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Forget the Kneejerk Reactions, Oil Prices Are Going Higher

With all of the concern exhibited over Cyprus' problems with banks and China's high-profile billion-dollar solar implosion, the doomsayers are once again predicting an oil price crash.

These guys must really need your money!

Each new geopolitical event is cast as the end of the world as we know it.

The fact is there is nothing on the horizon that will collapse oil prices for one very simple reason.

The prospects for oil prices are increasing, and elevating oil products along with them. Most sections of the U.S. will be testing 2008 gasoline price highs at the pump well before mid-summer.

Yes, we did see a swing down in crude futures during the initial stages of the Cypriot crisis, augmented by some short-lived negative comments on Chinese industrial prospects.

But by last Friday morning, stabilization had occurred and an oversold crude oil futures market began to move back up.

The perception is that this remains driven by demand expectations. Now I have discussed several times the essential shortcomings of what the pundits regularly do with demand. Whenever a negative appears, most of the initial reactions witnessed in the market are overdone.

These negative reactions also come without a justification in data.

Remember, the tangible figures supporting a reduction in futures contract prices, the data that actually provides an indication of a decline in demand, takes at least three months.

And even then, the indicators are very provisional.

As a result, knee-jerk reactions drive the initial investment response.

But it usually results in an oversold condition. As we have also noted in the past, such an immediate read says nothing of the genuine value about crack spreads – the difference between futures contracts in crude oil and those in gasoline and heating oil.

On this score, consider the current situation in crude versus RBOB ("Reformulated Blendstock for Oxygenate Blending," the NYMEX futures contract in gasoline). Both have performed about the same this month, with NYMEX prices up 0.3% for WTI (West Texas Intermediate benchmark grade), while RBOB posted a 1% gain.

However, the price of gasoline will be spiking for three reasons that have nothing to do with projected demand.

What's Actually Driving Demand?

First, the main driving season of the year is approaching.

Second for most of the populated areas of the country, a required switch from winter to the more expensive summer blend of gasoline is approaching.

And third, there is the ethanol situation.

This last consideration is the new wrinkle. Admittedly, it is the result from a political (though still largely bipartisan) decision. Washington mandates that a certain percentage of the retail gasoline mix sold must be ethanol. In fact, the credits refiners have to buy, called RINs (short for "Reusable Identification Numbers"), to fill in the gallons processors are required to buy.

Each year since 2007, the number of gallons of gasoline sold in the U.S. has declined. That will be the case again this year. With the ethanol mandate remaining, however, the overall volume of ethanol in fuel will be increasing just to maintain the 10% level.

But the legislation states that the number of RINs (that is, ethanol gallons) purchased must increase each year for the next decade. And that is where the pricing pressure hits.

Corn Futures, Weather a Major Concern

Last year's drought brought about a huge rise in corn prices. With more than 40% of the corn grown in the country now going to ethanol production and the price of that corn rising over 60% in less than a year, the situation has translated into a rapid increase in the cost of the ethanol component in gasoline.

Normally, an open market would compensate for this by reducing the percentage of biofuels in gasoline. Unfortunately, that is not possible, given federal statute.

This is not a demand-push scenario. It is one dictated by an attempt to rebalance motor fuel to require a greater domestic (and diversified) composition. Yes, there will be a guaranteed market for American-produced biofuels in the new energy mix emerging.

In addition, the problem now experienced was caused by Mother Nature's decision to preserve rainfall. I normal times, the cost of the ethanol in gasoline was counted in pennies to the gallon. Nonetheless, this is another example of politics messing up the normal market pricing mechanisms and costing the consumer.

Now we are all consumers and we will all have to pay until the ethanol situation is resolved. Certainly, the interests of corn growers in Nebraska and Ohio must be considered right along with the drillers of oil in Texas and Oklahoma.

Before too long, with the advent of a push to use natural gas as a vehicle fuel, we will also have to throw the interests of gas producers in Pennsylvania and Colorado into the mix.

All of which leads us to a very clear conclusion. There are always elements other than simple supply and demand that are influencing the ultimate price of an oil product.

Remember, we may complain about external pricing pressures that are human in origin. But as investors, they are also likely to make us some money.

As this pricing swing moves into full gear, I will be talking right here about how to gain from the dynamics unfolding.

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About the Author

Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle

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  1. Jeff Pluim | March 26, 2013

    I have NEVER heard Moors say anything about the price of oil other than that it is going up. Even when oil goes down, Moors is saying that the price of oil is goig to rise. Even a clock that doesn't work is right twice a day. He has been wrong so often, I have lost count.
    With the printing of money debasing most currencies in the world, it is enevitable that the price of all commodities will rise. That includes oil. The main reason that oil has been so low over the last couple of years is that the backlog of oil trying to get to market from Alberta, Canada, has caused an artificial dip in the price. Canada is working on getting 3 pipelines working to alleviate that backlog. Any one of those pipelines will open up the floodgates for Alberta and they will be able to get Brent pricing for their oil instead of $30 per barrel less than WTI pricing. What they are getting for their oil now, is keeping the overall price of oil down.
    Interestingly, even though Canada has one of the largest oil reserves in the world, and is the largest supplier to the United States, Moors never addresses the issues associated with Canada's oil development or its impact on the price of oil. He needs to take a good look at the BIG PICTURE. His dogma of "the oil is rising, the oil is rising", sounds amazingly like Henny Penny, "the sky is falling, the sky is falling".

  2. dunce | March 26, 2013

    Prices are set by supply and demand PLUS cost of production. The ethanol is part of the cost of production but so are all the regulations and the ever higher costs of exploration and drilling. The govt. can reduce costs by abandoning ethanol, and reducing regulatory burdens. The other costs are outside the control of the oil companies and the govt. Supplies of much of the worlds oil reserves are in the hands of other sovereign states and deep water drilling is high cost.

  3. Don | March 31, 2013

    Instead of using grain based alcohol, why don't they turn to wood alcohol? Right now we have this insect problem in pine trees. There are holes bored all over in the trunks of pine trees everywhre and it is killing a lot of all pine trees. The trees look like they have been shot with a small caliber machine gun. I've heard the insects bore clear to the center. They say there is dead trees all over the rocky moutains. Couldn't these dead trees be ground up and turned into wood alcohol. It would probly beat $7.00 + corn and would clean up forests. It probly burn just as good as grain alcohol and would save lots of money without effecting our food supply. With 2 years of drouths the last thing we need is mass food shotages.

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