Gasoline prices are sure to rise significantly by summer – Published in the Santa Barbara News Press in February of 2011

The recent unrest in Egypt and Libya has underscored a serious issue facing every American as we drive (no pun intended) ever closer to the summer driving season.  Despite the fact that crude oil and gasoline inventories are at record levels in the United States; well above the five-year average and at the top end of the five-year range of inventories for this time of year, we are seeing prices spike.  Given the political and economic unrest, the improving U.S. economy, and the sustained, high price of oil, we can be certain that gasoline prices will continue to move higher – significantly higher – as we approach mid-year.

Demand growth for gasoline has been modest. For example, a gauge of gasoline demand – miles traveled by vehicles in the United States – is rising only slowly on a year-over-year basis, according to the U.S. Department of Transportation.  Supply has been strong with oil imports from Canada having been up along with higher U.S. oil production (despite the decline in Gulf of Mexico production).
The U.S. average retail price of regular gasoline marked its largest weekly increase of 2011, increasing by five cents to $3.19 per gallon, $0.53 per gallon higher than last year at this time. Prices on the West Coast gained ten cents, the biggest increase in the country. Gasoline on the West Coast is also the most expensive in the country at $3.48 per gallon.
One of the quirky things about gasoline futures is that they trade, based on Brent, North Sea crude futures, and not on West Texas Intermediate (WTI) futures prices.  This may seem like a completely esoteric fact, and it is, but unfortunately it matters (a lot).  Normally, anytime WTI futures prices and Brent futures prices diverge, creating a wider gap that is the historical norm, traders will take advantage of the arbitrage opportunity this divergence presents, and through their buying and selling, prices will converge – come back into historical alignment.
Due to a variety of (again) really esoteric reasons, WTI and Brent prices have diverged and have maintained and even expanded their gap, which is now about $15 to $20 per barrel.  This week, WTI futures (for April delivery) spiked above $100 per barrel on the tensions in the Middle East and other factors.  At the same time, Brent futures traded above $119 per barrel.  This is the first time WTI has traded above $100 per barrel in 2 years.
Recall that in mid-2008, when oil spiked to almost $150 per barrel, gasoline prices shot up above $5 per gallon here in town.  We were lucky at that time, in a sense, for several reasons:
Oil prices spiked, but immediately began trading back down, and by December, were below $30 per barrel
Because oil prices has traded up so rapidly, the hedging operations that refiners use were in place, and basically locked the refiners’ costs so that they did not experience major price increases for their crude oil needs, and therefore were not forced to pass those higher costs onto the consumer at the pump
The economy was already feeling the effects of the coming recession, so demand for gasoline was relatively low
This time, unfortunately, it’s different.  Oil prices have been elevated for months and months, so any hedging that gasoline refiners have been using cannot protect them (and us) forever.  As the futures contracts they use to hedge expire, they are forced to replace them with more expensive contracts, or allow their costs to rise with rising crude oil prices.  Either way, they have higher costs and in most cases will pass most, if not all of those higher costs, on to the consumer at the pump.
If we couple the higher cost issue with the divergence of Brent crude futures, the result is even more upward pressure on gasoline prices.  Since, as stated above, gasoline futures trade on Brent crude futures, and Brent has spiked far more than WTI, there is added upward pressure on gasoline prices, which will ultimately make its way to the pump.
Again, there are many reasons that have to do with traders, pipeline flows, production changes in the Gulf of Mexico and Canada, storage availability and composition, and a host of other issues that are weighing on Brent prices, but the bottom line is that the gap we see today has been developing for some time, and it does not appear that traders will be able to realign WTI and Brent futures prices anytime soon.
On the positive side, we are only in February, so there is still time for things to settle down a bit before summer.  In fact, the Saudis just this week announced a new $36 billion package for new programs to pacify citizens, which was taken as a sign that tensions in the Middle East could diminish.  Some of the Saudi aid package, which included interest-free home loans and a pay raise for state employees, was seen as an direct effort to quell potential unrest in the kingdom.
Algeria also officially lifted a 19-year-old state of emergency, according to media reports Thursday that cited the country’s press service. That action lifts restrictions on freedom of speech and assembly that were imposed in 1992, during the country’s civil war.
Moammar Gadhafi’s grip on power in Libya appears to be weakening as rebel forces fought government loyalists near Tripoli this week. Parts of eastern Libya, including the country’s second-largest city, are believed to be in the hands of the opposition, according to media reports.  The situation in Libya could be seen as improving, if Gadhafi is ousted, or it could signal more uncertainty and strife, if no one comes forward who can quell the unrest and take power peacefully, quickly, and (hopefully) democratically.
Concerns have been growing not only that Libya, one of Africa’s top oil producers with its largest proven oil reserves, might spiral out of control, and that neighboring countries, on the heels of Tunisian, Egyptian and other turmoil, could be similarly gripped by mass unrest.
The International Energy Agency earlier Thursday said between 500,000 and 750,000 barrels of oil a day have been removed from the world market due to the Libyan situation. That represents less than 1% of global consumption, the IEA noted.  The agency added it is in close contact with the Organization of Petroleum Exporting Countries, and IEA’s member countries have 145 days’ worth of emergency oil stocks at their disposal.
News that Saudi Arabia and other OPEC member countries were willing to put more oil into the market pushed crude prices down somewhat from their highs this week.  However, it will not take much to push them to even higher levels, especially if the unrest in other countries, such as Bahrain continues to escalate.  Some reports indicated this week that as much as half of Libya’s total oil production was taken off-line as the turmoil mounted.
Libya supplies about 1.55 million barrels-per-day of crude, primarily to Europe. These disruptions in their supply do not affect us directly in the U.S., but the uncertainty, tensions, and political implications are certainly impacting us indirectly, through the spike in oil prices we are experiencing.
Ultimately we have about three months before summer, so we have time for these problems in the Middle East, and potentially the spike in oil prices and the gap between WTI and Brent crude to correct.  Unfortunately, I feel that oil prices have been elevated for so long that, even if prices come down quite a bit, and if the tensions in the Middle East subside, we will still experience very high gasoline prices this summer – possibly as high as $5.50 per gallon.  I feel confident in saying that $5 per gallon is a probability and not a possibility.
If the mid-2008 oil price spike and the subsequent spike in gasoline prices taught us anything it was that many Americans living paycheck to paycheck cannot afford $5 per gallon gasoline.  We saw the evidence of this fact on the nation’s freeways, as people were running out of gas between paychecks, and leaving their cars abandoned on the roads.  The economy is improving, but most of us are not earning any more today than we were two years ago, and many are still out of work.  We should all plan for high gasoline prices this summer, and do our best to reduce our driving, where possible.

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