Monday, April 9, 2012

The threat of higher gasoline prices is receding

According to AAA, the nationwide average price of regular gasoline is $3.93/gal. (In California we are paying well over that, with prices for premium approaching $5/gal.) As the chart above shows, gasoline prices today are about as high as they have ever been. Does this pose a threat to our struggling economy? While it's undoubtedly a problem, I think it's more in the nature of a headwind rather than a big recession threat.

The chart above compares the nationwide average price of regular gasoline (orange line) with the price of nearby wholesale gasoline futures prices (white line). Note how well these two series track each other, but especially note that the orange line tends to lag the white line a bit. That makes sense, since future prices operate in real time and wholesale prices necessarily lead retail prices. Note also how wholesale prices have rolled over in the past week, and are basically unchanged over the past month. Pump prices have only recently gone flat. So the price of gasoline futures today suggests that pump prices will probably decline to $3.80-3.85 in the next few weeks.

The first of the above two charts focuses on recent trends in crude oil prices, using the NYMEX futures contract. Here we see that prices today are about 30% less than their peak in mid-2008. (Arab Light Crude currently has been trading at an unusually wide 20% premium to U.S. crude for the past nine months or so, and I'm guessing that mid-east tensions account explain a lot of that.) The second chart shows the inflation-adjusted price of Arab Light over the past 40 years. On this basis crude is about 15% below its mid-2008 level.

The chart above compares the price of Light Sweet Crude to the wholesale price of gasoline. They track each other closely—as they must—but it should be clear that gasoline prices today are quite high relative to crude prices. This is probably a function of a shortage of refinery capacity. It's going to be difficult for gasoline prices to move higher unless crude prices increase by a lot. Meanwhile, market arbitrage is going to tend to bring gasoline prices down relative to crude prices. And since pump prices are high relative to wholesale prices, and wholesale prices are high relative to crude prices, it is reasonable to think that pump prices are at least unlikely to rise further, absent a significant increase in crude prices, and could well decline.

From a longer-term perspective, these charts show that, thanks to the greatly increased energy efficiency of the U.S. economy (last year the U.S. consumed 18.84 million barrels of oil per day, the same as in 1978, despite the fact that the size of the U.S. economy has increased by 130% since 1978), the average person is spending only 6% of his disposable income on energy, or about one-third less than in 1980. They also show how spikes in the price of oil lead to a substantial reduction in U.S. oil consumption, thanks mainly to technology gains and ongoing conservation and energy efficiency efforts. Since gasoline prices are very high in both nominal and real terms, it is thus reasonable to expect that gasoline demand will be soft for the foreseeable future, while the demand for more energy-efficient vehicles will remain strong.

This chart shows how drilling and exploration activity respond to the real price of crude, which is perfectly rational; crude prices have jumped since the end of the recession, and this has led to a surge in drilling and exploration activity all over the world. Combine this with the prior two charts and you see how expensive gasoline is the "cure" for high gasoline prices, since high prices lead to reduced demand and increased oil drilling and exploration. Prices are definitely high in real terms today, so gasoline demand is likely to be soft, even as drilling activity continues to pick up. And with prices at the pump somewhat high relative to wholesale prices to crude prices, we are unlikely to see pump prices rise much further, if at all, in the near term. Finally, gasoline prices at this level do not represent an unusual burden on consumers' pocketbooks in historical and relative terms.

Expensive gasoline is a problem, but market forces are working to alleviate the problem, and consumers are less dependent on energy prices in general than they have been in the past. So the current spike in gasoline prices is not necessarily an economy killer.

UPDATE: The following two charts show how incredibly cheap natural gas has become in the U.S. This undoubtedly alleviates to a meaningful degree the problem of expensive gasoline.


Anonymous said...

Withholding tax receipts are definitely trending upward. The past 4 weeks have averaged 6.6% over the 4 comparable weeks last year, which is easily the best 4-week performance so far this year.

PD Dennison said...


Great report!!

I suspected that consumer spending on gasoline is lower today than years past, despite the high relative price today.

The media loves to kick the gasoline price around, especially to attack "Big Oil" (despite the low margins compared to say, Apple) or Republican Presidents.

This type of perspective is missing from most conversions about gasoline, even on the financial news.


Benjamin Cole said...

Top-rate blogging by Scott Grannis.

Note that oil prices are set by global supply and demand, by OPEC, and perhaps by speculators on the NYMEX.

George Gilder warned against fighting commodity inflation through domestic monetary policy. 1) It is ineffective in global markets, but you can kill your own economy, and 2) Higher prices bring new supply and conservation, leading to lower prices.

I see a bright future in energy, for everybody. Energy will be a decreasing cost in years ahead.

McKibbinUSA said...

Smart investors will hope for higher energy prices -- $10 per gallon gasoline may hurt Main Street, but not global investors -- better to pile into energy stocks and get your share of the dividends -- the sooner gasoline goes to $10 per gallon, the sooner we can see windfall profits from the energy sector -- it's all about dividends -- saving Main Street with lower energy prices is a lost cause, just ask Dr Ben Bernanke.

PerformanceSpeaksForItself said...


Great info, love the charts. As far as the effects on the US economy, don't forget that we now import (net) 3 million barrels/day less than in 2008, due mostly to domestic supply increases, i.e., more of the $ spent on higher gas prices stays in the U.S.

However, the Cushing oil pipeline to the gulf (switching from importing to exporting) will be reversing flow by June 1 of this year, so don't expect WTI to be so far below the rest of the world for too much longer. And despite the fact the economy is holding up for the moment, I think we're near the limit of what the U.S. consumer can pay for gasoline without feeling the need to cut back elsewhere...

scottmba09 said...

I don't know why people don't understand the very simple correlation between the equity markets and gasoline prices. Why has gasoline come down? Risk assets are rolling over. It is really that simple. All you have to do to follow this is to go onto the CFTC website and follow open long contracts in oil and gasoline. So, it is a double edged sword for an equity investor. If gas prices are significantly lower, don't bother opening up your brokerage statement.

Squire said...

Hey, my last fill up was 5 cents a gallon cheaper. At $4.35. San Francisco Bay Area where the restaurants are busy even on Monday evening.

Buy the dip or short the bounce? Yes, WTIC IS tightly correlated to the SPX.

Hans said...

The Crude vs whole gasoline chart is very interesting and indeed telling, perhaps...

Public Library said...

Energy's share of personal consumption: notice the downtrend was broken when the money printing began in earnest?

The only way gasoline doesn't tank the economy is if the Fed stops printing money. Otherwise, technology cannot advance fast enough to offset the damage caused by the printing press.

Scott, you missed high oil prices back in 2007/08.

Benjamin Cole said...

The markets want to see QE. Ouch, this is ugly. Hope it stops soon. Below 13k again.

With earrings flat, and the Fed passively tightening, who expects the Dow to rally much?

Squire said...

The Alcoa earnings report is a setup to get a bounce on Wednesday as the massive miss was to the upside.

Sell the bounce or buy the dip?

Rob said...

Dear (Cheer)Leader,

Your people need you ! Speak, oh Great One, speak !