Gas Prices Rise, but the Industry Approaches Growth Stagnation

As the weather warms, my thoughts turn to the summer vacations of my youth: endless days riding in the car as we traveled north to grandma's house; summers spent tooling around in a speed boat; road trips of my college years that are better left misremembered.

I am an American. I like to drive my car. Or at least I did. Now drives to the store and kid-hauling trips are planned with a precision that would impress the ground commanders at Normandy.

Not only do I have to worry about my carbon footprint (to be trendy and all) but I am trying to make as few painful trips to the gasoline pump as I can. I remember when I would scrimp together my last $10 and FILL MY TANK during my early driving years. These days I celebrate not breaking $60 topping off the minivan.

Get off my lawn, you pesky kids!

Minivan Demand

I am not alone in reducing my driving. Last week the EIA released its Short-Term Energy and Summer Fuels Outlook report. In it, the EIA projects that gasoline consumption will drop 0.4% as people reduce their driving because of high prices at the pump and the "general economic slowdown" (don't say the "R word"; recessions only happen to bad people). Already in the first quarter of 2008, gasoline consumption has dropped 0.6% from the first quarter of 2007.

To make matters better (if you're a driver) or worse (if you're a refiner), the annual average gasoline consumption growth has been declining since the 1950s. That average doesn't mean consumption isn't growing - we Americans are putting thousands of new drivers on the road each year (not all of them in Priuses) - it's just that our rate of growth is slowing. Gasoline is a mature market, and mature markets grow slowly, if at all.

It's a picture worth a thousand words: No matter how much we all complain about prices, if you're in the business of making gasoline, you simply aren't in a growth industry; you're in an industry rapidly approaching demand stagnation.

Rising Costs

And yet, gas keeps going up. How much has gas risen? A lot.

We all feel the pain at the pump. But in black and white, gas is up 32% in the last year, from an average of $2.36 a gallon in 2007 to an average of $3.11 a gallon this year. By the way, someone want to let me know where I can find that $3.11 a gallon gas? Because those national averages don't seem to be weighted by the New England/California consumption curves.

When that 32% rise is compared with the measly 0.9% growth in real personal disposable income, it makes sense that people are driving less.

As the chart above shows, 2007 was the first year since 1980 that the annual average vehicle miles traveled fell rather than grew. Do you remember what happened in 1980? 1979? Or what could have caused that rather large drop that represents 1974? Oil shocks and high gas prices!

It takes quite a bit to get American drivers to cut back, but even the great American love affair with the automobile is not immune to the irrefutable laws of supply and demand. Eventually drivers will stop going places they do not have to go. (This is good news to any student of economics - because when the fundamental laws start breaking down, where else do we have to turn?)

High Inventory

Of course, gasoline prices always rise at this time of year as refiners perform their annual maintenance and switch-over to refine summer formulated gasoline. Refiners are also looking to get rid of their "winter" gasoline, which causes a fairly predictable inventory drop - which is happening now. But compared with most years, gasoline stocks are still well above average range. The summer driving season theoretically started on April 1. On that date, we had the highest gasoline inventories since 1999.

Breaking the Law, Breaking the Law (apologies to Judas Priest)

Wait a minute here. We have lower demand due to persistent high prices and long-term suppression of driving trends, and higher supply due to stockpiled inventory. Gasoline prices should be falling. Right? Kind of.

Here's the kicker - with oil over $100, the refiners are being squeezed between the high cost of oil and the price of a gallon of gas. The gap between what it costs to buy the crude and what they can sell the gas for is called the crack spread, and when it's up, the refiners make money. When it's down, the refiners make less. Some reports have the crack spread in negative numbers in March, meaning that it makes sense for refiners to slow or cut production entirely, at least until the spread widens and they can make money off the spread again.

Think about that for a minute - with a negative crack spread, it actually COSTS the refiner to make gas. Their only incentive to keep doing it is simply to keep employees on the line for when things get better. Even if the crack spread isn't locally negative for a refiner, the low crack spreads make a pretty good argument to look for higher, rather than lower gas prices in the future.

The Play

So what's an investor to do with this information? The EIA's forecast suggests that gas prices reach $3.60 a gallon in June and average $3.54 over the summer, with a real possibility of crossing $4 a gallon at times. There are pure-play gasoline ETFs out there to try, or broad-based index ETNs and ETFs heavy in energy. It all depends how you like your gas.

For me, I'll be looking for ways to do my errands on my bike.

Comments

[CRYSBALL]

Of all the refiners, look at HOC which has very low material costs becasue of their ability to process sour crude and black way crude, which they obtain at significant discounts.......additi... there Western refinery location and markets have better domographics [longer driving distances on average].

[Ron2008]

Gasoline inventories are going down because there is less demand and 15 year highs in inventory. But when the futures markets see a lower gas inventory number they raise the price of crude. So the RBOB futures have to go up to keep the crack from being negative. And when the gasoline price goes up in further erodes demand. So the refineries make less gasoline. Which causes inventory to drop. Which causes crude to go higher. Which causes RBOB futures to go higher.

And so on and so on.

If the weather is normal this Jun-Jul and there are no major damaging hurricanes, there will be a huge crash in energy prices this August.

[JOXXON]

GREAT ARTICLE, BUT LIVING IN CALIFORNIA, YOUR PRICE PER GALLON OF GASOLINE IS UNREAL. I WOULD LOVE TO PAY THE NATIONAL AVERAGE AS STATED BY YOU. I AM NOW PAYING $3.63/GALLON AND THAT IS BECAUSE I LOOK AROUND FOR THE CHEAPEST. WHAT I WOULD LIKE TO KNOW IS WHY THE OIL COMPANIES ARE MAKING BILLIONS IN PROFIT IF IN FACT THE REFINERY COST IS SO HIGH? SOMEONE IS DOING SOME CREATIVE ACCOUNTING!!

[JOXXON]

GREAT ARTICLE, BUT LIVING IN CALIFORNIA, YOUR ARTICLE SEEMS UNREAL. WITH GAS PRICES NEARING $4/GALLON AND THE OIL COMPANIES REPORTING BILLIONS OF DOLLARS IN PROFIT, IT IS HARD TO UNDERSTAND THAT THE COST OF REFINING IS CAUSING THE PRICE OF GAS TO GO UP. WHY DOESN'T THE OIL COMPANIES FORGO THE BILLIONS IN PROFIT AND LOWER THE COST OF SELLING THEIR PRODUCT. YOU MUST REALIZE THAT THE COST OF PRODUCTION OF GASOLINE IN TEXAS DOESN'T GO UP AND DOWN EVERYDAY. THE COST STAYS BASICALLY THE SAME WHILE THE OIL COMPANIES RAISE THE PRICE OF GASOLINE BASED ON THE WORLD MARKET IN ORDER TO PROFIT IN THE MILLIONS.

[knaug60]

For those who think there is a huge collapse in oil prices coming, I have two things to say:
1. Peak Oil
2. Asia
Because production apparently can no longer keep up with demand, I see no credible reason crude oil prices will come down. This particularly until the US gets its dollar under control. But it is hard to eliminate a huge trade deficit when a good chunk of it is purchased oil.