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Outlook 2011: Crude Oil & Gasoline, Escalator Up and Elevator Down
By Dian L. Chu, EconForecast
Just in time for Christmas, On Wednesday, Dec. 22, U.S. gasoline prices hit an average $3 a gallon for the first time in more than two years, according to AAA's Daily Fuel Gauge Report. Meanwhile, U.S. stocks and oil also climbed to the highest levels since 2008.
Crude = 71% of Gasoline Price
Crude oil is the biggest component, and accounts for about 71% of the price of gasoline as of Nov. 2010, based on EIA estimate (Fig. 1). Roughly, for every one dollar increase in the per barrel (42 gallons) price of oil, gasoline prices rise 2.5 cents per gallon. So, a ten-dollar rise in crude price per barrel would add about 25 cents at the pump, not accounting other components.
Crude Prices Defy Ample Supplies
This new gasoline high came just as crude oil also reached a two-year high as traders bid it up after U.S. Energy Dept. reported a week-on-week inventory draw, while unusually cold weather in the United States and Europe has also helped.
Oil futures for February delivery rose to $90.48 a barrel, the highest since Oct. 3, 2008. Prices have climbed 14% this year, and up about 26% since late August. And by the way crude oil prices are climbing; you’d think there’s a supply shortage. Totally not so:
- The week-on-week crude inventory draw was largely due to refiners’ year-end strategy to minimize potential taxes on year-end inventory.
- Despite a weekly draw, crude oil, along with products inventories (except distillate), all saw a year-over-year increase (Fig. 2). Crude inventory level is still above the average range (Fig. 2), while gasoline inventory is also close to the high end of the average range.
- If there’s strong demand elsewhere around the globe, as many have suggested, there should not be such a build in the domestic inventory.
- The global physical oil market also tells a similar story. WSJ reported that the International Energy Agency (IEA) estimates OPEC spare capacity is around 6.4% of global demand, nearly double the level of late 2007. Data from Oil Market Intelligence also indicate the world oil inventories stood at 20 days worth of demand, up from 14 days in November 2007.
Gasoline Prices Defy Historical Pattern
Moreover, gasoline also saw some unusual movement. Gasoline prices in the U.S. generally follow a seasonal pattern – prices typically rise during summer driving season and drop after Labor Day. However, the EIA reported that there’s a reversal of pattern this year - the national average price has risen by 30 cents per gallon since Labor Day (Fig. 3), the largest increase over that period since 1990.
Blinded by Santa
Meanwhile, many analysts, including the EIA, attributed the run-up in crude prices and the reversal of historical pattern in gasoline prices to strengthening global product demand and firming economic growth in the U.S.
However, people seem to have been blinded by Santa as to the obvious:
- An above $3 a gallon gasoline price during the third week of December was last seen in 2007-- one year prior to the financial crisis.
- The last time, any time during the year, the national average for regular unleaded was above $3 was in 2008, when crude reached an all-time high of $147 a barrel!
Bear in mind, the unemployment rate was 4.6% and 5.8% in 2007 and 2008 respectively when gasoline was above $3 a gallon, and there was actually a global supply crunch due to robust (pre-crisis) global growth.
What’s Wrong with This Picture?
In contrast, here we are in 2010, barely out of the Great Recession, the jobless rate is hovering around 10%--twice the levels in 2007/08--while the housing sector remains under intensive care with existing home sales down 27.9% year-over-year in Nov.
So, it begs the question-- what’s wrong with this picture? How could crude oil and gasoline be at this price level given ample supplies, and a lack luster macroeconomic condition?
QE Liquidity Euphoria
As discussed before, one thing the U.S. Fed’s QE has accomplished is building up concerns about the possible inflation. Expectation of inflation, improving global growth, and increasing risk appetite because of the U.S. Federal Reserve's QE pumping up the economy, have driven investors to plow money into the commodities and stocks at a record pace.
This massive QE liquidity is also a major factor in the current strong correlation between WTI crude and S&P 500--another reversal of historical pattern. So, it is no coincidence that the S&P 500 index also hit its highest level since the collapse of Lehman Brothers.
The broader equity and commodity markets, including crude oil, are artificially supported by the U.S. Federal Reserve, and largely detached from the market demand and supply factors, where traders/speculators will run the show at least through 2011.
