Crude Oil and
Gasoline Prices:
A Perfect Storm
By John Brodman
Fasten Your Seat Belts
The world oil market is a rollercoaster, and we’re
in for a wild ride. After falling slightly for two years
in a row during the recession, world oil demand rose
by more than 2.5 million barrels per day (mmbd)
in 2010, to surpass the previous consumption peak
of 86.5 mmbd reached in 2007. This represents the
second largest annual demand increase in the last
30 years. At the same time, the political turmoil in
the Middle East and North Africa is threatening the
supply of oil. Oil production in OPEC member Libya
is completely shut down, effectively removing 1.8
million barrels per day of oil supply from the global
marketplace. Unrest in Egypt, Jordan, Oman, Iran,
Iraq, Yemen, and Algeria is fanning expectations
about what might happen if unrest spreads to disrupt
more oil supplies. This expectation is driving the
market higher.
The loss of Libyan oil by itself is not enough to
create an immediate shortage. Global inventories of
crude oil and petroleum products are well above their
normal levels for this time of year, and other oil pro
ducers (like Saudi Arabia) with spare oil production
capacity are moving to produce replacement barrels.
So why then are crude oil and petroleum product
prices rising so rapidly? The answer is that oil is a
widely-traded commodity, and like all commodities,
its price is driven by both current market conditions
and expectations about what might happen in the
future. The current volatility in the oil market is really
a variant of Economics 101, in this case, supply and
demand on steroids.
Ten years ago, the average price of crude oil was
$26 per barrel. The average price rose in each of the
next seven years to a level of $99 in 2008, surging at
one point to an intra-day trading high of $147 per
barrel. Prices then dropped with the global economic
meltdown to a low point of $34 per barrel in De
cember 2008. Crude oil prices have since recovered,
with the economic recovery and rising demand, from
an average price of $62 per barrel in 2009, to $79 in
2010 and to $87 per barrel at the beginning of this
year Prices rose further to just over $100 per barrel
in February and continued to strengthen to an
average of just over $110 per barrel by the middle
of March. The average regular retail price of gasoline
at the pump in the U.S. followed crude oil, rising from
a level of $2.35 per gallon in 2009, to $2.78 a gallon
in 2010 and to a level of $3.10 per gallon in January.
Since then, gasoline prices have literally exploded, ris
ing by $0.38 per gallon in the last three weeks alone,
to a national average of $3.52 per gallon, with prices
higher than $4.00 in some parts of the country.
The increase isn’t over yet. The U.S. Department
of Energy’s Energy Information Administration
(EIA) expects motorists to see further increases now
through spring and into the summer driving season
(April through September). Increases will occur for
seasonal reasons and because the recent rise in crude
oil prices and gasoline prices at the wholesale level
has not yet been fully passed through to the retail
price of gasoline at the pump. Without any further
increases in the price of crude oil, the EIA expects
the national retail price of regular grade gasoline to
average $3.71 per gallon from April to September,
which is $0.98 higher than last summer, with the
projected average price peaking at $3.75 in June.
Furthermore, the implied volatility of the futures
market contract price for reformulated gasoline
delivery in July suggests that there is a 25% chance
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«2 Tlie,^hqreUne i April 2011