Consumers Are Responding To Energy Market Shenanigans

Includes: UGA, USO
by: Robert Loftus

The most important figure in the EIA Weekly Oil Inventory Report -according to this author- is the "Finished Gasoline Delivered to Market" figure, which has indicated a steady and progressive decline over the last several months. This decline in consumption is caused by a change in consumer habits. Consumers are making rational responses to higher gas prices, and changing their purchasing habits. In prior articles I've written about the "Threshold of Elasticity" for finished gasoline, which refers to the price threshold at which consumers begin actively seeking means of reducing their consumption of gasoline. Although the oil and gas industry benefits from short term price spikes that can generate significant additional profits, the long term implications for consumer behavior suggest a pattern of long term decline for oil and gasoline refiners.

The volume of finished gasoline delivered to market as reported by the EIA Weekly Oil Inventory Report has been declining over the course of the last several months, with the recent report for the period ending November 4th indicating a YOY decline of 5%. There are multiple factors contributing to this decline in gasoline consumption. A high unemployment rate definitely contributes to less gasoline being burnt as there are fewer people driving to work but we should not assume that the unemployment rate alone is the cause of declining gasoline consumption. If it were we wouldn't have seen finished gasoline delivered to market continuing to decline over a period of time when the unemployment rate appears to have remained constant. Fuel efficiency may be a more significant factor than many people realize at this particular point in time. During the late 90s and early twenty-oughts there was a period when many consumers drove large truck-based SUVs. Many of those vehicles only delivered mileage of 16 to 28 mpg. Since the gasoline price spikes of 2008, consumers have lost much of their fervor for large SUVs and are focusing their attention on smaller and more fuel efficient sedans like the Huyndai Elantra, Ford Fusion and Chevy Cruze. This change in consumer tastes means that significant gains in vehicle mileage are on the horizon. When vehicles that get 16 to 18 mpg on the highway are retired from America's roadways, and there is a significant consumer preference for smaller vehicles that get 32 to 36 mpg on the highway, there will be a significant decline in gasoline consumption. A recent report by Wards Automotive on auto sales in the first 10 months of 2011 indicates that while sales of Ford and Chevy pickups are still strong, sales of SUVs have fallen behind small and mid-sized sedans like the Toyota Camry, Nissan Altima and Ford Fusion.

"Threshold of Elasticity" refers to the price threshold at which a good which was initially thought to have inelastic demand characteristics begins to show signs of markedly increased demand elasticity. I've written about this concept in other articles and it is important to understand that this figure is not static in any given market. How much consumers are willing to pay for gas is a product of many factors. Whether the economy is expanding or contracting is a principal factor. Also important is how long gas prices have been high. Given that high fuel prices have a tendency to lead to higher prices for other items -especially food - it is reasonable to assume that given even if all other figures and conditions in an economy remain relatively static, consumers will become disgruntled with high fuel prices over time and become less satisfied with a given price point for gas. This seems to be the case in our current economy; whereas gas prices have fallen roughly 30 cents per gallon in many markets over the course of the last few months, consumption of gasoline has continued to decline. This suggests that consumers are disgruntled and are very dissatisfied with the price of fuel and are actively seeking ways to develop new economies in their daily habits. The progressive decline in consumption noted in the EIA Weekly Oil Inventory over the course of the last few months suggests that our current economic stasis has led to just such a reaction on the part of consumers, as weekly gasoline consumption has declined on a comparative basis from near parity with last year's consumption at the beginning of the summer to -5% today.

Although high gas prices lead to increased short term profits for oil and gas refiners, those firms may be setting themselves up for a massive constriction of their primary market. November 10th's market movements were a perfect example of how oil markets can be manipulated by the most ridiculous news. An EIA report relating to a shortage of diesel fuel in and around Cushing Oklahoma led to a run on prices that pushed futures up more than $2 per barrel in a single day. The irony was that shortage of diesel fuel was an industry-created problem that related to increased oil and gas drilling in North Dakota and Canada. U.S. Oil production is increasing rapidly at a time when overall consumption is falling. Spending more money and expanding the oil delivery infrastructure at a time when total consumer demand is falling can only lead to an eventual market crash. If we see another run on oil prices in the U.S., it's almost inevitable that the exact same thing that happened with the Real Estate market will end up happening to commodities markets - with massive over-investment in a market segment that is not supported by sufficient organic demand.

Consumers are finding ways to use less gasoline. The longer gas prices remain at current levels the more we should expect the amount of finished gasoline delivered to market to fall. The notion that energy prices should spike because of an industry created shortage related to the development of increased capacity for a contracting market is ludicrous. Over-speculation in energy commodities is reaching dangerous levels, and if more rational minds do not prevail in these markets the outcome could be very ugly.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.