I’m flabbergasted by the number of national television ads designed explicitly to coax consumers to purchase a car, or perhaps a truck, for that special someone this Christmas. My parents couldn’t afford the purchase of a new car when my siblings and I reached driving age. Even if an on-the-rebound Scarlett Johansson decided to stalk me in my middle age, she would have to supply the transportation.
Nevertheless, the gift of a gasoline driven vehicle seems to be in vogue this holiday season, so I’ll offer this advice. Stay away from those gas-guzzling SUVs. My view of 2011 suggests that we are looking at the second fuel price apocalypse of the 21st century, commencing during a time line that will begin with spring training and end when the Cubs are written off as a baseball non-contender.
Nationwide gasoline prices approach this last Christmas shopping weekend at $2.984 gal, up 39.35cts gal or about 15% over last year. A standard price of $3.00 gal or higher is the rule in just over twenty states. Alaska and Hawaii are the high priced outliers, with average unleaded prices of $3.54 gal and $3.60 gal, respectively. The lower 48 states vary from numbers above $3.25 gal in California and New York, to relatively low priced offerings of $2.75-$2.80 gal in some Rocky Mountain states.
Reporters’ questions of late are almost singularly focused on when will the country see $3.00 gal surpassed for gasoline? Or, will we be paying more than $3.00 gal on Christmas? Or, will the U.S. consumer retreat into a cocoon-like funk as fuel costs cut into their disposable income? I choose to answer these questions (and more!) in the Q&A format below. But let me get one issue out of the way in this preamble.
We have never ever celebrated Christmas day with U.S. gasoline prices at $3.00 gal or higher, although we hit $3.00 gal just after Christmas in 2007. We’re probably looking at a 50-50 chance for $3.00 gal or higher on Christmas Day 2010. But more importantly, we are looking at a visit this spring to the rarified air of $3.25-$3.75 gal gasoline, or perhaps even higher.
I’m hoping that paragraph is a sufficient tease that will lengthen attention spans for those with the patience and energy to dig beyond the what, where, and when and examine the who, how, and why behind this likely 2011 forecast. On to the Q&A.
Q. What’s the deal with $3.00 gal gas in midwinter? Why are we knocking on this door?
A. The escalating price for crude is the major culprit. Benchmark crude prices are flirting with $90 bbl, reflecting a raw cost of nearly $2.15 gal. Break-even costs for refiners are about $6 bbl, so finished gasoline leaves the plant at a break-even cost of about $2.30 gal (this varies considerably based on refinery efficiency and the blend of crude). Transportation to a U.S. gasoline station, via pipeline and truck, can be estimated at roughly 5cts gal. Credit card costs and other fees account for perhaps 6cts gal.
So, when you add the 5cts gal in transportation with the 45cts gal in taxes, and 6cts gal in credit card fees and related expenses, you have an approximate current break-even cost of $2.86 gal at the pump, before any real profit for refiners, distributors, and c-store operators can be divvied up.
Q. It sounds like all the money is on the crude oil production side. Is that what you are getting at?
A. At this moment in time, it’s all about crude, and the abstract value that market participants place on crude. A $90 bbl crude price is quite festive for the producers.
Q. We saw crude prices of only $33 bbl less than two years ago. Why have they almost tripled?
A. There was tremendous demand destruction in the second half of 2008 when the lords of finance lost their collective heads, and deflation wreaked havoc across all businesses. Inventories of petroleum moved to all time highs, and land-based stocks of oil weren’t enough. Companies had to put excess oil in “floating storage”, which is quite expensive. But somewhere around the middle of the second quarter of 2010, the tide began to turn, and worldwide demand for petroleum has most likely surpassed supply for the last six or seven months. The floating storage is largely history. Note: my reference to “most likely surpassed” is relevant: the quality of global supply and demand data is poor.
Q. That still doesn’t explain why crude traders have $100 bbl numbers in their crosshairs. What gives?
A. 21st century markets are reactive, but much of their trajectory is anticipatory. The markets begin factoring in changes in supply and demand some 12-24 months in advance. Financial companies –including commodity pools, hedge funds, and index investments—represent the straw that stirs the energy price cocktail. Many of those financial companies, which control billions of dollars of money looking for a home, are convinced that oil futures offer a wonderful parking spot. I expect that the first week of 2011 will see a surge of money moving into oil futures and other resource commodities. The autumn move from $70 bbl to nearly $90 bbl is all about money flow as well. The spring move will be helped in part by fundamentals, but money flow is the performance-enhancing drug for prices.