More Downside Possibilities
Most agencies forecast the world oil demand to outstrip supply in the long run; however, during next year, there could be a lot more downside possibilities than upside surprises. Some of crude oil’s downside possibilities in 2011 could come from one or a combination of the following (but not limited to):
- China & India Slowing Growth & Oil Demand - Beijing just slapped a 4% hike on domestic gasoline and diesel prices effective Dec. 22. India is also expected to decide whether to increase state-set fuel prices amid crude oil at near two-year highs. This and other tightening measures to fight inflation would crimp growth as well as oil demand in both countries, the major growth engine of the world.
- High oil prices could trigger a global recessionary cycle - Bank of America Merrill Lynch estimates that a $15 rise in the price of oil could shave about half a percentage point from U.S. economic growth in 2011, enough to wipe out the Fed's QE2 effect.
- A deepening European debt crisis
- Escalating geopolitical tensions in N. Korea, the Middle East, etc.
- U.S. sovereign debt and/or municipal debt crisis
And don’t count on a U.S. recovery to be the upside surprise factor either. The EIA Short-term Energy Outlook published on Dec. 7 projects gasoline consumption in the U.S. to increase by 0.4% and 0.8% in 2010 and 2011 respectively.
$110-$115/bbl by April?
Technically speaking, crude could see some profit taking in January with major support at around $89 levels. Look out below if it breaks resistance of $87. On the upside, the next two key resistance levels should be at $95/b, and $100/b respectively (See Chart)
Nevertheless, if the stars are aligned, that is, global economy really picking up stream with two consecutive months of good U.S. jobs numbers, inflation concerns and QE could form a perfect storm for crude to hit $110 to $115 a barrel late March or April next year, after a few retracements, and if it breaks above $100. At that level, gasoline at the pump could hit $3.70-$3.80 a gallon range.
Escalator Up, Elevator Down
Right now, speculative longs are dominating the crude market with hedge-funds and other large speculators long positions outnumbered short positions by 205,890 contracts in the week to Dec. 14, according to the Commodity Futures Trading Commission (CFTC).
Whenever you have an over-bullish market like this, it sets up for increasing risk and huge swings, particularly for crude oil, as it is one of the most widely traded and speculated asset classes in the world. Liquidity could only drive prices up to a point as there is no real strong demand to support the lofty $100+ crude price levels, but plenty of land mines to spook an exit en masse.
So, expect volatility to be the major theme in the New Year with crude oil taking the escalator up, but the elevator down, and a couple of $12- to- $15 moves in both directions along the way.
Remember, the market is designed to fool most of the people most of the time. ~ Jesse Livermoore
Dian L. Chu, Dec. 23, 2010,
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We are not exiting, on our way or "leaving" the Great Recession. To imply this is laughable.
Here we are back confusing demand and supply forces and the economy with simple repricing. People are not "expecting" inflation, they are experiencing it. $2.3T in new money was authorized in 2010, the expansion of the money supply is inflation. It occurs on the POMO schedule. I am not arguing other points in the article, that there may be miscalculation and needed corrections, however to a large extent the money has left the presses and will continue to make its way in a lumpy and irregular fashion, into real asset pricing.
This is from the EIA site,Dec 22, I wonder why the above author did not include it in the analysis, maybe the data didn't support the theory they are espousing? Would make more sense to argue that this is a "Enron" style price run up............
http://www.eia.doe.gov/oog/info/twip/twip.asp
"Gasoline supply in the East Coast market is highly dependent on imports, and events in the weeks following Labor Day complicated the import picture. In October and November, a planned outage at Irving Oil’s St. John refinery in Canada, a major supplier of gasoline to the United States, coupled with port and refinery strikes in France, limited the amount of gasoline available for import. These events, along with routine seasonal maintenance at several key domestic refineries, led to a sharp drop in inventories on the East Coast. In late August, gasoline inventories on the East Coast were in excess of their five-year average by over 11 million barrels; however, by the end of November, that excess inventory had been completely eroded, with inventory levels almost 3 million barrels under the five-year average. "
This might explain the "decoupling" of the price per barrel and the price paid at the pump? (2008 $147/barrel=$3.27/gallon, 2010 $90/barrel=$3.27, rough numbers)
Good work....this is what I am referring to.. Also remember that the effective price at the 2008 peak was $134, and that the dollar was 10% weaker then.
The Oil Drum has a good piece on World Oil Production, written yesterday.
http://www.theoildrum.com/node/7258
Where I live the gas/oil price relationship works perfectly on the way up; never on the way down.
Reposted from an earlier thread:
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Ah here we go again...
