Peak Oil is You

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Page added on February 20, 2011

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Here comes $4 gasoline

Here comes $4 gasoline thumbnail

At first blush, a replay of the 2008 gas price spike seems far fetched. The biggest driver of U.S. gasoline prices is the cost of crude oil, and near-month oil futures on the New York Mercantile Exchange have sat out the scorching commodities rally. They lately fetched $85, some 40% below the crisis peak.

But that’s where the good news ends for motorists — and for a U.S. economy that is sputtering even with gas at $3.15 a gallon.

Much of the oil being made into gasoline now actually costs $105 a barrel. For this we can blame a few of the usual suspects – try Middle East unrest and strong overseas economic growth – and one new one, a weak link in the U.S. petroleum supply chain.

Those factors make the Nymex price “irrelevant for the price of U.S. gasoline,” says Olivier Jacob, who runs the Petromatrix trading advice firm in Zug, Switzerland.

Even the government agrees. Last week it projected a 1-in-3 chance the gas price will break $3.50 this summer and a 1-in-10 chance it will hit $4. And if anything those estimates may understate how fragile the balance is.

“It would not take much” to send gas prices back to $4, says Jacob. Cold weather, Saudi reluctance to increase production and possible refinery outages could all play their part.

Even a smaller rise could slow the snaillike recovery of the U.S. economy. Jacob and others say $3.50 a gallon this summer looks like a good bet, and a gas price at those levels could kneecap the limping jobs market yet again.

A study released last month by IHS Global Economics says a 25-cent rise in the gasoline price, all else equal, will reduce employment by some 600,000 jobs over the following two years. And the steeper the rise, the more jobs that stand to be lost.

“Suddenness is very important in determining how much damage is done to the economy,” says IHS economist Gregory Daco.

So how do you get $4 gas when oil is just $85? The answer starts with some unprecedented behavior in global oil markets, where the benchmark European oil standard, known as Brent crude, is trading at a $20-a-barrel premium to the U.S. benchmark, the West Texas Intermediate futures contract that trades on Nymex. The two typically trade within a few dollars of one another.

Increased flows from Canadian tar sands and the Bakken shale fields in the northern Great Plains have sent oil flooding into Cushing, Okla., where the WTI crude contract is priced. But because pipelines are set to run into Cushing, not out, much of that oil is going into storage rather than into refineries. Oil stockpiles in Cushing hit their highest level in seven years last month.

The glut has disconnected the widely quoted WTI market from a sobering energy market reality. “Cushing isn’t worth looking at,” says Steve Kopits of energy forecaster Douglas Westwood in New York.

Not everyone shares this view – including, you’ll be shocked to learn, the Nymex itself.

Joe Raia, a managing director for energy and metals products at the CME Group (CME), which runs Nymex, contends that Cushing isn’t as bottled up as you might think. “Storage at Cushing isn’t full,” he says.

Raia adds that WTI remains the most liquid, transparent oil contract, with three times the open interest of Brent.

But like it or not, prices on the U.S. East Coast already are linked to Brent, because refineries there use oil imported by the tankerload from Europe. And other regions are feeling the squeeze as well.

Take Louisiana Light Sweet crude, a fuel blend favored by refiners in the south who are cut off from the WTI market. The spread between WTI and Louisiana Light recently hit $21 a barrel, another record.

Running off the WTI glut could ease the pressure on Brent and Louisiana Light prices. But the glut isn’t going anywhere any time soon.

Pipelines that take oil out of Cushing are at least two years away, and oil companies that stand to rake in fat refining profits aren’t exactly looking to rush that timeline.

Conoco (COP) chief Jim Mulva shot down talk about reversing a pipeline that feeds oil to Cushing from the Gulf Coast, saying, “We don’t really think that’s in our interest.”

Meanwhile, the steep contango in the WTI futures curve – the condition in which the near months are cheaper than future ones – creates incentives to add to the Cushing glut.

A refiner or trader with storage rights can buy the March future today, take delivery when it expires, sell the April contract — and lock in an easy $1.75 a barrel in practically risk-free profits, says Stephen Schork, who writes the Schork Report newsletter in Villanova, Pa.

