Today's Analysis: Gasoline: $5 Per Gallon On The Way?

Five dollar per gallon gasoline is on they way. The Energy Information Agency, on 8-3 reported a 2.8% drawdown in gasoline supply, for the latest recording week, as it also reported record oil imports into the U.S. When supply swells, as it has been doing for the last several weeks, albeit at different places along the supply chain, it is usually a negative for the market. But, this market continues to defy logic, as traders continue to factor in shortages of fuel for the winter, as well as the potential effects of what is supposed to be a very deadly hurricane season, that will not be over until November.

Much of the worry now, has shifted to gasoline, and away from distillates, which includes diesel fuel, as well as heating oil. According to ["The gasoline drawdown is devastating and, on top of all the new refinery problems, it sets up [retail] gasoline prices for well over $3 by summer's end," said commodities trader Kevin Kerr, who also edits the Global Resources Trader investment letter, a service of MarketWatch.]

Kerr's ultra scary pronouncements continued. Referring to the current price of unleaded gasoline, Kerr told Marketwach's Myra Saefong: " (The current price) shows the impact the hurricanes and all the refinery outages are having. Coupled with the announcement that MTBE will no longer be used in blending, gasoline is setting up to move to the next level of $4 and $5 a gallon long-term." And "any more new refinery problems or weather disruption will be all it takes to drive the whole complex higher," he said, adding that he thinks $65 for crude oil's front-month contract is now "imminent."]

But supply numbers tell a different story. According to Marektwatch: "Crude inventories climbed by 200,000 barrels to total 318 million barrels last week, according to the Energy Department, ending a four-week decline. They're now 7.7% above the year-ago level."

Indeed, crude imports are coming in at record pace: ["The third-highest [crude] import total ever of 10.95-million barrels [per day] suggests that talk about storm-induced interruptions in Mexican supply was just that," said Tom Kloza, chief oil analyst at the Oil Price Information Service."

The Refinery Issue

So what's the problem? As we've been saying for years, and as we noted in "Successful Energy Sector Investing," it's all about refinery capacity, and the bottleneck created by those limits, as well as the ever present perception that Iran and Iraq are going to be a major and escalating problem in the future, especially with a change in the Saudi power structure after the death of King Fahd.

According to the Wall Street Journal, though, refinery problems are not likely to go away. Instead of new refineries, "domestic refiners are investing in equipment that can process cheaper crude and overhauling their plants to meet clean-fuel mandates. That lack of new capacity could keep upward pressure on prices for gasoline, heating oil, jet fuel and other petroleum-based products."

Indeed, there is a list of reasons usually thrown around for the lack of new refineries being built. "U.S. refiners – are spending a total of $8 billion to bring their plants into compliance with the latest rules requiring reduced levels of sulfur in diesel beginning in 2006, says John Felmy, chief economist at the American Petroleum Institute. In all, Mr. Felmy says, the nation's refiners will spend about $25 billion from 2002 to 2012 to meet new low-sulfur gasoline and diesel standards. No new refinery has been built in the U.S. in nearly 30 years; capacity gains typically come from extensions to current facilities. In the U.S., many refiners remain reluctant to undertake major new projects for a variety of reasons, including public resistance, expected returns on investment and environmental regulations. Exxon Mobil Corp., for instance, warns against significantly expanding refining capacity for fear of a price collapse."


This is a demand market. Demand markets in commodities are like momentum markets in stocks. They always go on much longer than anyone expects them to. They seem as if they will never end. And when they finally crash, it takes several months for anyone to acknowledge that a bear market is under way.

If it sounds familiar, think back to December 1999, when the Internet stocks led the technology sector into the blowoff of a lifetime, only to crash and burn three months later.

At that time, nearly 100% of all investors bought into the notion that technology stock prices would rise forever, no matter what.

That's what we hear in the oil markets now. Peak oil is here. There are no refineries. China's economy is unstoppable. And gasoline is going to double in price with the next hurricane.

To be sure, many of those arguments, especially peak oil are worth noting, and indeed have some merit, at least partially, and when applied in the proper context.

But, just because all the oil that can be produced is being used up today, it doesn't mean that it will be the same way tomorrow.

At some point, supply is the major factor that affects prices. Unless, supply is truly about to run out, the usual supply-demand scenario will eventually play out. When it does, oil prices will fall.. For a long time, and to levels that no one is expecting them to.

As traders, though, we trade with the trend.

Oil Market Summary And Outlook: $60-62 Tight Trading Range

Oil futures were trading above $61 in the September contract overnight. Prices failed at new intraday records on 8-3, as buyers ran out of steam.

Rising crude supplies were not bullish enough to overcome a drop in gasoline inventories, leading some to call for $5 per gallon prices under the right circumstances.

Peak oil is gathering steam now as a hot topic. The Wall Street Journal is holding blog sessions on the subject. We found that interesting, given our frequent discussion on the Financial Sense News Hour with Jim Puplava radio show about peak oil. Puplava is a devout subscriber to the notion. We are less enthusiastic, but are not discounting it either, mostly adhering to the notion that the easy oil has been found and that oil prices are not likely to hit $11 anytime soon, with $40 being the new bottom in prices, at least in the next down leg, whenever that is.

Oil and oil service stocks again moved up with oil prices on 8-2, setting marginal new all time highs, but pulling back on 8-3.

Exxon can't get above $60, which makes us wonder how much conviction the bulls have on this market at this point.

We'll say it again. Nothing is etched in stone in the oil markets, especially during the mega bull market of all time, which is still unfolding. But, the action lately has been less than inspiring for the bulls. In other words, it's always possible that we've seen the top, at least on a short term basis. Our very long-term opinion on oil has not changed. We are still in a very long-term bull market in oil, until proven otherwise. The long-term line in the sand, for us, remains $40 per barrel.

The Philadelphia Oil Service Index (OSX) made all time highs on 8-2, but may be pressed to hold onto the lofty levels reached.

The Amex Oil Index (XOI) is testing the 950 area, after an all time high on 8-2.

In the Rigzone Store:

Successful Energy Sector Investing: Every Investor's Complete Guide

Dr. Duarte's book predicted many of the current developments in the economy and the energy markets, and provides an excellent set of benchmarks and trading lessons for what could be in store for the future.