Back in 2008, based on demand, spare oil capacity in Saudi Arabia (primarily Arabian heavy, for which there is no spare refining capacity in the world, 99% of people do not understand that a refinery is optimized for its feedstock, variables include API, sulfur content etc... this is not plug and play) there was strong case for $125 a barrel for oil of WTI quality. The weighted monthly peak price was $134, 7% higher, and there was a blow off top to $147. Moreover, DXY was about 73 at the time. Now the dollar index is 80, implying an equivalent crude price of $100.
Demand is there, it is reflected in the Brent-WTI spread. Brent is tanker deliverable, i.e. you can ship it anyway. WTI is completely US-centric. The US is no longer the swing-demander, any drop in US demand is absorbed by the BRICs and the the increasing demand of net Exporting nations.
The surefire way to gauge demand in the US is to examine the relative spread between diesel and gasoline at your local station. There is no longer an excess, relative to gasoline, of diesel on the market. This reflects the demand from the rest of the world.
Recently as you know, there have been numerous refinery outages in France among other places. There is a mismatch between the quality of oil on the market and the requirements for refinery feed stock.
Production, excuse me, extraction has not kept pace with rising demand since 2004. Do not be fooled by the increases in NGL and "other liquids". While useful, they are not oil.
Get used to living "on the peak", we have maybe 3 years in this situation. I call it the saw-tooth economy. By no later than 2018, the worlds oil supply will tip over into decline. You can make good argument that the decline rate will be anywhere from 3 to 6% per annum. Plan accordingly
If oil drops for what ever reason, I suggest you snarf up PBT. There was a generational buy when it dipped in the panic of 09. Was $8.30, now $22.50 and paying ~$0.11 per month taxed as a long term cap-gain.
Now, is there is anything here that you do not understand?
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For those interested
Permian Basin Royalty Trust
Research the dividend and price history at any decent financial web site. Or go straight to:
http://www.pbt-permianbasintrust.com/
The only distateful aspect of the company is that B of A is the trustee agent. PBT is not really to be traded often, it is very liquid (pun intended) but it is more complicated from a tax perspective. This is complexity that you incur by owning the underlying cashflows of an oil field. In an IRA, trade away, but, you loose some of the tax advantages.
If you would like to balance out with more Nat Gas, try SBR as well. And the pure Nat gas play HGT.
Disclaimer: Between my clients and myself, all three are held with significant positions.
good article...vast majority of people do not understand that all of the "new supply" that has come online in the past 10 years has been of the heavy sour variety, for which there simply isn't the refining capacity.
People also wonder why for many years there have been no new refineries built in the US, supposing that there is some conspiracy. It is because the oil grades that the existing refineries are built to refine are in production decline. The new refinery capacity in KSA has been for the heavier and sourer crudes; nobody is going to sink money into this type of plant here. When KSA cites their slack capacity, they mean heavy sour that nobody can refine, so it's not really slack.
2007 was when consumption exceeded production; this was validated by the sustained drawdowns in inventories. What people do not want to hear is that the existing refinery capacity is sunk cost and there is no real "growth" in heavy sour either as production volumes of that inevitably decline too. There is a refining dilemma in terms of return on cost for new plant capacity. It is more economical to maintain existing refineries and just let them run down over time as the lightsweet grades they were built to process diminish in volume than it is to sink tons into a new plant to process heavy sour which will also decline.
I used to own PBT and some other ROYs, but my concern going forward is in the threat of nationalization of these assets. Certainly we've seen the start of that in Alberta.
Merry Christmas, you loveable curmudgeon... :)
I'm off ZH till the New Year...
My view on gasoline as an indicator is that once the U.S. adjusts to $7.50 per gallon it will have made it through the recent bout of horizontal years and be ready for another run of prosperity.
Never underestimate the replacement power of crude oil futures within an inflationary Zimbabwe-like, laser-printing, Atlas Shrugged spiral.
Cash is trash and oil is gold.
Federal Reserve Notes + Euros = garbage.
There is only one reason crude is increasing in price...unbridled greed by traders. casino action that affects everyone's pocketbook.
New Rules required...if you don't already own it or produce it, you can't sell it. if you are not going to consume it, you can't buy it.
Gambling not allowed.
This is just another bankster tax on people.
Of course, the current administration doesn't mind...it plays right into their cap and trade bill goals.
"Oh my, OIL is getting expensive because consumers needlessly waste this precious resource!!! WE must protect you. Give me your wallet."
lol.