Q. Do you agree with investment bankers who see $100-$120 bbl oil in the next 15 months?
A. Oil markets always get sloppy drunk, and why should 2011 be an exception? I do sense that we will see a spring peak in the neighborhood of $100 bbl or higher, and it is well set up by low interest rates, economic enthusiasm, and the typical crowd behavior that finds oil rising toward the end of the first quarter, with a peak in April or May. There will be a chapter of reckoning for many classes of assets - - including oil futures—in the last seven or eight months of 2011. Predicting oil prices beyond 150 days or so is pure witchcraft.
Q. What about gasoline futures?
A. I see a three headed animal in early 2011. Gasoline futures will initially rise with the money flow into crude oil and other commodity futures. That may quickly give way to a dip in prices, thanks to the typical drop of demand that comes in the first six or seven weeks of 2011. December is a strong demand month, but January and February are the weakest demand months for gasoline in any year.
Somewhere between Groundhog Day and Valentine’s Day, the futures market will begin its relentless march higher. Traders, aware of an average winter-to-spring historical rise in gasoline futures, will look to ride those typical waves higher.
Here’s the problem as we approach 2011. As the lyricists for Spinal Tap might note, we have recently witnessed a “Big Bottom.” A candidate for the off-season low tide number for gasoline futures was the $2.10 gal price we saw just before Election Day.
If gasoline futures match the 25 year average incoming tide, we could expect a springtime peak of over $3.25 gal (the typical increase from 1985-2010 was about 55%). If we match last year’s tidal surge (33.3%) the move will take gasoline futures to about $2.80 gal.
Q. Those are futures numbers. How do they translate to the driving public?
A. The wholesale gasoline market is like an adjustable mortgage that adjusts every business day. The prime rate for this adjustment is the futures price. A futures’ surge to $2.80 gal puts wholesale prices at between $2.75-$3.00 gal, and adds up to street prices of $3.35-$3.75 gal. A futures’ surge to say $3.25 gal would equate to retail prices of nearly $4.00 gal in some cases.
I recognize that these numbers appear to be out of line, or questionably excessive.
But it’s quite likely that even a “cooler heads may prevail” spring will push prices to the $3.25 gal and higher range.
Q. Won’t these numbers have a dramatic impact on consumer spending? What are the consequences?
A. Gasoline demand is fairly easy to project between now and say mid-May. It will be on either side of 9-million b/d or 378-million gallons per day if you prefer that measurement. At the current price of $2.984 gal, the daily bill for American motorists is about $1.128-billion. This month will see an aggregate bill of between $34-billion and $35-billion. December 2009 cost about $15-billion less.
A move to $3.25 gal would indicate monthly bills of about $38-billion and $3.75 gal would equate to about $44-billion.
Q. I thought that the U.S. had a refining surplus. How can gasoline prices rally when there is excess refining capacity?
A. U.S. refineries see two seasons for maintenance; one of which occurs largely in September and October, and another that takes place from February through April. In addition to necessary maintenance and upkeep, refiners like all other manufacturers, have to walk a tightrope: they don’t want to overproduce and flood markets. So, early 2011 is about maintenance but it is also about margin management. These twin factors tend to drive gasoline up by even more than crude each spring.
Q. Might you be wrong about these bold prophesies? Or might the investment banks be dead wrong?
A. I have been wrong many times. The difference between yours truly and investment banks is that (a) I have a soul and (b) I don’t predict what I want to happen.
That said, one can’t argue that this half decade won’t see some very stiff oil price hikes. I believe the price escalation has consequences, particularly when the numbers move at the speed of light through the ether world which passes for futures, options, and derivatives trading these days.
Q. Aren’t there efforts to curb speculative trading that could impact these markets?
A. To quote the noted author Steven Tyler “Dream On.”
Q. So will oil companies be demonized next spring?
A. Yes. The difference will be that blame will be spread among refiners, producers, Wall Street traders, and perhaps even the distributors and gasoline dealers. In 2011, we’ll see HDTV shots of LED signs and price placards instead of oil lathered ducks and pelicans.
.