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Why Gas Prices Are Outrunning Oil Prices

by | published April 22nd, 2011

As we take a holiday break from what will continue to be a very unstable energy market, it seems like a good time to draw from the many questions and comments I’ve gotten from your fellow Oil & Energy subscribers. I appreciate all of your emails, as always, even if I can answer only a few.

Today, I am actually answering only one. It introduces a very important element – and one we need to watch carefully in the coming months.

Q: Oil is now at about $113 per barrel, and gasoline prices are approaching more than $4.00 per gallon in some areas. Two years ago, gas prices were indeed $4.00 – and then some – but oil prices were over $140 per barrel. With oil prices now 22% to 25% less than they were then, why are we already “enjoying” $4.00-plus gasoline? ~ Pete

A: Pete, while it is true that crude oil prices remain the single highest component in calculating the resulting retail price of refined products like gasoline, they do not tell the entire story.

We need to do a little detective work here, my dear Watson…

Traditionally, a $1 increase in a barrel of crude would result in a 2.5-cent increase at the pumps.

On January 3, the first trading day of 2011, NYMEX WTI (West Texas Intermediate) next-month (near-month) futures closed at $91.55 a barrel, while RBOB futures closed at $2.43 a gallon.

RBOB, which stands for “Reformulated Blendstock for Oxygenate Blending,” is the futures standard for gasoline in New York trading.

The corresponding figures on July 1, 2010, were $72.95 and $2. That means, on average, a 2.3-cent rise per RBOB gallon for each $1 rise in crude price per barrel over the second half of 2010 – or just about where the historical averages would conclude we should be.

However, something significantly different takes place when we move further into 2011.

Yesterday, the WTI price closed at $112.29 and RBOB at $3.31 – a $20.74 rise in price per barrel since the January 3 close, but an 88-cent rise in the price of a gallon of RBOB. That works out to an increase of 4.2 cents per gallon for each $1 in barrel price

The spread has widened quickly this year. By January 31, the year to date ratio had spiked to an increase of more than 9 cent per gallon for each $1 in oil. By February 18, the price of crude had actually decreased, but the price of gasoline continued to climb. By March 1, it was still over 6 cents; and by April 1, it had settled into a differential of 4.4 cents, essentially the spread we’ve experienced since.

So what happened?

Many pundits blame the rise in MENA (Middle East / North Africa) tension and the disaster in Japan. This certainly may have something to do with the rise in prices globally, but explaining this away as a risk factor means nothing in the actual calculations. Such a “fur ball” explanation cannot be plotted.

It also becomes a hard sell in the U.S., wherewe have historically high surpluses of crude oil at Cushing, Okla.Cushing is the confluence of pipeline systems, one of the primary storage locations and the place where the NYMEX WTI contract prices are actually set.

One cannot explain away a price hike like this when there is excess supply over demand in the market served.

Something else is afoot (a little Sherlock Holmes paraphrase for the real detective fans among us).

The answer begins by searching elsewhere – in the widening spread between WTI trading in New York and Brent trading in London (as well as globally on ICE). Both are denominated in dollars.

Until recently, WTI would usually be priced higher than Brent because, while both are lower sulfur-content crude than what is traded in most consignments worldwide (“sweeter” oil, in market parlance), WTI is of slightly higher overall quality. That would normally translate into a premium over Brent.

Indeed, this is what we witnessed until August 16, 2010.

Yet from that point onward, Brent has traded higher than WTI for 174 consecutive trading days. Some of this results from that glut forming in Cushing. But the deeper reason reflects the actual usage of the two benchmark prices.

Taken together, WTI and Brent represent a grade of oil used in less than 15% of all the daily trades across the globe. Brent, however, serves as the benchmark for more markets than does WTI. It also feels the impact more immediately to the MENA unrest.

On January 3, Brent priced higher than WTI by $3.29, or 3.6% of WTI. By January 27, those figures had increased to $11.75 and 13.7%. By February 16, they stood at $18.79 and 22.1%, respectively; on March 1, $16.04 and 16%; at close yesterday, $11.70 and 10.4%.

There is a marginal decline in the spread as we have moved forward over the last two months. Yet the difference has remained, on average, the same for all of April (the April 1 figures were actually a bit lower – $10.76 and 10%). We have also witnessed a slight tightening of WTI to Brent.

A more complicated algorithm will provide us with part of the answer.

Using a progression of times-series equations as an overlay of the WTI-Brent spread onto the futures price/RBOB relationship – for all of 2011 – results in the spread between the two benchmarks accounting for, on average, an effective daily incremental factor of 77 cents.

Combining this increment and the traditional $1 rise per barrel equaling a 2.5-cent increase in gasoline prices, we are at 3.2 cents, or 76% of the 4.2-cent average already mentioned for the year to date.

This clearly tells us that the markets for both crude oil and gasoline are global, not local.