Posting at ZH, yet not understanding the role of speculation in markets. Thats just... I don't know. wow. You sound like Keynes. PRICES signal when there is further incentive for production. Please read the bottom of page 177 and a page or so further...
http://books.google.com/books?id=55s04t8jP-4C&lpg=PA179&ots=BfhR7f3tYS&d...
+$5/gallon
If you don't like banksters you may like this... happy xmas.
from the man who brought you vampire squids … “America is quite literally for sale, at rock-bottom prices, and the buyers increasingly are the very people who scored big in the oil bubble … When you're trying to sell a highway that was once considered one of your nation's great engineering marvels … when you're offering that up to petro-despots just so you can fight off a single-year budget shortfall, just so you can keep the lights on in the state house into the next fiscal year, you've entered a new stage in your societal development … You know how you used to have a job, and a house, and a car, and a wife and a family, and there was food in the fridge – and now you're six months into a drug habit and you're carrying toasters and TVs out the front door every morning just to raise the cash to make it through that day? That's where we are … the cruellest joke is that American banks now don't even have the buying power needed to finish the job of stripping the country completely clean. For that last stage we have to look overseas, to more cash-rich countries we now literally have to beg to take our national monuments off our hands at huge discounts, just so that our states don't fall one by one in a domino rush of defaults and bankruptcies. In other words, we're being colonised – of course it's happening in a clever way, with very careful paperwork, so we have the option of pretending that it's not actually happening, right up until the bitter end.” (Rolling Stone, December 18)
The Rolling Stones are well known for abusing drugs.
Drugs distort perception.
I wonder what monuments are taken from US hands at huge discounts and by whom.
And nobody can beat the US in an auction.
Same in Britain. Karmas a bitch.
QE3. The economy is never going to recover until the income is distributed more evenly amongst population, rather than almost everything going in pockets of top 5% earners. Every system gets corrupted and is subject to Law of Entropy. It only remains to be seen how it plays out.
In SoCal, we've had $3.00 per gallon (regular) for 1.5 years, now edging toward $3.39/gallon.
I've been expecting $5/gal for the past 2-3 years.
But what, you think the Arabs are going to take less (in USD) value because the Bernank likes to print? $90/bbl will be a long forgotten wet dream by mid-2011 - $120/bbl and $45/oz for silver by May/June 2011 (maybe my wet dream).
Will that be QE 4 or 6? Or QE4 (May 2011), QE5 (mid-May), & QE6 (early June 2011)?
Crude Oil inventories -reserves
http://www.eia.doe.gov/emeu/steo/pub/cf_tables/steochart.cfm?periodType=...
reserves
http://www.eia.doe.gov/emeu/steo/pub/cf_tables/steochart.cfm?periodType=...
total consumption
http://www.eia.doe.gov/emeu/steo/pub/cf_tables/steochart.cfm?periodType=...
so, supply is up and reserve supply is full and consumption is down... now I understand the raise in crude price and pump price.
DOE is full of BS
As someone who is posting on a financial board, I would hope you could guess what would happen to the price of a commodity if the general supposition was that demand was going to increase in the future.
Yes, during the economic downturn, demand was hedged. What will an increase in economic activity do to this demand? How do you think the plastic pumpkins get from China to the US? How do US consumers get to the Wal-Marts to buy them? What is plastic made of anyway?
Debt based economies are predicated on growth, and growth needs energy to back it up. Inevitably, a point will be (was, rather) hit where oil demands outpace supply.
Not to mention, oil priced in depreciating dollars = ???
What happens when 10% of the Chinese can afford a moped?
Beats me. What happens when 90% of Americans can only afford a moped?
Bingo!
I guess the thought was, pull a little wool over the eyes of the average American?
US as a net exporter
http://paul.kedrosky.com/archives/2010/12/the_us_net_oil.html?utm_source...
whale oil
long ahab...
I was telling people two years ago that there would be no "recovery," because the economy couldn't come back without also driving up the price of oil again, which will in turn, depress economic activity.
I stand by this assertion.
It's a vicious cycle that I couldn't agree more with! I keep telling everyone that the next "Recession" will be worse than the last. I only base this on higher unemployment going in, much more government debt, an even shittier real estate market, declining wages, and less available "tools" for the FED to use for relief.
Absolutely. The entire foundation of the modern economies is a ponzi scheme. We all understand that as money is created from debt and loaned out at an exponential rate, we have written our endings in our beginnings.
You cannot make more money than you have energy to back it up, and here we have all of our undoing points converging.
If uncle Ben doesn't kill the economy...the price of crude will...........