Futures prices for both crude and gasoline were down yesterday. Unfortunately, that barely tells the real story.
So, enjoy the respite while it lasts.
Thanks to the growing Sunni insurrection and the rapid unraveling of the Shiite government in Baghdad, you can bet that prices for both crude and gasoline will be making the headlines over the next two months.
In fact, when it comes to oil, some bankers are now openly questioning the ability of the market to meet global demand a year out. Now prices further out on the futures curve are rising much more quickly than anticipated.
As the next-month rates (August 2014) fell in yesterday's trade, oil prices as far out as December 2018 began to spike.
Here's why yesterday's drop in prices is just the pause before the storm...
If Iraq Unravels, Oil Production Will Be Crippled
There's a reason why Iraq figures so prominently in this discussion. Everybody's estimates now suggest that global oil demand will accelerate to 94 million barrels a day by the end of this year.
That will place a greater reliance on expanding the existing sources of supply.
Previously, when in the same situation, the Saudis would bail us out since they have the ability to put 12 to 12.5 million barrels a day on line in a matter of a few hours. In the past, that provided a reliable cushion, restraining a real breakout in prices to the upside.
Well, this time that's just not so. The projected demand spike will flat out exceed the ability of Saudi Aramco to deliver. That means relying even more on other OPEC members. The problem is that consistent overall production increases have been muted, with Iran and Venezuela actually posting declines.
However, the singular exception in all of these estimates has been Iraq, where the government has ambitious plans to ratchet up production at major fields in the south from the about 3.1 million barrels a day to more than 6 million barrels a day with further expansion planned beyond that.
In this position, Iraq has become the new "balancer" in the international oil equation.
Now, keep in mind that the ongoing crisis has not hit the oil fields directly. And there is little indication that the Islamic State of Iraq and the Levant (ISIL) has the ability (or intent) to capture these fields. While they have effectively immobilized the nation's largest refinery at Baiji, near Tikrit and north of Baghdad, their forces are far too small to capture and control the critical fields and pipelines.
Unfortunately, the ISIL can accomplish the same result without occupying a single square inch. All they need to do is immobilize the current government and allow the fragmentation already underway to render the new Parliament (supposedly sitting by the end of this week) powerless to act. After all, even without a major insurrection, it usually takes that body months to come up with an ineffective patchwork administration.
Needless to say, that would only make a bad situation even worse.
Here's why: Losing centralized governmental regulation of the oil sector freezes field development and will prompt international majors to start moving personnel out of the south, even though insurrectionists are 200 kilometers away.
In fact, some of these companies have already begun to make their exits. And that's what is prompting a rise in prices further out on the curve. The problem is, even more bad news is right on the horizon.
These Two Numbers Tell Me Why $4 Gas Is Coming Back (Again)
But now there is another shoe about to drop. In this case, don't blink, because the price you see at the pump isn't going to last much longer.
From my experience, I can promise you gas prices are going higher.
Several years ago I was an expert witness in a very large gasoline pricing fraud case. In the course of that proceeding, I developed a way to estimate the real refinery margins from which processors obtained their profits, rather than the basis used by most analysts.
You see, real refinery margins (the difference between actual costs of operations versus initial wholesale prices of finished product - that is, the real profits made by the refinery) are considered proprietary and are not released to the public.
But after two years of study, I was able to set up a working model that allowed me to determine what was really going on. In fact, there are 94 pages of appendices in my book The Vega Factor: Oil Volatility and the Next Global Crisis that breaks all of this down.
Anyway, here are the two numbers you need to remember if you want to ruin your day.
First, I have estimated through last Friday that refiners and wholesalers have not actually passed on to consumers about $6.20 a barrel in average crude oil price increases. Second, according to my number crunching, a $1 increase in a barrel of crude in the current market (these vary) translates into slightly more than a $0.039 increase in the pump price for unleaded regular.
So, sorry, but whatever you paid for gasoline this morning is a thing of the past. You can now expect prices to move up by more than $0.22 a gallon as the providers begin to phase in their cost increases to the product flow pricing.
According to the Oil Price Information Service (OPIS), the national average for regular gasoline was $3.76 on Friday.
Don't look now, but $4 a gallon, here we come...
Unless you live in California or Chicago, where that price is already in the rearview mirror.
Kent has been an energy advisor to both the Iraqi and Kurdish governments. No one knows the players in this ongoing crisis like he does. His decades of experience in energy have brought his readers a consecutive string of double- and triple-digit gains, beating the broad markets almost 10 times over. To sign up for Kent's free Oil & Energy Investor, and receive regular, twice-weekly updates on the situation, along with any unscheduled alerts as they happen, Click here.