U.S. oil prices look reassuringly calm till you look below the surface.
At first blush, a replay of the 2008 gas price spike seems far fetched. The biggest driver of U.S. gasoline prices is the cost of crude oil, and near-month oil futures on the New York Mercantile Exchange have sat out the scorching commodities rally. They lately fetched $85, some 40% below the crisis peak.
But that's where the good news ends for motorists -- and for a U.S. economy that is sputtering even with gas at $3.15 a gallon.
Much of the oil being made into gasoline now actually costs $105 a barrel. For this we can blame a few of the usual suspects – try Middle East unrest and strong overseas economic growth – and one new one, a weak link in the U.S. petroleum supply chain.
Those factors make the Nymex price "irrelevant for the price of U.S. gasoline," says Olivier Jakob, who runs the Petromatrix trading advice firm in Zug, Switzerland.
Even the government agrees. Last week it projected a 1-in-3 chance the gas price will break $3.50 this summer and a 1-in-10 chance it will hit $4. And if anything those estimates may understate how fragile the balance is.
"It would not take much" to send gas prices back to $4, says Jakob. Cold weather, Saudi reluctance to increase production and possible refinery outages could all play their part.
Even a smaller rise could slow the snaillike recovery of the U.S. economy. Jakob and others say $3.50 a gallon this summer looks like a good bet, and a gas price at those levels could kneecap the limping jobs market yet again.
A study released last month by IHS Global Economics says a 25-cent rise in the gasoline price, all else equal, will reduce employment by some 600,000 jobs over the following two years. And the steeper the rise, the more jobs that stand to be lost.
"Suddenness is very important in determining how much damage is done to the economy," says IHS economist Gregory Daco.
So how do you get $4 gas when oil is just $85? The answer starts with some unprecedented behavior in global oil markets, where the benchmark European oil standard, known as Brent crude, is trading at a $20-a-barrel premium to the U.S. benchmark, the West Texas Intermediate futures contract that trades on Nymex. The two typically trade within a few dollars of one another.
Increased flows from Canadian tar sands and the Bakken shale fields in the northern Great Plains have sent oil flooding into Cushing, Okla., where the WTI crude contract is priced. But because pipelines are set to run into Cushing, not out, much of that oil is going into storage rather than into refineries. Oil stockpiles in Cushing hit their highest level in seven years last month.
The glut has disconnected the widely quoted WTI market from a sobering energy market reality. "Cushing isn't worth looking at," says Steve Kopits of energy forecaster Douglas Westwood in New York.
Not everyone shares this view – including, you'll be shocked to learn, the Nymex itself.
Joe Raia, a managing director for energy and metals products at the CME Group (CME), which runs Nymex, contends that Cushing isn't as bottled up as you might think. "Storage at Cushing isn't full," he says.
Raia adds that WTI remains the most liquid, transparent oil contract, with three times the open interest of Brent.
But like it or not, prices on the U.S. East Coast already are linked to Brent, because refineries there use oil imported by the tankerload from Europe. And other regions are feeling the squeeze as well.
Take Louisiana Light Sweet crude, a fuel blend favored by refiners in the south who are cut off from the WTI market. The spread between WTI and Louisiana Light recently hit $21 a barrel, another record.
Running off the WTI glut could ease the pressure on Brent and Louisiana Light prices. But the glut isn't going anywhere any time soon.
Pipelines that take oil out of Cushing are at least two years away, and oil companies that stand to rake in fat refining profits aren't exactly looking to rush that timeline.
Meanwhile, the steep contango in the WTI futures curve – the condition in which the near months are cheaper than future ones – creates incentives to add to the Cushing glut.
A refiner or trader with storage rights can buy the March future today, take delivery when it expires, sell the April contract -- and lock in an easy $1.75 a barrel in practically risk-free profits, says Stephen Schork, who writes the Schork Report newsletter in Villanova, Pa.
"We get on that hamster wheel and it's hard to get off," he says. "That trade is a printing press if you've got the tankage."
The question, then, is not whether we should be paying attention to WTI but how high Brent might go. Gas prices didn't hit $4 in 2008 till crude was approaching $130 a barrel on its way to $147, Jacob says.
But he says we could be treated to $4 gas this year at a much lower price, possibly as low as $115 a barrel, thanks to bigger refining margins and the apparent reluctance of the Saudis, the world's biggest exporters, to increase production.
Prices are likely to rise regardless heading into the summer refining season. If the U.S. recovery gains steam, a replay of the ugly summer of 2008 looks like an unhappily good bet.
"The question is how high do prices have to get before demand starts to wane," says Schork. "There's a pretty good chance we're going to get to the jumping off point."
That doesn't sound enjoyable.
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