March 2, 2012 Leave a comment
Why retail gasoline prices are nearing a record
SAN FRANCISCO (MarketWatch) — Gasoline prices have climbed every day for the last 36 days so it’s no wonder why consumers are worried that record levels are destined for the pump in the next few months. But the many reasons behind the climb aren’t quite so easy to decipher — making prices even harder to predict.
The simplest explanation for high gasoline prices goes like this: “you’re paying more for gasoline because oil refiners are paying more for crude,” said Byron King, editor of investment newsletter Outstanding Investments.
Alternatives to gasoline find favor
Biofuel and electric cars are gaining traction in the face of a spike in crude oil prices. Steve Gelsi from MarketWatch reports.
Recent political and military tension with Iran has added a “war risk” premium to the markets, he said. “War is bad for business, but rumors of war are good for the oil business.”
“It doesn’t matter that the U.S. imports exactly zero Iranian oil,” King said. “The U.S. competes for oil with every other oil-importing nation and the tensions with Iran have set a higher price at the margin. The margin sets the price for everything else.”
The average U.S. retail price for a gallon of regular gasoline stood at $3.741 a gallon Friday, up 29 cents from a month ago and 31 cents higher from a year ago, AAA data show. Prices have shot well over $4 in some parts of the country, such as California.
Average national prices have been climbing from Jan. 26, when unleaded was at $3.38 and midgrade was at $3.51, after starting the year at the highest–ever level for the beginning of a new year, according to the Oil Price Information Service, which compiles the AAA data, in cooperation with Wright Express. Read about how gasoline started the year.
The record average was $4.11 a gallon reached in July 2008.
“Rumors drive prices upward, especially when it comes with fear of even a temporary closure of the Strait of Hormuz,” said King.
Flows through the strait, located between Oman and Iran, represented about 35% of all seaborne-traded oil in 2011. Read about Iran’s impact on oil.
“Everyone fumbles for a single reason to explain high crude-oil prices, which are the primary reason for high U.S. gas prices,” said Tom Kloza, chief oil analyst at OPIS.
Brent oil futures, which traded around $124 a barrel on Friday, have climbed around 20% year to date. West Texas Intermediate crude CLJ2 -1.99% , which trades near $106 on Nymex, is about 8% higher year to date. Read about Friday’s action in oil.
Gasoline for future delivery has rallied more than 20% year to date, with the April contract RBJ2 -2.07% trading at $3.28 a gallon Thursday on Nymex.
And while the higher crude costs have come on the heels of tensions with Iran, there are many other reasons why consumers are paying the highest gasoline prices at the pump since June.
“Iran, money flow, refinery closures, refinery maintenance, exports, imports, poor non-OPEC production growth, and flat OPEC output are all legitimate factors,” said Kloza.
It’s about the “cost of making a product,” he said, and on the East Coast, most of the refiners’ cost in making it comes from Brent.
Strong world oil demand, with China growing at a rapid pace and India right behind it, along with supply that is “challenged,” with Libyan production still offline and problems in Nigeria, have all contributed to oil’s strength — and creates a “cloudy crystal ball” for gasoline prices, he said.
Recent closures in the refining sector have certainly been bad news for consumers.
Sunoco Inc. SUN +0.09% plans to shut a 335,000-barrels-per-day Philadelphia refinery this summer if no buyer is found.
And in the last few months in Pennsylvania, Sunoco shut a 178,000-barrels-per-day refinery and ConocoPhillips COP +0.16% closed a 185,000-barrels-per-day refinery. More recently, Hovensa SA shut its 350,000-barrels-per-day joint venture refinery in the U.S. Virgin Islands. Read more on refinery closures.
“A lot of refineries that are refining Brent are losing money,” said Felmy.
Still, the U.S. refinery system produced a record amount of 9.1 million barrels per day of gasoline last year, outpacing 2011 demand of 8.5 million barrels a day, he said, adding that refiners were able to increase their exports of gasoline to keep in business.
In fact, the U.S. exported more gasoline, diesel and other fuels than it imported in 2011 — for the first time since 1949, government data show.
And this year has already been different from most in terms of winter weather and fuel demand.
