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WHAT’S UP WITH GASOLINE PRICES??

FORECASTS & TRENDS E-LETTER
By Gary D. Halbert
March 30, 2004

IN THIS ISSUE:

1.  Gasoline Hits A Record High – What’s Next?

2.  Why Prices Are High & Could Go Higher.

3.  Why Bush & Kerry Are Helpless To Stop It.

4.  China & The Big Bull Market In Commodities.

Gasoline Hits Record High – What’s Next?

Gasoline prices hit an all-time record high on Monday.  AAA reported that the average price for a gallon of regular unleaded gas across the US hit $1.76 yesterday.  In California, gasoline prices topped $2.10 last week on average.  Consumers are complaining that the government should do something, and many are crying foul play by the big oil companies.  This is nothing new.

All eyes will be on OPEC tomorrow as oil ministers meet in Vienna to discuss oil production.  Earlier this year, OPEC decided to cut daily oil production beginning on April 1, but this is not likely to happen, regardless what the sheiks may announce tomorrow.  As you will read below, OPEC has been cheating on production quotas for the last six months, and they’re not about to stop now with the current high prices.

The Bush administration says it is working actively with allies in OPEC to increase oil supplies and blames the Democrats for blocking Bush’s beleaguered energy bill.  John Kerry, on the other hand, is set to announce his plan for lowering fuel prices later today.  Below I’ll tell you why neither plan will lower gasoline prices significantly anytime soon.

In fact, gasoline prices are likely to continue to increase as we head into the peak consumption period from May to August.  Most consumers do not plan to cancel travel plans and stay home this summer just because gas prices are 11-15 cents a gallon higher than a year ago.  As I will discuss below, there are no quick fixes to the current energy problem.

The bottom line is that global demand for oil and energy products is booming.   Gasoline consumption is rising rapidly, not only in the US but also in China, Asia, India and elsewhere.  Meanwhile, inventories of crude and refined fuels are the lowest in years.  In addition, some of the major producers of sweet light crude, the grade of oil best suited for making automobile fuel, are reaching capacity limits.  Add to that a global energy transportation shortage, and you have all the ingredients for higher prices. Commodity prices in general are also in a major bull market.

This week, we’ll look at these issues, but I would not plan on gas prices falling significantly anytime soon.  We’ll also look at why the current bull market in commodities is likely to continue and what you can do about it.

Short-term Dip, But Then Even Higher

In the last few days, futures prices in light sweet crude have dipped from near $38 per barrel to near $35.  Deliveries of crude to US ports and shipments to refiners have increased slightly over the last few weeks as well.  This suggests that we could see gasoline prices dip several cents per gallon over the next couple of weeks.  But that is far from certain.

News from OPEC tomorrow could send the energy futures sharply higher or lower for several days, depending on at they say, or don’t say.  Events in the Middle East, especially in Saudi Arabia and Iraq, will continue to buffet energy prices in both directions.  But at this point, with supply and demand so tight, most surprises will send prices higher not lower.

Absent a major positive surprise, gasoline prices are likely to trend even higher until at least mid-summer.  Over a month ago, the Department of Energy forecast that gasoline prices would rise to at least $1.80 per gallon average during the peak summer travel season.  Now that the average price has spiked to $1.76 – and it’s only late March – there is wide agreement that the DOE’s forecast of $1.80 is probably at least 10 cents a gallon too low.  Some analysts are predicting that the average price will hit $2.00 nationwide this summer.

OPEC – What They Do, Not What They Say

OPEC’s current “official” production quota, set back in November, is 24.5 million barrels per day (mbd), not including Iraq.  However, OPEC’s actual daily production has been running at 25.5-26.0 mbd since last September.  As always, OPEC members tend to cheat whenever prices are high.

At the last OPEC meeting, members decided to lower the daily production quota from 24.5 mbd to 23.5 mbd on April 1.  This is what the meeting tomorrow is all about.  Most analysts believe OPEC will abandon the earlier decision to lower the quota in light of the big increase in oil prices since the first of the year.  However, if OPEC votes to lower the official daily quota, expect this decision to send the oil markets higher at least temporarily.

