paradigms for refinery maintenance had led to a “new normal” in this sector. Have refiners recovered?
A. Much of what was said about 2007 refinery operations was a combination of nonsense and cheerleading. Refinery maintenance is indeed more complicated than it was a few years ago. But, U.S. refineries have modernized equipment this decade and the technology to squeeze more products out of every barrel of crude has improved. Looking back, I wondered at the time whether the second quarter refinery problems represented a mere cluster of bad fortune. In retrospect, I think that theory has some merit, particularly if you now review statistics and see that U.S. refineries are operating at over 90 percent of capacity.
But marketers and consumers should watch out for excess on the relief side. The U.S. is still running about 600,000 bbl per day less crude than we did when Katrina came ashore, and we’ve yet to recover from 2005-2007 refining events.
4. Q. What about demand? The pundits and reporters all held that people were driving more than ever, even as prices raced to all time highs. Were they in error?
A. Yes. Gasoline demand is incredibly difficult to measure. No one aggregates the sales at some 171,000 stations that dispense fuel in the country. Those year-on-year demand “lift” numbers in March and April were overstatements. When all of the data for 2007 is collected, you’ll probably find that people used about 1.0 percent to 1.3 percent more motor fuel than in 2006.
And they are using considerably less of late. Gasoline demand peaked around mid-July and it has been easing ever-so-slightly since that time. It may rev up next week in front of Labor Day, but it will then drop down a few hundred thousand barrels per day just about the time you are watching the first meaningful NFL games. (Is there any greater rip-off in the U.S. than preseason football?)
5. Q. I heard that a couple of investment banks predicted $80-$100 bbl crude less than a month ago. Will that happen?
A. It could happen, but everything has to fit in neatly for these super-bulls. Global economies must maintain strong growth, and consumers need to behave accordingly. There probably needs to be some interruption in the flow of oil from one of the crucial production areas, whether it be the Mideast, Central Africa, Russia, or perhaps Venezuela.
But while global interruptions are “possible”, they are clearly not probable. And recent history has shown that it is difficult for crude oil to move sharply higher without gasoline leading the way. Gasoline prices don’t tend to be excessive from September through February.
6. Q. Does all the financial turmoil this Summer have an impact on oil prices?
A. You bet. The refined products market is a macroeconomic business, and growth in gasoline and diesel depends on growth in the economy. A recession, or even a mini-recession would invite sharply lower prices, particularly for crude and diesel fuel, which are much more representative of the commercial economy.
And, don’t believe the myth that holds that oil and equities move inversely. If you wake up in the morning and the stock market is up 300 points, there’s a better than 50-50 chance that oil markets will be up as well. There’s an even greater correlation when equity markets deteriorate. There is only so much money out there to purchase oil futures, derivatives and other financial instruments that represent surrogates for actually owning the physical petroleum. If you hear that the Dow is down 300, you can pretty much expect that oil prices will be down sharply as well.
7. Q. Have renewable fuels cut into traditional petroleum products’ market share?
A. Yes, but by a relatively small amount. Prices for ethanol have actually been cheap enough so that blending 10 percent ethanol into a gasoline grade actually lowers the cost this year, although much of that price relief comes because of the federal tax subsidy on ethanol blends.
Fairly modest margins have been recorded all year for ethanol producers. In late Winter, the price of corn hit highs for the decade on the fear that there wouldn’t be enough grain to satisfy food and fuel needs. But much of that price gain was attributable to investment money getting placed in corn and other commodities, much as what happened with energy.
In the next few months, you’ll be able to purchase ethanol blends of gasoline in additional states like Florida, Georgia, the Carolinas and perhaps even Vermont, upstate New York or western and central Pennsylvania. The rollout has less to do with the desire to be green, than the desire to pick up a little green. This could change on a moment’s notice, but right now, blending ethanol in most U.S. states results in a lower priced finished fuel, with a little more octane.
8. Q. This is not an election year for federal office. Does that mean that gasoline prices won’t slip between now and November?
A. This is one of those completely nonsensical American legends. Gasoline prices dip in the September through February period (roughly) because it’s easier to make Fall and Winter blends of gasoline, and it’s easier to find it on the offshore import market. There is also less demand. Americans may use 20-million gal less gasoline per day in some of these weeks, than in say July or August. The conspiracy that sends gasoline prices lower between Labor Day and the Winter solstice is similar to the conspiracy that makes northern leaves turn. It’s all related to climate.
9. Q. What about gasoline retailers? Didn’t they make a killing when prices advanced to $3.25 gal?
A. Nope. They were pretty miserable when retail prices ramped up from $2.20 gal on Groundhog Day to $3.27 gal on Memorial Day. That’s because wholesale prices moved up by even more and retailers couldn’t pass along increases as quickly as they occur (Wall Street calls this “pricing power”.) They’ve actually seen much better margins now that retail prices have dropped by 50cts gal, since wholesale prices are down by 60-80cts gal in some cases. Net retail margins are pretty nominal on a percentage basis - - stores make a lot more money on your purchases of Slim Jim’s and Drake’s Cakes than they do on gasoline.
10. Q. How come so many oil analysts overreacted, and predicted a price spike? Don’t they have impeccable credentials?
A. Many have advanced degrees in economics and statistics, and there is much wisdom to be found in the analytical community. But, it’s difficult to predict what you don’t want to happen. Most of the talking heads and voices one hears have clients who are invested in the oil markets. It is difficult to be objective under those circumstances and nothing clouds one judgment quite so much as a stake in the market’s outcome.
I have no such stake, and no advanced Ivy League degrees, but I have nothing invested in oil price or equities, and I have better hair than nearly all of the talking heads.