“We get on that hamster wheel and it’s hard to get off,” he says. “That trade is a printing press if you’ve got the tankage.”

The question, then, is not whether we should be paying attention to WTI but how high Brent might go. Gas prices didn’t hit $4 in 2008 till crude was approaching $130 a barrel on its way to $147, Jacob says.

But he says we could be treated to $4 gas this year at a much lower price, possibly as low as $115 a barrel, thanks to bigger refining margins and the apparent reluctance of the Saudis, the world’s biggest exporters, to increase production.

Prices are likely to rise regardless heading into the summer refining season. If the U.S. recovery gains steam, a replay of the ugly summer of 2008 looks like an unhappily good bet.

“The question is how high do prices have to get before demand starts to wane,” says Schork. “There’s a pretty good chance we’re going to get to the jumping off point.”

That doesn’t sound enjoyable.


5 Comments on "Here comes $4 gasoline"

  1. Lampert Scratch on Sun, 20th Feb 2011 3:16 am 

    Call me crazy, but could Saudi ‘reluctance’ to increase production have anything to do with ‘inability’ to increase production? No, the Saudis don’t lie.

  2. MrEnergyCzar on Sun, 20th Feb 2011 3:25 am 

    I’ve been preparing for a lot worse than this. I attached a video to help and show people what my family did to prepare for the real negative effects of Peak Oil. There is still time to prepare…


  3. DMyers on Sun, 20th Feb 2011 5:44 am 

    To take a different turn on a few points here, I would start with the price spread phenomenon (WTI v. better grades). The author treats this as a supply phenomenon, which it is, but there could be much more to it than that. The Cushing glut is bringing the price down, but the glut itself may be indicating peak oil.

    What is this Cushing storage facility, the Dead Sea of oil storage? Flows in but it doesn’t flow out? What kind of engineering feat is that? It seems more likely to me that this oil is sitting there for different reasons.

    Sounds like this is some rough, low yield oil. Further, the statement by Steve Kopits, that Cushing isn’t worth looking at suggests that nobody wants this oil under current circumstances. Why wouldn’t anyone be interested? Probably because it’s going to be so difficult to refine, with low yields in the end. In other words, this is post peak oil, the oil we’re always talking about that’s more expensive to recover and refine than the pre-peak variety.

    This oil is not going to be profitable and is therefore being shunned as a last resort. And at the same time, it is being given fungible status with regular oil, as its volume affects the same price.

    As a consequence of my alternative description of the circumstances, the expense of bringing this crude oil to market as gasoline will push prices up substantially, just as the peak oil theory would predict. This is the hard stuff and it ain’t gonna be like the easy stuff. So when the time comes that this oil must be utilized, it will be a double whammy to the price of gas; the Cushing supply will decline (removing that downward pressure on price), and the expense of refining this sludge, with declining yield per unit volume, will be incorporated into the pump price.

    As another speculation regarding this stored crude, it may be that this grade crude requires a long settling process due to so much worthless solid mixed with little liquid. If this were true, it would corroborate the low yield expected, and it would suggest a huge slowdown in the crude pump to gas pump process (again, creating upward pressure on gas prices). As it appears this price explosive resort to true post peak oil is being pushed out as long as possible, it will likely take effect in a sudden way.

  4. BS on Sun, 20th Feb 2011 5:49 am 

    During football games, GM advertises a 500HP pick up. SUV and truck sales have returned to their prespike levels.

    Not much learned during round one of the volatile oil price paradigm. Here we go on round two.

  5. Mike999 on Mon, 21st Feb 2011 2:48 am 

    It’s called ADVERTISING.
    And apparently, it’s very effective.
    Nobody’s taking out a Peak Oil or Global Warming AD out during the Superbowl. So your stuck with the Auto Industry selling for a short term profit, to race to catastrophe.

    What should a shareholder with a long term interest do? Demand they stop advertising pickups? Demand 4 cylinder pickups? For preparation to peak oil?

    Demand the Government tax pickup’s is there’s a level playing field?

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