Could Gas Prices Provide Bush an October Boost?

The rise in gas prices has given the Democrats yet another sharp stick with which to poke George W. They should enjoy the advantage while they can, for come the fall we could very well see gas prices moving dramatically in the opposite direction, an October surprise that would be most welcome to the Republicans.

Why? Here are the details. The recent price surge was not caused by a shortage of crude oil. The world will run out of oil eventually. But as of now everyone agrees that supplies are plentiful; there is no shortage of production capacity. We can also dismiss the theory that OPEC (Organization of Petroleum Exporting Countries) is to blame. As of mid May the OPEC countries were producing 2 million barrels per day above their official quota. In any event, US gasoline prices have soared by over 40 percent this year, double the rate of crude oil increases.

So why are gasoline prices so high? Part of the price rise is normal. In the past ten years gas prices from December to August, that is, from the stay-at-home winter months to the high-driving summer months, have risen on average by 15 cents per gallon. In 2000 and again in 2002 gas prices rose by more than 30 cents per gallon in the spring and early summer.

The second part of the reason is that gasoline demand has risen faster than people expected. U.S. gasoline consumption, about 45 percent of global use, has risen by 4.5 percent in the last 12 months. Asian economies are booming. China's economy continues to grow at the astonishing rate of 8-10 percent a year. The recent impact of this fast-industrializing nation of 1.3 billion people on world commodity prices has been remarkable. Stockpiles of all minerals, from copper to coal to recycled metals are disappearing into the maw of the Chinese economy. This year China displaced Japan as the world's number-one oil importer. One fifth of the world's ocean freight now delivers to Chinese ports, triggering a doubling in the cost of moving bulk freight. Currently the U.S. is experiencing a shortage of concrete in large part due to the global impact of Chinese construction projects.

The third reason that gasoline prices have risen more rapidly than normal is the bottleneck in world refining capacity. The International Energy Agency (IEA) estimates world-refining capacity at about 82.1 million barrels a day (bpd). That is about 2 million bpd above consumption estimates for the first quarter of this year but below estimates for global oil consumption of 82.4 bpd expected in the fourth quarter of this year.

In the United States refineries were operating at 96 percent capacity as of mid May. In California, operating capacity is nearer to 98 percent. Nationally, the U.S. has less than half the number of oil refineries it had when Jimmy Carter was in office. In 1983, California had 37 refineries; today it has 13 and Shell recently announced it would close a refinery in Bakersfield in the next few months, further straining capacity.

Today when a refinery goes down, the price of a gallon of gasoline in that service area can rise by 25-50 cents. A problem at the ChevronTexaco's El Segundo refinery outside Los Angeles in early February reduced production, precipitating a quick 30-cent-per-gallon increase.

M.J. Ervin & Associates, a Calgary-based petroleum industry analysis group, estimates that 90 percent of the fuel price hike in Canada since January was a result of a sharp climb in refiner's margins, from about 44 cents (Canadian) to about 88 cents per gallon. In the U.S. the refiner's margin has increased from about 32 cents per gallon to about 48 cents per gallon in the last few months.

Finally, there is the impact of speculation.

Many industries, like airlines, buy oil futures to hedge against the possibility of steep price hikes. Speculative funds once operated on the edges of the commodities arena. They now make up about 20 percent of the crude oil and gasoline markets on the Mercantile Exchange.

This artificially raises the cost of oil. Bill O'Grady, director of futures research at the brokerage firm of A.G. Edwards in St. Louis told Reuters, "it is hard to justify $38 (oil prices) ... I see the fair value at $30 to $31."

Some are calling this the terrorist risk premium. The late May terrorist attack in Saudi Arabia caused the greatest one-day increase in the price of oil ever. There is a growing fear of terrorists targeting oil pipelines and refineries. This fear is reinforced by the specter of the American (and other governments) buying oil for strategic petroleum reserves even with the price so high. As the Economist magazine reported in March, "The administration's persistence, coupled with increased strategic purchases by other governments, has fuelled suspicions that officials might have some intelligence about terrorist threats to oil infrastructure." In February, Congress passed a resolution urging the President to stop fueling these fears by halting strategic oil reserve purchases. The Administration refused.

Who's winning and who's losing from the oil price run-up? Oil-producing countries are winning, but not by as much as one would think. The reason is that almost all of the world's oil is sold in dollars. The dollar has declined in value by about 25 percent in the last year against the euro and other major currencies. Which means OPEC is, in effect, receiving 25 percent less for its oil than a year ago. That fact was what initially prompted OPEC to raise its target price range above the $22-$28 per barrel.

We might recall that Saddam Hussein threatened to require that Iraq be paid in euros for its oil just before we ousted him from power. And the European Union's outgoing energy commissioner, Loyola de Palacio, made the same suggestion recently in his call that oil trade be priced in a basket of currencies as a way promote greater price stability.

Oil companies are making out like bandits.

The typical motorist is paying about $30 more per month for gasoline. ExxonMobil recently announced profits of $21 billion last year and that numbing number could go even higher this year. Much of the increased profit has come from the remarkable increase in oil refiner's margins.

Local gas station owners, the lightning rods for most motorists' dissatisfaction, are losing. They are making half as much per gallon as they did six months ago.

For George W. Bush the gasoline price rise is bad news. But the election is in November, not in June. By late September we can expect the gasoline prices to drop by 10-25 cents per gallon as cooler weather sets in. And speculators can withdraw from the market as quickly as they entered it. If the situation in Iraq stabilizes in the fall and OPEC's promised increase in oil supply materializes, we could see prices drop by another 20-30 cents per gallon. A 55-cent drop in the price of gasoline would be a most welcome October surprise for the Republicans.

Of course, if that does occur the Republicans would probably attribute it to divine intervention.

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