Regardless of what is decided tomorrow, expect OPEC to continue pumping at the current rate of 25-26 mbd or even slightly higher.  While many are calling on OPEC to pump more oil, eight of the cartel’s members are reportedly producing at or near capacity now.  Only Saudi Arabia, Kuwait and the United Arab Emirates have the ability to significantly increase production, and there is no indication that they are about to do so.   So, I would be very surprised if the cartel decides to increase the daily production quota above the official 24.5 mbd level.  But if it did, that could send crude oil futures sharply lower temporarily.  Again, I wouldn’t bet on it.

Declining Availability Of Oil Used For Gasoline

Sweet light crude and brent crude are the primary choices for refining into gasoline, and this raises another bottleneck.  As noted above, OPEC does have the ability to increase production but this excess capacity is primarily in the heavy and medium grades of crude oil, which are not generally used in making gasoline.  Saudi Arabia, Kuwait and the UAE are reportedly near their limits on production of sweet light crude. 

There are more reserves of sweet light crude around the world, including in the Arctic National Wildlife Reserve, but the energy industry currently doesn’t have enough capacity to pump it.  As I will discuss below, it is a given that the industry will increase its capacity to produce light sweet and brent crude as a result of exploding demand for gasoline and the current high prices, but that will take time.  Meanwhile, more refineries around the world are being reconfigured to use heavier oils, but it is a complex, expensive and time-consuming process. 

Along this line, many consumers are asking why the other oil exporters of the world can’t increase their production to cool world oil prices.  OPEC only accounts for about one-third of all world exports.  Part of the answer is that some of the other major exporters face similar constraints on the amount of sweet light crude they can produce.  Another part of the answer is that political upheaval has reduced the ability of several countries to produce and export oil, including Venezuela, Nigeria and Indonesia.  Iraq is producing at only a fraction of its capacity.    Even Russia’s production has come into question amidst the recent serious scandals in its oil industry.   

Refining Capacity Has Also Grown Tight

The subject of capacity to refine crude oil into gasoline is one that is rife with debate and controversy.  Critics of “big oil” believe this is the one area of the energy equation where the oil companies have been the most guilty of price-gouging the public.  The oil companies, on the other hand, claim it is the mountain of environmental restrictions and regulations that have led to the capacity shortage in refining.  Both sides have very strong arguments (some correct and some incorrect), but I do not have space to sort them out in this issue.

Suffice it to say that the capacity to refine crude oil into gasoline is growing tight (regardless of the reasons).  Five years ago, global refining capacity showed a surplus over demand of 5.7 million barrels a day.   Back then, we had a “glut.”  Now, with the exception of plants that are seasonally down for repair prior to the peak season, global refining is running flat out.  PFC Energy, a well-known Washington consulting firm, estimates that even with all refineries back online, global demand will exceed refining capacity by the end of this year.

While refineries are constantly finding ways to increase production, we are approaching hard limits according to industry sources.  The oil industry hasn’t built large numbers of new refineries in recent years and others have been shut down due to age, low profit margins and/or environmental concerns/regulations. 

Another problem is that the oil industry has reduced its reserve inventories of crude oil and gasoline stocks in recent years in order to cut costs and avoid tying up capital.  Here, too, there are strong arguments on both sides, especially with oil companies earning record profits now in some cases.  Arguments aside, this means there is much less of a cushion to make up for production shortfalls and/or supply interruptions, and we are more susceptible to price spikes.  This could be especially true on a regional basis this summer given that there are so many different standards for gasoline in different parts of the US. 

Bush & Kerry’s Plans Are Just So Much Talk

The discussion above would suggest that oil and gasoline prices are going to remain generally high for some time to come.  Yes, there will be periodic downswings in prices, as I will discuss below.  But for now, and especially the next several months, we should expect to see high prices continue and most likely get even higher, despite what President Bush or John Kerry say.

The Bush administration has not advanced any new initiatives directly aimed at bringing down gasoline prices in the near-term.  They have indicated there have been talks with allies in OPEC about increasing production but as discussed above, such discussions may be largely symbolic.  While continually accused of being in the back pockets of the big oil companies, the Bush administration recognizes that oil and gasoline are “commodities,” the prices of which are ultimately governed by supply and demand, not by Washington directives.

John Kerry is supposed to announce his new plan for reducing gas prices at the pump today in California.  He is expected to call on Bush to divert oil shipments being used to replenish the Strategic Oil Reserve and send those supplies into the marketplace.  He may also call for tapping into the oil supplies currently held in the reserve.  Neither of these ideas will have any appreciable affect on oil and gasoline prices, short of some wild short-term gyrations in the futures markets.  Kerry is also expected to unveil some long-range plans for energy policy. 

