Forgive me for the tentative nature of the headline and the pathetic rhyme scheme. The paper markets in oil and gasoline have sobered up after a sloppy drunk spring, but there is one pressing physical issue that leads me to caveat what would otherwise be a cheerful forecast for fuel price relief.
I’ve taken the liberty of providing an extensive Q&A in this post, with some of the questions that the press should be asking, but have not. But first, let me review the numbers, and address the caveat.
The average price of gasoline today is $3.982 gal. That is up nearly 18cts gal in the last month and is $1.09 gal above what Americans paid on May 13, 2010. For details of all markets, including metro areas visit the AAA website at www.fuelgaugereport.com
I believe that U.S. gasoline prices in June, July, and August will probably average between $3.25 gal and $3.75 gal. If you live in Western or Rocky Mountain time zones, you will probably observe tumbling prices much earlier than June. California retail prices for unleaded hovered around $4.25 gal for most of May, but the Golden State will see competitive prices of $3.75 gal and lower by mid-June. This is a temperate forecast, and intemperate zealots get all the attention, but trust me.
The caveat comes by way of what is happening on the lower Mississippi River. I turned on ABC World News Tonight earlier this week and saw Diane Sawyer wearing hip boots, and reporting on the floods near Memphis. We’re likely to see more TV personalities doing remote coverage from Louisiana parishes in coming days. More than 2-million barrels per day of refining capacity is adjacent to or near the river and its tributaries from Baton Rouge south to the delta. The experts suggest that water levels could rise to levels last seen in 1973.
If refineries are flooded, we’ll see the dramatic increases in gasoline and diesel that are normally associated with hurricane landfall. More importantly, we’ll witness yet another tragedy for a region that has been battered for six years.
Hope can intrude and muddle analysis under these circumstances, but the most likely outcome is that refineries will be impacted, but catastrophe will be avoided. High water levels will challenge logistics. Refineries get some of their crude or feedstock via barge and tanker delivery. They also dispatch a portion of finished products like gasoline and diesel through these methods. Pipelines can be utilized for input and output, but a temporary loss of waterborne options compromises operations at least temporarily. In a few weeks, things could be back to normal.
So, that’s the caveat and it’s an important one. It explains why I’m not quite sure what the price of gasoline in some states might do in the next six or sixteen days. I’m quite confident that fuel prices will be considerably lower in six weeks.
There’s a simple rule that one can follow when predicting second quarter gasoline prices. Expect prices to ease just as crappy movie after crappy movie gets released from Hollywood. Of course, there could be a year without any crappy movies, but I have faith in Michael Bay, Jerry Bruckheimer, and many other Hollywood directors.
Q&A for the PD*
Q. What happened this month to the price of crude oil?
A. As mentioned in previous blogs, it is crowd behavior that accounts for most of the overreactions registered for crude oil every year. Plenty of dumb money was parked in oil futures & options from January through April, as WTI and Brent futures represented the “can’t miss bet” for money managers. Commodities had a long overdue sell-off during the first week of May. It is quite typical for oil futures to crest around Cinco de Mayo, but this year, they crested a few days early.
Q. Were there tip-offs that prices were too high?
A. Yes. Oil rose as it typically does on the twin engines of hope (for monetary price appreciation) and fear (of supply disruptions) in 2011. The loss of Libyan crude probably added $10 bbl or $15 bbl to the normal springtime froth. Another adumbration of the overbought market came as bulls far outnumbered bears among money managers. That signaled that buying was exhausted.
Q. Crude oil prices hit $147 bbl in 2008, and exceeded 2011 numbers by $20-$30 bbl. Yet some U.S. gasoline markets achieved new all time record highs this month. What gives?
A. Refinery margins were very modest in the great un-tethering of 2008. Typically, refiners could expect to get only about $5 bbl or $10 bbl over the price of crude. This year, we saw several clusters of refinery problems. The maintenance that is always performed in late winter and spring was more extensive than anticipated, and weather, power outages, and typical snafus hit independent and major refineries in March, April, and May. As a result, the market rewarded the fortunate refiners with huge numbers because of temporary gasoline scarcity. In some cases, grades of gasoline sold for $30 bbl or even $40-$45 bbl above the price of crude.
Q. Are these refinery problems symptomatic of a secular problem or an underlying frailty in the system?
A. I don’t believe so. Refining is more complex than it was a decade ago, thanks to Clean Air necessities such as sulfur reduction. In the old days, parts of a refinery could remain operating if one unit had a problem.
