Gas Prices May Hit $4 Before Falling Back

April 25, 2006
MSNBC

Look for $4 in some markets and for the national average to peak near $3.50 a gallon before the Fourth of July. But relief should follow, if everything falls into place. And there are no hurricanes.

The big question motorists want to know right now -- whether filling their gas tanks at $2.54 a gallon in Boise, Idaho or $4 a gallon in Brooklyn, N.Y. -- is how bad will gas prices get?

The short answer: higher for a while and then lower.

Since crude oil topped $75 a barrel last week, the question has quickly become a national obsession. Republican leaders of Congress were asking the Bush Administration on Monday to investigate possible price gouging.

"High gasoline prices drain from the pockets of working families' money that could be used for food, clothing and health care," California Gov. Arnold Schwarzenegger wrote, asking the California Energy Commission to investigate price gouging.

There was even talk about windfall-profit taxes on oil companies from at least one Republican.

Depending on whom you talk to, $4-a-gallon gasoline is a distinct possibility, and $5 shouldn't be ruled out. "We'll probably see a lot of people paying $3.50 and a sizable minority of people paying above $4," said John Kilduff, a vice president of Fimat USA, an oil trading firm.

Others are skeptical. "The issue of oil prices and the possibility of supply problems has displaced politics, pop culture and global calamities, and taken over the front page," said Tom Kloza, editorial director at the Oil Price Information Service in Rockville, Md., which runs the daily price survey published by AAA. "That is often a sign that a rally is in its most mature stage."

Here's what is known now. The price of crude futures in New York hit $75.17 a barrel on Friday. Wholesale gasoline futures hit $2.24 a gallon, which translates into something close to $3 a gallon at the pump.

Monday, prices fell back slightly in the futures markets -- to $73.33 per 42-gallon barrel and $2.17 a gallon on gasoline. And in electronic overnight trading, the price was falling back some more to $2.14 a gallon. This pullback is probably a short-term lull. In recent years, Department of Energy statistics show, the wholesale price of gasoline has tended to peak in May and early June and then fall back as much as 20% to 25% to a low in December and January. Then, the cycle repeats itself.

If that's the case, motorists have about a month of prices increases ahead before that slow drift kicks in. Let's say we add another 15% to the current national average of around $2.90 a gallon. That brings us to $3.35 a gallon in the next few weeks and then a drift back to $2.50 a gallon -- in December.

In fact, the futures markets are predicting just such a scenario with wholesale gasoline dropping back to $1.9323 a gallon by January.

There are a couple of big ifs, however.

GEOPOLITICS

"Obviously the big problem is geopolitics," Fimat's Kilduff said. That translates into three questions:

* How serious will tensions get with Iran? Iran seems intent on developing a nuclear-research program that many observers worry will lead to a nuclear-weapons program.
* How serious will tensions get with Hugo Chavez? The Venezuelan strongman is making increasing noises about nationalizing his country's huge oil industry. At the very least, he wants to raise taxes on the oil companies that operate in his country.
* Will unrest continue to disrupt oil production in Nigeria? Looks that way. Royal Dutch Shell's joint venture with the state-run Nigerian National Petroleum Corp., said it is in no hurry to resume crude production in Nigeria until the oil-rich Niger Delta region is secured against further attack by militants.

WILL DRIVERS CHANGE THEIR HABITS?

Next is whether U.S. motorists, who use roughly 20% of the world's gasoline, will cut back their usage. The forecasters suggest Americans won't change their habits. A cattle rancher in Wyoming, for example, has little choice.

Americans have been burning significantly more gasoline -- 9.1 million barrels a day more than a year ago -- at a time when the nation's fuel supplies are below average, Phil Flynn, senior market analyst at Alaron Trading Corp., told the Los Angeles Times.

"That $3 level has to stay in place for quite a period of time to see any substantial change in consumer behavior," added Kurt Hallead, an oil service analyst with RBC Capital Markets

But most forecasters haven't expected gasoline prices at these levels. It is possible habits will change. Indeed, there was anecdotal evidence after last year's big price spike that drivers did adjust.

They may also adjust in ways that hurt others. Wal-Mart Stores (WMT, news, msgs), the nation's largest retailer, warned earlier this week that it expected reduced sales throughout 2006 from its least wealthy customers, and the company highlighted its strategy to market more higher-end goods to maintain growth.

WILL THERE BE ENOUGH ETHANOL?

Ethanol may be the trickiest question in the gas price puzzle. Refiners are substituting it for MTBE, an additive in gasoline that reduced air pollutants from auto exhausts but causes groundwater pollution. The problem is getting enough ethanol fast enough.

"The ethanol industry is not fully ramped up to supply all the ethanol the market is going to demand this summer, said Addison Armstrong, ETF manager at TFS Energy. "Nothing is going to change that over the next three to five months."

It's is true, commodity expert Bill O'Grady of A.G. Edwards in St. Louis said, that because of constraints in oil production and refining "very small increases in demand bring about outsized gains in prices."

But he added, "Likewise, a very small drop in demand would have a similar but opposite impact. That's the part that's going to surprise people."

HURRICANES

Everyone knows what Katrina, Rita and Wilma did to the oil and gas industry in the Gulf of Mexico and along the Gulf Coast last year.

The industry has not recovered. Shell Oil's giant Mars production platform --which accounts for 5% of total production in the Gulf by itself -- is expected to go back online only next month after eight months of repairs. Battered by 80-foot waves and 175-mph winds, it sustained some of the worst damage from Katrina.

If another big one hits, you can expect yet more pain at the pump.

-- Charley Blaine and Kim Khan

http://articles.moneycentral.msn.com/Investing/CNBC/Dispatch/060425gasprices.aspx