The bottom line is that neither Bush nor Kerry can do much, if anything, to make oil and gas prices go down in the near-term.  In fact, prices may well go even higher during the peak travel season just ahead.  If there are any major disruptions, prices could go a lot higher.

Looking long-term, and based on demographics, the demand for oil and gas will only go higher.  People in China and other developing nations around the world want cars and all the other consumer goods that use energy.   So long as the global economy continues to expand generally speaking, the demand for energy will only increase over time. 

High Prices Are The Solution for High Prices

There is an old saying among veteran commodities traders: “The solution to high prices is, high prices.”  Let me explain.  Commodity prices rise and fall based on supply and demand.  Both supply and demand are largely influenced by prices.  If prices go high enough, supply will increase and demand will decrease (and vice versa).  This is true in all commodities and especially in energy.

If energy prices remain high enough long enough, there will be:1) more oil and gas exploration, more drilling, more tankers, more refineries, etc. and increased supplies; and 2) either reduced demand or at least a slowing of the increase in demand.  Higher prices also mean increased research and development of alternative sources of energy and more energy efficient products.  This process historically leads to lower prices, and the cycle then repeats itself over time.

It is important to note, however, that these cycles vary widely in length, and I believe the current trend of higher energy prices will prove to be a longer-term cycle.  Let me repeat again that there will be periodic downswings in prices, and some will undoubtedly be big ones.  However, the demand fundamentals in the energy world are daunting. 

The Bull In The China Closet

The numbers from China alone are immense.  China’s demand for oil is projected to more than double by the end of this decade.  Ditto for most other commodities.  China is already sucking in vast amounts of commodities from all over the world.  China is a big reason why we have seen a major bull market in virtually all commodities over the last 2-3 years, including some markets that had been generally depressed for a decade or longer.  While China is the 800-pound gorilla, demand for energy and commodities is increasing rapidly throughout most of the developing world.

It is my view, and that of some of my best sources, that this upward trend in energy and commodities prices will continue, perhaps for several more years.   Again I must emphasize that there will be some serious downturns along the way; commodity prices don’t move in one direction only.  However, I can see the bull market in commodities continuing for some time to come.

Conclusions

In this E-Letter, we have looked at some of the major reasons why oil and gasoline prices are where they are today.  Prices have risen substantially already, and it may still cost more to fill your tank in the next few months during the peak travel season.  Historically, gas prices should come down some after the summer.  How much, I don’t know.

The current high prices in the energy sector will contribute to increasing supplies in a variety of ways.  Some of the oil exporting countries that have reduced production due to political upheaval should get back into full production.  Iraq will be steadily increasing output.  The recent high prices will begin to stimulate new production of sweet light crude for making gasoline.  Refining capacity should increase slowly.  All of these developments will serve to bring down prices or slow the rate of increase – at least temporarily.

Yet longer-term, I can see the bull markets in energy and commodities prices continuing – in their normal, very volatile manner with plenty of downs to go along with the ups. 

This outlook depends, of course, on the US and global economies continuing to grow at a decent rate.  I believe this is a reasonable assumption for the next few years.  This outlook suggests that inflation will return in the next few years.  I will discuss this issue in a future E-Letter. 

Commodity Futures Funds

There are investment funds that specialize in buying and selling commodities.   Some of these funds invest in diversified portfolios of commodities on US and global markets, while others specialize in only a limited number of markets (or even only one).  There are hundreds of them out there.  Generally speaking, they don’t advertise, and most investors don’t know where to find them.  Like other investments, there are some good ones and there are some bad ones (including some really bad ones).

If you agree that the bull market in commodities may continue, and you would like to learn more about professionally managed commodity futures funds, I suggest you give my company a call at 800-348-3601.

We have been monitoring the futures fund world for over a decade and recommend selected funds to our clients.  We can help you to understand and evaluate these types of investments.

All the best,

Gary D. Halbert

SPECIAL ARTICLES

What’s up with oil?

Kerry to offer new plan for gas prices.

Karl Rove’s home surrounded by left-wing goons.

 

 

 

 

 

 

 


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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc. Gary D. Halbert is the president and CEO of Halbert Wealth Management, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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