By Tony Daltorio
If there is one economic item that unites Americans in frustration, it’s the rising price of gasoline. The fuel for our vehicles has become a necessity for many of us, so price hikes hit hard in the wallet, affecting purchases of other items.
So why are gasoline prices on a long-term upward slope? Some Americans point the finger at greedy oil companies, but that is not the answer. Yes, refining margins do play a role in the price of gasoline, but there is one critical factor behind higher gasoline prices: the rising price of crude oil.
A 2012 study by Credit Suisse showed that the cost of crude oil now makes up 72% of the total cost it takes to make a gallon of gasoline, up from around only 50% in the previous decade. To be more specific, we are talking about the price of Brent crude oil, the global benchmark for oil. Gasoline prices more closely track the price of Brent than the price of domestic West Texas Intermediate (WTI) crude oil [see also What Is Brent Oil? The Ultimate Beginner’s Guide].
To put it in as simple terms as possible, the marginal supply of gasoline in the United States still comes from coastal refineries. These refiners process crude oil from overseas which is, of course, priced in the global market. So that imported oil (and the gasoline produced from it) is based on the price of Brent crude oil. In effect, Brent prices are putting a floor under domestic gasoline prices.
So why are Brent crude prices rising? Probably the biggest factor here is the so-called Arab Spring, which is sweeping through the major oil producing areas of the Middle East and North Africa. It is not only the actual curtailment of production, such as what happened in Libya, that affects global oil prices but also the reaction of the governments in the region to their citizens’ calls for more freedoms and a better economical life.
In response to Arab Spring, Saudi Arabia and other governments in the Gulf region have sharply increased domestic spending. In 2011, the Saudi government alone went on an additional $129 billion spending spree, on top of its regular budget, to help meet people’s basic needs in food, fuel and housing. This amount alone was equal to more than half of Saudi Arabia’s 2010 oil revenues. Other Gulf States went on similar spending sprees in an attempt to placate their citizens.
This additional spending has raised the price of oil that is “required” in order for these countries to balance their budget and meet their obligations. Estimates today are that the price needed by these countries for Brent crude is somewhere in the mid $80s per barrel, placing a floor under Brent crude and in turn gasoline in the United States. Only a decade ago the price needed to balance budgets in the Gulf region was only about $20 a barrel.
Hedge Using ETFs
Although this economic and geopolitical trend is quite serious for the Untied States (the world’s biggest consumer of gasoline) and looks to continue for years to come, consumers and investors can do more than just shrug their shoulders about the situation and accept it. They can hedge against rising prices at the pump through the use of ETFs.
The first ETF for investors to consider is the United States Brent Oil Fund (BNO), which is designed to track the movements of Brent crude oil futures as traded on the ICE Futures Exchange. The fund invests in the near month contract, except when that contract is within two weeks of expiration, in which case the futures contract will be the next month contract to expire. BNO charges expenses on 75 basis points. [see also Crude Oil Guide: Brent Vs. WTI, What’s The Difference?].
The second ETF is a more of a pure play on the price of gasoline. It is the United States Gasoline Fund (UGA) which is designed to track the movements of gasoline prices in percentage terms. It does so through the use of futures based on unleaded gasoline, which is also known as reformulated gasoline blendstock for oxygen blending, or RBOB. Once again the contract followed is the near month gasoline futures contract to expire, except when that contract is within two weeks of expiration, in which case the futures contract will be the next month contract to expire. UGA comes with an expense ratio of 0.60%.
There is also another ETF which investors could use to hedge rising gasoline prices. This is the PowerShares DB Energy Fund (DBE) which has 22.5% each devoted to RBOB gasoline futures and Brent crude oil futures. The fund also has a similar percentage allocated to heating oil and WTI crude oil futures, while the remaining 10% is invested in natural gas futures. The management expense ratio is 0.75% [see also The Different Types of Brent Oil Futures Compared].
Disclosure: No positions at time of writing.
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