Now, most of the gasoline purchased daily in the U.S. comes from local refineries. I say “most”because, as with crude, we are importing a greater amount of daily oil product needs from refineries elsewhere. Those imports, along with the distribution of crude internationally to begin with, mean that pricing anywhere is no longer simply an exercise in local costs and profit margins.

Nonetheless, profit margins are also coming into it – or refinery margins, to be more precise. (See “In Oil Refining, It’s All About the Margins,” March 22, 2010).

While crude oil is the single greatest cost for a refinery, the margin between costs and wholesale levels are the primary source of profits.

Here, compare the continuing high crude oil surpluses against the drawdowns in gasoline inventories and the refinery usage figures (in the low 80% range). That tells us the market uncertainty is allowing the opportunity for an unusual relative rise in refinery margins.

Both of these factors – the WTI-Brent spreads and the acceleration in refinery margins – speak to the underlying environment of high volatility. This will be with us for some time.

It may seem unsettling. But the previous market dynamics are now impossible to maintain, and something previously regarded as “improbable” has taken over.

As Holmes reminded Watson in The Sign of the Four: “How often have I said to you that when you have eliminated the impossible, whatever remains, however improbable, must be the truth?”

Sincerely,

Kent

[Editor’s Note: On Tuesday, Kent released a special “crude spread” play to readers of his Energy Advantage, where he recommends his favorite energy stocks. When you sign up today, you’ll also find out about another one of his favorite stocks – a little company that just figured out how to plug safe, affordable, and nearly unlimited electricity into the grid – the global grid. North America, Europe, Asia… What’s more, you can pick up these shares “early,” for less than $4 apiece. Here’s the full story.]

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  1. Carol Ferguson
    April 22nd, 2011 at 11:35 | #1

    Thanks Kent, With the US dollar breaking through a 30 year
    support level, how will it impact the energy markets if
    we see an ouright collapse of our currency?

    It also appears that the USD is no longer the world’s reserve
    currency, though an official announcement has not been made
    comments?

  2. RoadKen
    April 22nd, 2011 at 11:45 | #2

    I’m not buying into the MENA tension, that has no bearing on our gasoline production here in the US, the problem is that we have a clueless president or maybe not, that is allowing the BIG Oil Companies to rape the American people to facilitate his agenda in bringing down the country to collapse, so the government can take over total control of the people, raising gas prices is just one of the many ways to accomplish this. We need to get this ‘Left Marxist’ out of office and put a hit squad out on Soros, he is the one that wants to bring the United States down, wake up!

  3. LEOPOLDO
    April 22nd, 2011 at 12:09 | #3

    mr kent.

    i am trader , with pemex international .

    I like your comments , about future price crude oil.

    how pemex , are looking , light crude oil, for mixed with

    heavy crude ,from owen drills fields for sale in the international market.

    i will be with special attention , at your notice.

    thanks .

  4. Walter Mitchell
    April 22nd, 2011 at 14:11 | #4

    I wonder how my father if he were still alive would think about your prognosis. He was a New York banker sent to run Oklahoma Natural Gas.

  5. DaveN
    April 22nd, 2011 at 14:15 | #5

    “refinery usage figures (in the low 80% range)” tells the whole story. This is a repeat of the Katrina story when critical equipment was lost and refineries stayed shutdown while prices rose. A few months ago a major plant in Texas was to come online after routine maintenance, the company got gov”t permission to shut down another plant, then claimed the Tx plant could not be refired. This game of contrived drawdown of fuels, diesel and heating oil being the worst game they play, has gone on for to long. Remember the truckers moving road blocks? Now they have pass thru pricing it is the retail consumer who is alone in this fight. We need to do away with the regional blends for gas and provide community storage for heating oils(long shelf life}. Gas will self regulate if the inspectors do their job and ensure the freshness of the supply(gas becomes a byproduct of the diesel frac)

  6. Walter Mitchell
    April 22nd, 2011 at 14:48 | #6

    This is a way to make a stunning reversal of fortune!

  7. Ventureshadow
    April 22nd, 2011 at 15:22 | #7

    @DaveN
    This makes a lot of sense. It is similar to the tricks played by Enron.

  8. George
    April 22nd, 2011 at 16:20 | #8

    I agree more with your article about the “Big Bank Oil War.” It will be interesting to see how much Goldman makes this time; i.e., selling one thing and betting the other way as with the mortgage debacle.

    Will the formation of a group by the President to investigate what you described have any effect on pricing?