But there is plenty of U.S. refining capacity, and more is on the way. This year’s difficulty had more to do with the nature of random events. Flip a coin one hundred times and you’ll be surprised how many consecutive times it comes up heads or tails. This spring saw a couple of periods where five or six refineries had difficulty, with the woes often unrelated.
Q. Why do I continue to hear predictions of $5 gal or even $6 gal gasoline? And why do these voices outnumber the more temperate predictions?
A. Many of the people who talk about $5 gal or $6 gal gasoline are in the investment community. When I make TV or radio appearances, I’m often confounded by the steady diet of money managers, brokers, and investment counselors who all offer bullish prognostications for stocks or oil. I feel like Mother Teresa or Gandhi when I’m on some of these panels. It’s pretty difficult to be objective when you have a vested interest.
Q. Wasn’t Gandhi something of a cad as a young man?
A. Yes, and so was I. When the Mississippi River last reached its high water mark in 1973, I may have indeed been “sloppy drunk” like the spring 2011 oil markets. Like Gandhi, I have pursued a noble path in middle age, albeit without dressing in the clothes of an Indian villager.
Q. Has speculation played a huge role in the 2011 price spike?
A. Money was the biggest driver in the first four months of 2011, but the line between speculation and investment is not clear. Among huge institutional money funds, there was about $40-billion more money invested/speculated on a higher price outcome. Some of that money is very patient, with index funds and other such buyers known as the “massive passives.” But these are not the typical speculators that one would associate with movies like Trading Places.
Q. What about Libya? Will the revolution there continue to impact world crude prices?
A. Yes. Libya makes a very light and very sweet crude that can be processed by very unsophisticated refiners. There is no hint that this crude supply will be restored any time soon, and it probably accounts for a $10 bbl to $15 bbl premium in world prices. The loss of most Libyan production is the reason why Brent crude and other at sea offshore sweet blends have fetched $110-$127 bbl this Spring.
It’s worth noting, however, that global traders and money managers are no longer rising each morning with the worry that another oil producing country has an “Arab spring” with a threat to MENA oil production.
I’m not sure whether there will be a second “Arab spring” in 2012. However, I am quite sure that there will be a groundswell of worries about prospective MENA events when we are in the thick of the 2011-2012 winter. In other words, I’m not sure whether the movie will have a sequel, but I expect trailers and coming attractions to inspire some new buying in crude about 6-8 months from now.
Q. Do you believe we’ll eventually see $5 gal or $6 gal gasoline?
A. Yes. At some point in this decade, we’ll see the mother of all price spikes, and it will be driven by a sharp move higher in crude. I don’t believe $5 gal or $6 gal prices are sustainable, and I also don’t believe that $150 bbl is sustainable for a long period of time.
But the wolf is not at the door in 2011, and I doubt whether the wolf will be at the door in 2012. More likely: we’ll continue to be visited by very large and ornery hamsters.
Q. Experts keep saying that most U.S. drivers don’t change their habits even when prices rise above $4 gal. Do you agree?
A. I agree that most consumers drive about the same amount when prices hit $4 gal. But I also believe that there has been more demand destruction in the U.S. than the various statistical associations, investment banks, and credit card processors have reported. OPIS surveys suggest that gasoline demand in recent weeks is down about 3% or 4% from same period in 2010.
Those are critical numbers. Gasoline demand is a bit like the human body temperature in that a difference on two or three degrees can have dramatic consequences.
You’ll also hear that emerging countries don’t encounter demand destruction until prices go well beyond where they moved this spring. My observation is that all of the data for emerging economies is incredibly muddled and flawed. We simply don’t have the tools to measure petroleum demand numbers in South America or southeast Asia, or Africa. Inevitably, the numbers that are produced tend to harmonize with the bullish views of investment banks.
Q. You haven’t mentioned anything about congressional hearings taking oil companies to task on subsidies, or efforts by some legislators to open up drilling on hitherto untouched federal land. What is your opinion of this rhetoric?
A. This is typical trench warfare from the left and the right that has put off any reasonable effort to come up with a truly coherent energy policy. Any such policy will involve sacrifices necessary from the public.
When I hear this scripted theater, it reminds me of hearing God Bless America at the baseball games. No offense to Kate Smith, but we could use different voices, particularly if the lyrics aren’t going to change.
*For newcomers to this site, I believe I am the only oil analyst with a bona fide Rap name, having been adorned with the sobriquet Pump Daddy a decade ago.