Wednesday, May 18, 2011

Where is the price of gasoline going? Jeff Beck knows..

Ok, so before you read through the post and links, I highly reccommend playing this awesome Jeff Beck song for background music..

SO, where is the price of gasoline going?  Everyone wants to know where so I figured I'd figure it out.  But don't like go and invest any of your money based on my advice.  My lawyer told me to say that btw.

In the end, price is a function of supply and demand. I say market manipulation eventually gets overrun by the masses so lets ignore the conspiracy theories.  To predict the trend of the price look at the trends for supplies and demands and you should be at least be able to figure out if the price is headed up or down.

First look at the data and recent trends. The US Energy Information Administration explains how futures contracts relate to retail prices. Great resource for an economics geek.   The relationship between retail gasoline prices and NYMEX RBOB futures prices  and then read this story about oil storage capacity peaking out just before the price of gasoline fell in May 2010.  Rising reserves of unused oil put strain on storage.   In 2010, as the storage capacity for oil filled it resulted in a bump down in price of gasoline so there is some correlation between inventories and prices.

And this story explains the glut in Cushing, Oklahoma the world's largest oil storage facilty. So much of a glut that Canada is losing patience with our ability to handle their increasing flow of oil through pipelines from their oil production fields. Oil Glut at Cushing Oklahoma Could Last Two Years  Yet, the price of gasoline has not fallen to reflect that glut in oil supplies.  

Of course, you don't put oil in your car, you put gasoline in the tank and so refining capacity is also part of the equation.  And we've all heard about how there hasn't been a new refinery built in the USA since the 1970's..  but there is no shortage of refinery capacity.  Quite the opposite.  Ernst and Young compiled this report on the prospects for the refining industry.  Doom and Gloom and low margins because of overcapacity.  US Refining 2010: From the Golden age to the dark ages  

Going forward, refiners are likely to continue to be squeezed by upward crude price pressures as a result of increasing depletion rates, spending cutbacks, access constraints and costs, and from downward demand pressures caused by economic weakness and a sluggish recovery. Additionally, the growing “greenness,” which is manifested in the newfound appreciation of vehicle ef ciency, increasing use of biofuels, and improved hybrid vehicle economics threatens refiners’ margins. Quite simply, growing Chinese and Asian oil demand can’t carry the whole burden for the global refining system.

We have a glut in oil reserves already with oil production from Canada increasing and there is a glut in refining capacity along with a permanent downward trend in gasoline demand in the USA.  Although the stock of gasoline is used to gauge demand, I think that is a misleading long term trend.  As refiners' margins get squeezed, they will reduce costs and that involves trimming inventory levels.  So don't look at falling gasoline inventories as a textbook 'shortage' when there is excess capacity to refine more if needed and the storage tanks don't need to be kept full.   That all points in one direction which is a decline in the price of gasoline,   The EIA called for $0.25 per gallon drop this Summer.  I'll go a little bolder and call double that.  Ah but when.

The one caveat of course is a financial crisis that might ensue from a default on the dollar if the geniuses in Washington are incompetent enough to let that debacle happen. Then all bets are off. Otherwise, I see a nice drop in the price of gasoline coming soon and it will be like a mini-stimulus package for the economy, fueling more consumer confidence and economic recovery that will enable converting more of the American fleet to fuel efficient cars reducing the demand for gasoline even further. It would be good for us if a glut in the oil market could do for prices what the glut in the housing market did.

Those who interpret the recent falling price of oil as a bad-news indicator of a slowing economy are ignoring the supply and demand trends or misunderstanding the reasons for the trends.  Falling oil and soon gasoline prices are in part due to consumers' diverse efforts to reduce fuel consumption and this is a key enabler for sustained economic growth.  I can't wait to say I told you so.

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