Gasoline Remains Strong Like A Bull - Get Ready To Pay $3 At The Pump This Summer

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About: The United States Gasoline ETF, LP (UGA), Includes: BNO, DBO, DBRT, DNO, DTO, DWT, OIL, OILK, OILX, OLEM, OLO, SCO, SZO, UBRT, UCO, USAI, USL, USO, USOD, USOI, USOU, UWT, VLO, WTID, WTIU
by: Andrew Hecht
Summary

Higher lows since early 2016 and before.

Strength through the season of weak demand.

The market will shift its focus to driving season in coming weeks and months.

Optimism will drive gasoline higher during the spring and summer of 2018.

$3 gas at the pump is a possibility this summer.

We are all consumers of the commodities and raw materials that touch our lives on a daily basis. Each time we get into a car and turn on the ignition, we consume gasoline. When we go to the pump to fill up each week, or more frequently, we are direct purchasers of the processed product of crude oil.

As economic conditions around the world have improved, more people are employed and commuting to their jobs. At the same time, people are more likely to travel when they are feeling good and making money. Therefore, gasoline demand tends to be a function of the health of the economy. The optimism that has gripped stock indices translates to increased consumption of gasoline.

Since 1987, the price of NYMEX gasoline futures has traded from a low of 32.55 cents to a high of $3.631 per gallon wholesale. Since the turn of the century, the price of the fuel has been making higher lows which is a sign of rising demand. However, over the past two years, this trend has become more pronounced as gasoline futures have been in a bull market since the beginning of 2016.

Higher lows since early 2016 and before

The price of gasoline future, like crude oil, fell to lows in early 2016. Crude oil found a bottom at $26.05 per barrel in February, the lowest price since 2003. Source: CQG

At the same time, NYMEX gasoline futures fell to 89.75 cents per pound, which was more than ten cents above its 2008 low. As the weekly chart shows, the price of gasoline has been making higher lows and higher highs for the past two years. The trend is a continuation of a much longer pattern in the gasoline futures market. Source: CQG

As the monthly chart highlights, the pattern of higher lows dates around two decades to before the turn of the century.

Strength through the season of weak demand

Most recently, the performance of gasoline prices has been impressive. Gasoline is a seasonal energy commodity, and the peak season for demand comes during the summer driving season when many take to the roads on vacation. The cold months of winter tend to see a decline in gasoline prices as weather conditions often limit driving activity. However, as the weekly chart illustrates, gasoline prices moved consistently higher with crude oil since the beginning of what should have been a soft period for prices in late 2017 and early 2018 despite some bone-chilling cold spells over wide regions of the U.S. over recent weeks.

In a sign of strength in the price of gasoline at the time of the year where demand should be weak, the gasoline processing spread is trading around the same level it was last year at this time. However, the price of nearby crude oil futures is around $10 or over 18% higher this year compared to last. Source: CQG

As the weekly chart of the gasoline crack spread shows, the processing margin was trading at the $15.47 per barrel level on Monday, January 22 compared to a range of $11.38 to $14.80 during the same week in 2017. Further evidence in the strength of the price of gasoline compared to crude oil this year comes from the profits refiners of gasoline are chalking up these days. Valero Energy Corp (VLO) is a refining company that concentrates on processing crude oil into gasoline. Source: Barchart

As the chart shows, the price of VLO has more than doubled since July 2016 moving from $46.88 per share to $98.98 as of Monday, January 22. VLO is trading at a new all-time peak price as margins from its gasoline refining business benefit from strong gasoline prices and a healthy crack spread environment.

The market will shift its focus to driving season in coming weeks and months

Futures markets tend to reflect supply and demand conditions months down the road. We are now approaching a time when the gasoline futures market will begin to prepare for the peak summer driving season of 2018. Refineries will do maintenance and switch the majority of processing from distillates back to gasoline in preparation for the increased demand. Therefore, the gasoline processing spread tending to exhibit strength during the spring and beginning of the summer seasons. At the same time, economic growth in the U.S. and around the world could increase the demand for gasoline in coming months.

Optimism will drive gasoline higher during the spring and summer of 2018

As we head towards the peak driving season in the United States, which commences on Memorial Day weekend in late May, we may see a move to the upside in the gasoline futures market if the price of crude oil remains firm or moves higher.

The price of gasoline last traded above the $2 per gallon wholesale level briefly in August 2017 when storms hit Texas causing a spike to highs of $2.1705 per gallon wholesale during refinery shutdowns. However, in 2014 the price of the fuel was above the $3 per gallon level during the driving season when the price of crude oil was north of $100 per barrel. The price we pay at the pump is significantly higher than futures prices. Today, the average price per gallon at the pump is around $2.58 per gallon in many parts of the United States with futures trading at the $1.8860 per gallon level on the March futures contract on NYMEX. The premium of almost 70 cents is the result of both taxes and transportation costs from the NYMEX delivery point, on a wholesale level, to destinations of consumption where consumers pay the retail price for the fuel.

$3 gas at the pump is a possibility this summer

If the current trend in the price of crude oil and gasoline continues, we could see prices rise to $2.50 or higher on a wholesale basis this driving season which would send the price consumers pay to above $3 per gallon once again this coming summer.

Inventories of crude oil have been declining according to the weekly reports from the American Petroleum Institute and Energy Information Administration. As of the week ending on January 12, they both reported significant declines of over 5 million barrels of oil which has been a trend that has supported the price of the energy commodity over past months.

Economic growth in the U.S. and around the world has caused oil prices to move appreciably higher, by over 50% since late June. Additionally, production cuts by members of OPEC, the international oil cartel, have also provided support to the price of oil.

While U.S. production has been increasing in the environment of higher prices, last week Baker Hughes reported that the number of rigs in operation in the U.S. dropped by five because of cold weather conditions and a lack of available skilled workers. Rig counts have been stable over recent weeks after increasing throughout 2017.

A recent EIA report said that the U.S. is poised to become the world’s leading oil-producing nation in 2018 or 2019, but the price of crude oil remains at close to the highest level since 2014. Moreover, tensions in the Middle East between Saudi Arabia and Iran has the potential to lift nearby oil prices if the situation in the region further deteriorates or hostilities increase. Any violence that threatens production, refining, or logistics in the Middle East could cause price spikes to the upside in 2018 which would cause the price consumers pay for gasoline to skyrocket. Source: Barchart

UGA is the United States Gasoline ETF product that seeks to replicate price action in the NYMEX gasoline futures market. As the chart dating back to 2008 shows, UGA has traded from lows of $16.10 to highs of $67.66. On Monday, January 22, the ETF closed at $33.44 per share which is below its midpoint over the past decade. The trend has reflected the pattern of trading in the gasoline futures market since early 2016.

UGA has net assets of around $48 million and trades an average of approximately 31,000 shares per day making it reasonably liquid. As we head into the time of the year where demand for gasoline will peak, buying UGA on any price weakness could hedge the higher gasoline prices will likely pay at the pump in the months ahead.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author always has positions in commodities markets in futures, options, ETF/ETN products, and commodity equities. These long and short positions tend to change on an intraday basis.