  9. C, ADKINS
    April 22nd, 2011 at 21:19 | #9

    WHILE THE EFFORTS TO EXPLAIN THE CRUX OF THIS DILEMMA MAY SEEM LOGICAL BY THE MANNER IN WHICH KENT PRESENTS IT; IN THE BACK OF MY MIND I CAN SEE ONE FACTOR NOT MANTIONED; THE MOST OBVIOUS TO ALL WHO HAVE RECEIVED SHOCK AT THE PUMP; WHICH IS CREEPING INFLATION. SINCE OIL IS STILL FIGURED IN U.S. DOLLARS THROUGHOUT THE WORLD, OUR QUATITATIVE EASING ( QE-2 ), MUST BE FACTORED IN THE EQUATION. AS THE CARTOON SAID,” WE HAVE MET THE ENEMY, AND HE IS US.”

  10. Sailor Jo
    April 22nd, 2011 at 22:21 | #10

    @C, ADKINS
    Kent gave us an exhaustive explanation. I have to admit, some of it I had to read twice to understand.

    From my point of view there is also another facet in the game. The big oil companies work internationally and have to buy or produce at varying cost. Imagine, the US military may get fuel from an ESSO refinery in Koeln (Cologne)in Germany. What may their cost be? As the Europeans pay much higher taxes on gasoline and diesel fuel they are much more sensitive to price fluctuations and leave the car in the garage if fuel cost hurts to much. That’s a luxury most people in the US don’t have. I guess that makes the oil companies think about where they can squeeze more money out of the consumers.

  11. Sailor Jo
    April 22nd, 2011 at 22:23 | #11

    @C, ADKINS
    Another point: The US military is quite expensive and some people say they add more than a few dollars to the price of gasoline. That combined with the market interference of the government produces “unintended consequences”.

  12. db
    April 23rd, 2011 at 06:51 | #12

    I am puzzled by those comments suggestion that “inflation” is the cause of the change in spread between the costs of crude oil & gasoline. Wouldn’t inflation hit both equally?

    Also, the “Caps Lock” button is on the left of the keyboard, in the middle. Look for it.

  13. john
    April 23rd, 2011 at 09:22 | #13

    I HAVE IN MY POSSESSION THE REPORTS OF 29 OIL COMPANIES WHO WERE SUPOENIED INTO FEDERAL COURT FOR CLAIMING TEXAS CRUDE AS IMPORTED OIL TO AVOID FEDERAL TAXES. NAMES AND ALL INFO IS CONTAINED IN MY INFO. IT IS FREE TO ANYONE WHO WILL GET IT ON THE NEWS. SEMD ME YOUR EMAIL ADDRESS AND I WILL CONTACT YOU FOR YOUR POST OFFICE ADDRESS FOR THE INFO TO COME TO YOU.. AFTER THE JUDGE DISMISSED THE CASE, HE WENT TO WORK FOR THE OIL COMPANIES AT 6 TIMES THE SALARY AS OIL MINISTER TO THE USA. IT SHOWS WHO THE CROOKS ARE! nitro

  14. Ron Marabito
    April 23rd, 2011 at 12:05 | #14

    Suffer for a year. Build the 74 miles of pipeline from Anwar to the current Alaskan Pipeline. Could be done in a year. Open it up, cut off the middle east for a period of time and prices will get back in line. We have ample supply in the U.S. for a long time.

  15. ranji samaraweera
    April 23rd, 2011 at 13:36 | #15

    we complain about all the subterfuge. why not just demand our politicians allow the building of more refineries. I would love to have one in my back yard. My gas prices would go down. There is a fix to the problem. Either pay more or build more.

  16. DaveM
    April 24th, 2011 at 09:01 | #16

    Doesn’t the high cost of ethanol and the special handling required for this government mandated additive add to the cost at the pump? Also it should be considered that when the Dept of Energy says they would like the price of gas in the US to be closer to that in Europe, the refiners would be foolish to not accomodate their desires.

  17. Breed
    April 24th, 2011 at 11:48 | #17

    Thanks Kent!
    Reading your writings helps make sense of the oil game. I would have to agree with the gentlement regarding Obama. It is a carnival show everyday it seems with him. Like he can save everybody, and I am afraid a lot of people are guzzling the Kool-Aid he doles out like a hummer burns fuel

  18. robert e lee
    April 24th, 2011 at 19:09 | #18

    please sene me your e mailc

    bob lee

  19. John Pearson
    April 24th, 2011 at 21:22 | #19

    Dr. Moors,

    Does not the decrease in value of the US $ fit into this scenario as much as anything else???

  20. hotrodlvr
    April 29th, 2011 at 07:18 | #20

    @Breed
    ‘a lot of people are guzzling the Kool-Aid he doles out like a hummer burns fuel’ Brilliant! Screen splatter.
    Moors is giving us great info.

  21. P.Mc
    April 30th, 2011 at 12:34 | #21

    @john I work for a major. Am curious as to what you have there.

  22. David Krebs
    May 1st, 2011 at 00:16 | #22

    @john
    Please send information regarding your comments about the this judge and his new position with these company(s). It truly sounds like what really happens in the U.S.A. and other countries.

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