Gasoline Prices Will Settle Down By Summer

Traders' nervousness over Iraq is buoying prices, but bulging gasoline inventories will keep any surge in check.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

March 15, 2002

Look for fluctuating gasoline pump prices to settle down by summer after cresting around $1.40 a gallon by Memorial Day and then slowly drop about 20¢ a gallon by fall. Along the way, the run-up in motor fuel prices will trigger surcharges built in to many shippers' contracts with trucking firms, overnight carriers and air cargo services.

Most of those billing adjustments kick in when the national average diesel fuel price hits the $1.20-a-gallon mark, as it did just this week. Odds are the surcharges, which immediately added 1% to 2% to many firms' shipping bills, will top out at 4% by June when diesel pump prices peak around $1.40 a gallon before beginning a slow decline. Meanwhile, United Parcel Service, FedEx and other air and ground freight haulers are tacking on a 0.5% surcharge to offset aviation and diesel fuel price run-ups, at least through the end of this month.

The motor fuel price increase, including this week's 8¢ spurt in the national average price of a gallon of unleaded gas to $1.22, is evidence of the continuing volatility of pump prices—and their sensitivity to swings in futures market trading. Spooked by rumors of U.S. military action against Iraq and a March 5 American Petroleum Institute report that U.S. gasoline inventories fell by 3 million barrels in the previous week—after weeks of reductions only about one-third that size—oil traders quickly drove up April crude oil contracts from $22 a barrel to nearly $25. That surge in petroleum futures prices had far more influence on the gas price rise than actual supply and demand conditions, which are looking pretty good.

With 10 million barrels of gasoline in storage, U.S. gasoline stocks are about 5% higher than a year ago, and the increase in consumer demand is good news everywhere except the trading pits. "Americans who had a tough time with the events of Sept. 11 are done with cocooning, feel less worried about losing their jobs and are getting their confidence back and getting back on the road," says Phil Flynn, vice president with commodities broker Alaron Trading.

Moreover, part of this week's gas pump price surge was due to a statistical fluke that's helping drive up the national average price. The average is skewing upward because of a larger rise in California pump prices to $1.45 a gallon, as refineries there switched over to producing summer blends to meet that state's stringent clean air requirements. Outside California, pump prices remain well below $1.20 a gallon in most regions.

Expect crude oil prices to peak from $26 to $28 a barrel in the coming weeks, then drop back to around $20 a barrel by summer as traders come to their senses and realize Iraq's oil production is not about to be cut off, despite President Bush's saber rattling this week against Saddam Hussein. Traders already have factored in a so-called war premium of about $3 a barrel into their bids for crude oil. That's one reason for the price jump this month in crude and the motor fuels refined from it. And even if the U.S. decided to attack Iraq, it would take months for the military to gear up to launch a campaign. It's likely that Russia, Mexico, Norway and possibly even Saudi Arabia would step in quickly to make up any Iraqi production shortfall.

Gasoline pump prices traditionally rise around 15¢ a gallon during the approach to the peak summer driving months as more people take to the roads for business and pleasure. But barring a full-fledged Middle Eastern war, pump prices won't get anywhere near the record $1.72 national average price set in late May last year.

Sure, the Organization of the Petroleum Exporting Countries (OPEC), which is meeting in Vienna today, will continue to play its shell game with crude prices, vowing to keep production at current, reduced levels on the strength of promises by non-OPEC member Russia to trim production simultaneously. OPEC members will say the agreement to limit production will keep crude prices above $25 a barrel, but economic pressures on Russia and other major producers will cut the legs out from under that strategy, says Ed Silliere, vice president of risk management at Energy Merchant, an energy marketing firm. "With Venezuela and Mexico in financial difficulty now, and Russia making it clear it will meet its $125-billion debt repayment next year, all three of them being dependent on oil revenues creates a tremendous pressure to cheat—which will drive down crude oil prices," Silliere adds.

Don't expect motor fuel pump prices to fall in tandem with trading prices for crude, however. The retail gasoline business is super-competitive, and gas station owners are as antsy as traders. "As prices now swing all over the place, retailers are reluctant to cut prices," says Timothy Evans, senior energy analyst with IFR Pegasus, a commodities trading advisory service. "When they don't know where their next gallon will come from and at what price, [pump] prices are bound to move down slower than they went up."