Friday, February 29, 2008

How Likely Is $4 Gasoline?

The recent 19 cent per gallon surge in the average retail price of gasoline has raised concerns that sustained high oil prices and seasonally-stronger refining margins could push US gas prices to $4.00 this spring. But while the recent seasonal patterns make it likely that prices will strengthen from the current $3.13 per gallon to at least $3.50, even with a weak economy, going much beyond that would probably take more than just the routine level of annual refinery maintenance. Breaking the next even-dollar milestone for the national average by the Fourth of July would require a combination of serious supply problems and expensive oil.

Although it may not be obvious at the gas pump, weak refining margins have shielded gasoline consumers from the full impact of $100 oil, so far. Using the commodity prices on the New York Mercantile Exchange as a simple proxy for refining margins, wholesale gasoline has averaged only $0.12/gallon above crude oil this week, well below the average for 2006 and 2007, and much lower than the second quarters of both years, when prompt gasoline futures averaged $0.63/gal. over the light sweet crude contract. That suggests that if oil prices remained near their current level, and refinery maintenance and unanticipated shut-downs were comparable to the last couple of years, then retail gasoline could average as much as $3.70/gal. nationally this spring, perhaps reaching $3.90/gal. for brief periods. In its most recent weekly oil report, however, the Energy Information Agency of the Department of Energy anticipates lower refinery maintenance than last year, along with lower gasoline demand, so those figures look like upper bounds, unless you live on the West Coast.

Californians routinely pay more for gasoline, for reasons I've described at length. Among other factors, the state-mandated fuel formulation is harder to make, and the gasoline tax is 17 cents per gallon higher than the national average. Residents of San Francisco are already seeing street prices above $3.70/gal., though they can beat that by at least 30 cents if they shop around. L.A. appears to be about a dime lower. From those levels, $4.00 gas confined to California won't require much of a stretch.

Trying to gauge the likely course of national gasoline prices this spring is complicated by uncertainties about ethanol. In previous years, shortages of ethanol have contributed to higher gas prices. At the moment, after accounting for transportation by rail and the $0.51/gal. blenders' credit, ethanol prices look cheaper than wholesale gasoline, so the continued expansion of ethanol production might help hold down increases in gasoline prices by a few cents per gallon. The wild card is the increased Renewable Fuel Standard created by the 2007 Energy Bill. It requires refiners to add about one-third more ethanol than they did last year. Logistical bottlenecks could impede that process and push up the price of the ethanol that can reach end markets, nudging gas prices even higher.

The scenario for a $4.00 per gallon average US retail gasoline price thus requires a combination of several non-routine factors: a larger-than-expected reduction in gasoline production than from scheduled refinery maintenance alone, a difficult transition to the higher ethanol mandate, or something that impeded our imports of a million-plus barrels per day of gasoline from offshore. And it's predicated on sustained oil prices at or above $100/barrel--a highly uncertain proposition, given the tension between weakening demand and a weakening dollar. The only thing certain about $4.00/gal. gasoline is that if oil prices keep rising, we'll get there eventually. This spring might only be our first shot at it.

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