It's remarkable to see the price of gasoline heading back to levels that we've only seen before in this country in the immediate aftermath of last summer's hurricanes. Gas prices are fueling more suspicion of oil company collusion, and I expect we'll see another round of Congressional hearings. People are talking about $3.50 or even $4.00 per gallon by summer, and I suppose we could see it, though when I look at the fundamentals of supply, the picture is much less clear.
First, look at the components of today's prices. Let's start with the wholesale level, since retail includes taxes, which widely vary from state to state, and dealer margins that are also hardly uniform. The New York Mercantile Exchange showed wholesale regular unleaded gas for delivery in May at $2.17/gal., as of the close of yesterday's trading. It also reflects an essentially flat forward price curve, indicating that traders don't anticipate prices dropping much before the fall. A quick look at gasoline inventories and production, which are both quite low vs. seasonal averages, supports that view.
But of that $2.17/gal. wholesale gasoline price, $1.75 is attributable to crude oil at $73.33 per barrel (bbl) for June. In fact, the crude market is now in contango, with expected forward prices climbing to $74.50 in July and up to $76 by November. There are two ways to look at that information. Superficially, you’d say that it confirms that gasoline prices could keep going up, as many expect. But contango is an unusual condition, as I’ve described before. It typically indicates an oversupplied market, and that’s just what you see when you look at US crude oil inventories, which are far above their seasonal historical average. Contango can flatten in two ways, by the front, or more prompt month prices rising, or by the back, farther out prices falling.
If I only looked at crude inventories, I’d conclude that oil prices ought to start dropping soon, and by a lot. After all, oil was trading at $60/bbl only a couple of months ago. That would take gasoline price down by 30 cents/gal., ignoring the well-documented constraints in our refining system and the substitution of scarce ethanol for MTBE as a component of reformulated gasoline.
So what is driving this market? In my opinion, speculation, driven by the uncertainties surrounding the Middle East and Iran, in particular. You can argue the virtues and vices of speculation, but it is as American as apple pie. And there’s something people tend to forget about it: speculators are sometimes prescient, but when they are wrong, markets can correct very rapidly and the speculators lose fortunes. So if the Iran nuclear situation keeps simmering, we shouldn’t expect much relief at the gas pump. But if there were some positive development, the market fundamentals could kick in with a vengeance, as speculators started to bail out. That would head off the climb towards $4.00 and be very welcome for consumers. I'm sure I'll be coming back to this topic in the months ahead.