Thursday, May 15, 2008

$4 In Sight

As of yesterday's market close, the price of light sweet crude oil on the New York Mercantile Exchange (NYMEX) was up 29% since December 31, 2007. In this environment, prognostications about the market become obsolete almost as fast as they're written, mine included. Ten weeks ago I assessed the prospect of $4 per gallon gasoline this spring and concluded that it would require a combination of unusual circumstances. Instead, after another $20+ increase in oil prices, the average US retail gas price stands at $3.72, with California at $3.92. That means that polesigns showing $4.00 or more for unleaded regular are already a common sight in many communities. In a normal year, I would suggest that we are probably only a few weeks away from the peak price for the year, but this has been anything but a normal year.

Aside from the unprecedented crude oil prices, refining margins have not followed their usual seasonal pattern, in which margins rise as refineries shift out of heating oil production and perform annual maintenance, while gasoline demand builds toward its summer level. But using the difference between NYMEX gasoline and crude oil futures as a proxy for margins, they are running at $0.42/gal. less for April-May than the average of the second quarters of 2006 and 2007. This reflects weak demand, which may now be rebounding. Refineries are operating at somewhat reduced rates, compared to this time last year, and diesel production is a bit higher and gasoline output a bit lower than normal, all driven by weak gasoline margins and the surprising strength of diesel fuel. If normal seasonal factors were superimposed on today's high oil prices, we'd already be paying well over $4/gal. for gas.

I wish I could point out some factor that promised imminent relief. The only candidate I see is the recent decline in the "backwardation" of oil futures. A few weeks ago, the first or "prompt" contract was worth about $2.00/bbl more than the contract for delivery four months out. Today, this premium is around $0.40. That suggests a market in better balance. A further shift into "contango", when prompt oil is worth less than oil farther out, would indicate a surplus and signal refiners and traders to rebuild inventories. Of course, it wouldn't take much in the way of bad news to resume our march toward $130 or higher.

For good or ill, the only element in all of this that consumers control is demand, which is a function of miles driven and fuel efficiency. After falling in the first quarter, it now seems to be running at about the same pace as last year. Americans may be driving less, but the highways speeds I observe others driving imply that for all our complaints about the high price of fuel, we still value our time more. Will the psychological impact of paying $4 per gallon alter that? If a 70% increase in the pump price of gasoline over the last three years hasn't done the job, then I doubt that another $0.30/gallon will.

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