Here's the reason. Image via Wikipedia
It’s not even March yet and already the groaning has begun over ramping gasoline prices. Nationwide the average gallon of gas cost $3.59 last week. That’s up big from $3.19 the same time last year. U.S. oil prices, benchmarked to West Texas Intermediate are $104 a barrel, versus just $85 a year ago.
Stop your whining. At $3.50 a gallon, fuel makes up just 29% of the total cost of driving. The U.S. Department of Transportation figures that insurance, license, registration, taxes, depreciation and finance charges on the average car come to about $5,600 a year. Enough gas to drive 15,000 miles will set you back just $2,300. I know that’s a lot for many people — but the average family could offset most of that fuel bill by cutting off its cable TV (you can stream the good stuff over Netflix anyways).
Indeed it’s incredible, considering the international sanctions squeezing Iran’s exports, that oil is still as cheap as it is. Yes, gasoline is still cheap in America, thanks to combination frugal driving trends spurred by the Great Recession paired with remarkable growth in domestic supplies.
Gasoline usage has dropped significantly. From 9.29 million barrels per day in 2007 to 8.2 million barrels per day last week (that’s from 390 million gallons a day to 344 million gallons), a plunge of 12%. What’s more, about half of that demand reduction took place in the past year.
We’re driving somewhat fewer miles too — about 100 million miles fewer last year than in 2007. Granted that’s only a 2% reduction in miles, or roughly a half-mile less for each of the 210 million licensed drivers in the U.S.
What’s more, thanks to universal use of techniques like hydraulic fracturing, America’s domestic production of crude oil is on the rise. Since hitting a low in 2008, drillers are pumping 18% higher volumes, totalling 5.8 million bpd. The U.S. now supplies more than half of its petroleum needs from domestic fields.
It gets better. Ample supplies from the Bakken shale in North Dakota and from the Canadian oil sands mean that oil inventories at the big storage hub in Cushing, Oklahoma are at record levels, and West Texas Intermediate crude trades at a discount of as much as $25 a barrel to Europe’s benchmark Brent crude. No wonder folks in Colorado and Wyoming enjoy the lowest gasoline prices in the nation, just $3.03 a gallon. More of the nation could enjoy the same if the Keystone XL pipeline were allowed to bring the bounty south to the refineries on the Gulf Coast.
Demand isn’t rampant in the rest of the world either, with the International Energy Agency predicting that total world demand will rise just 1 million bpd this year to average 90 million bpd. China will account for 40% of that managable increase.
And you can’t blame those big evil oil refiners for trying to milk us dry either. Analyst Thomas Yoichi Adolff at Credit Suisse notes that demand has fallen so much that 31 uneconomic refineries have been shut down in recent years, with two dozen more on the chopping block. The refiners that are left earn an average profit of about $11 for every barrel they process. That’s about 26 cents a gallon, in line with average profitability of the past decade. (Compare that with the average 39 cents per gallon of state and federal taxes.) With their profit margins of less than 10%, it’s hard to justify calling the oil companies greedy.
So with all those upbeat data points why is gas so seemingly expensive?
John Felmy, chief economist at the American Petroleum Institute says that after taxes and refiners’ profits, 84% of the price of gasoline is tied directly to the price of crude oil. And who controls that? “It’s all the Saudis,” says Ed Hirs, professor of energy economics at the University of Houston. “What’s wrong with this picture? Demand is flat, we’re still in one of the worst recessions. Prices should be down as well. The Saudis are the only swing producer.”
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His point is that only the Saudis have the ability to open the chokes on their oil wells if they desired. Their 2 million bpd of spare capacity could keep prices stable, which, says Hirs, is the swing producer’s job.
In mid February came the news that the Saudis had cut their output in December 2011 by 237,000 bpd — pretty sizable amount, especially in the face of already high oil prices. What got lost in the mix, however, was that in November the Saudis had pumped 10.047 million bpd — their highest rate in more than 30 years.
The world leaned heavily on the Saudis last year to replace most of the oil production knocked offline in Libya. According to the IEA, the Saudis boosted their output 950,000 bpd in 2011 to average 9.34 million bpd. Neighboring Kuwait also added 210,000 bpd and UAE added 190,000 bpd. All that largesse kept the markets well supplied during Colonel Khadafi’s final days.
It’s one thing to replace Libya’s oil. Quite another to replace Iran’s. Even though no bombs have yet been dropped on Iran’s nuclear facilities, the U.S/U.N. sanctions on Iran are having the effect of keeping Iranian crude off the world market. China and Europe have been reducing purchases of Iranian crude. Iran says it has already halted sales to the U.K. and France. Now it looks like Turkey may be forced to cut its imports as well.
And although rogue traders usually figure out how to get oil out of restive areas one way or another (like Marc Rich did for the Iranians in the 1970s), it’s harder when big tanker companies like Frontline (controlled by billionaire John Fredriksen) say they will no longer load Iranian crudebecause they can’t get insurance coverage.
If sanctions on Iran bite enough to prevent most of Iran’s 3.5 million bpd of crude from getting to market, not even Saudi Arabia and its neighbors will be able to make up the difference. Hirs doesn’t think they’d even want to. “For the Saudis it’s a defensive move against Iran to keep prices up,” he says. This is counterintuitive, given that there’s no love lost between Riyadh and Tehran, but the Saudis don’t want to slash Tehran’s oil income too much for fear of giving the mullahs reason to retaliate.
Though it’s the threat of Iran blocking the Straits of Hormuz that gets the attention, a far easier missle target for an Iran under attack would be the giant Saudi oil fields or the Ras Tanura tanker port on the Persian Gulf. Already in recent weeks gunfights have broken out in Saudi Arabiabetween Sunni groups loyal to the Saudi royal family and Shiites who feel more allegiance to Shiite-dominated Iran.
As Iran is pushed deeper into the corner and its crude exports cut off, oil prices could very likely soar even as the Saudis open their spigots. That would push gasoline prices well beyond where they are now. U.S. stockpiles of oil and fuels currently amount to 1.7 billion barrels, including 700 million bbl in the Strategic Petroleum Reserve. That would be enough to cover foregone imports for at least 6 months, but not enough to keep prices down. We’ll sure wish we had that Keystone XL pipeline then.
Economist Hirs says that even if the Iran issue is resolved peacefully, it’s nearly inevitable that the Obama administration (looking for election-year votes) will open the Strategic Petroleum Reserve, as it did when Libya was on fire last year: “They may view opening the SPR as a kind of SuperPAC at taxpayers’ expense. But because every barrel they take out has to be put back it won’t do a thing to bring down gasoline prices. With gasoline now being exported from the U.S. it is the world price that will control domestic pricing.”
Instead of whining about gasoline prices, buy insurance in the form of crude futures or shares in North America-based, oil-leveraged companies. For what it’s worth, my favorites include Continental Resources (NYSE:CLR) which is big in the Bakken, Canadian Natural Resources (NYSE:CNQ) a leader in the oil sands, and Occidental Petroleum (NYSE:OXY) a cash cow. Then at least you’ll have some capital gains to balance out those pump pains.
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