“During winter months, refiners of gasoline and other oil products usually shift production in favor of heating oil HOJ2 -1.99% and like products in order to meet that usually higher demand versus summer, while driving usually declines when the weather is bad,” said Jeffery Born, a professor of finance at the College of Business Administration at Northeastern University in Boston.
Overall, it has not been cold and “I suspect that folks have not cut back their driving as much as they normally do when there is snow. Normal production patterns aren’t serving us well during this unusually warm winter.”
The good news for consumers is that because of the warm winter in the U.S., refiners got an early start on planned maintenance, which means some of the spike that is usually seen in March and April “may be happening now,” said Phil Flynn, energy analyst at PFG Best.
“So if oil breaks, we could see a counter-seasonal move in gas to the downside,” he said.
For now, as average nationwide gasoline prices at the pump look set to surpass $4 a gallon, consumers may wonder why slowing U.S. fuel demand hasn’t really helped to offset the factors driving prices higher.
Weekly U.S. gasoline demand has fallen to an average of 8.4 million barrels per day as of the week ended Feb. 24, compared with 9.2 million barrels a day a year earlier, according to government data.
“Demand for gas in this country is off quite a bit, but our gas demand only accounts for about 1/10 of world demand,” said Jeff Lenard, a spokesman at the National Association of Convenience Stores, a trade group for an industry that sells 80% of the nation’s gasoline.
“So while our demand is decreasing, the other 90% of demand is not,” he said. “What is happening on the global market really affects what you see at the corner store.”
Consumers also wonder why retail gasoline prices appear to spike at the same time as crude-oil prices.
Most energy companies value their inventories using a “last-in, first-out method,” said Northeastern University’s Born, which “basically means that they use the most recent materials cost to compute cost of goods sold.”
When crude-oil prices are rising, the material costs for gasoline refineries right alongside, he said, and if companies don’t raise their prices for gasoline as fast as the rise in the cost of their crude oil supplies, “they will experience a decline in profits and profit margins.”
At the retail level, consumers don’t really see the effect of that initial rise in oil prices, because retailers are holding back prices, said Lenard.
“There is usually a lag of a week or two as retailers cut margins to retain customers, but just like refineries can’t sell fuel at a loss, neither can retailers — and they start passing along more of these increases,” he said. “Then as both rallies continue, it seems like they are operating simultaneously, but gas prices are reacting to previous oil price increases.”
Against this backdrop, the impact of $124 Brent crude prices may not be fully factored into U.S. retail gas prices yet.
There may be some hope of relief for consumers. This year, after all, includes a U.S. presidential election.
“High gas prices are not favorable to the incumbent administration as they can hinder economic growth and aggravate the voting populace based upon the direct impact on their day-to-day lives,” said Kevin Mahn, president and chief investment officer of Hennion & Walsh Asset Management.
“President Obama recently announced his energy policies focusing on increased levels of U.S. production and further promotion of alternative energy research, [but] whether these policies are adopted or successful remains to be seen,” he said.
‘There are no short-term solutions unless all opposing factions in the Middle East and North Africa kiss and make up.’
James Williams, WTRG Economics
The election year could also increase the probability of a release of oil from the Strategic Petroleum Reserve, said James Williams, an energy economist at WTRG Economics. That would provide a “relatively small and temporary relief.”
He doesn’t expect any real solutions from politicians of any party, however, and there are no short-term solutions “unless all opposing factions in the Middle East and North Africa kiss and make up.”
An SPR release would give the East Coast and Gulf Coast refineries some relief from high Brent crude prices and send “an important message” that the U.S. is “capable of protecting its domestic market as Iran threatens to close down the Strait of Hormuz,” said Bob van der Valk, a petroleum-industry analyst based in Terry, Mont.
Also, crude from the Bakken shale of North Dakota and Canadian oil sands, along with additional production in Texas coming on stream “will go a long way in making the U.S. energy secure,” he said.
For now, van der Valk said California gasoline prices may reach an average $4.50 by July 4, while the East Coast reaches $4.
“All heck will break loose when Iran comes out fighting and we have a bad [Atlantic] hurricane season,” van der Valk said.
Myra Saefong is a MarketWatch reporter based in San Francisco.