Weak Signals

Today’s posting will be brief, since I’m traveling. An item in this morning’s Wall St. Journal caught my eye. It interpreted some recent oil-related options trading as an indication that some market participants expect a correction in oil prices. While I share the view that oil at $118 per barrel has inflated beyond any realistic interpretation of the supply and demand fundamentals, even with the prospect of a further deterioration of the dollar exchange rate, I wouldn’t make too much of this news. Oil futures have run up by more than $10 in the last two weeks, and it wouldn’t require deep pessimism for traders to want to buy a little insurance. They could pay for it with the profits from just the last day or two.

At the same time, while a correction seems long overdue, I’m concerned that oil has reached its current heights without any major supply crisis, driving the average US retail gasoline price above $3.50/gallon without any serious refining or product distribution problem. An event on either front could send oil prices or refining margins to levels that would quickly translate into another 20-30 cents per gallon at the pump, pushing large parts of the county over the $4.00 mark, which is already appearing at higher-priced retailers in California.

As consumers contemplate that possibility, we should remember that we have more influence over prices than we think. A 0.5 mile-per-gallon improvement in fuel economy from avoiding jackrabbit starts and coasting into stops--rather than accelerating until the last moment—would aggregate to a 6 million barrel per month reduction in demand and ease the pressure on prices, while filling up at ½ instead of ¼ would deplete US gasoline inventories by 10 million barrels, or about 5%. That could make $4 gas a self-fulfilling prophesy.