Rising Gas Prices: Not Demand Driven

By Matthew Philips, Bloomberg Businessweek

17 February 12

as prices are off to a fast start in 2012. The national average for a gallon of regular gasoline is up more than 8 percent since the end of 2011, rising from $3.25 per gallon to $3.52, according to new data released by the U.S. Energy Information Administration.

While gas prices tend to rise through the first half of the year, this is the earliest the average price per gallon has breached the $3.50 mark. If this pace continues, the national average should hit $4 a gallon by May, if not sooner. The last time the average price did so in the U.S. was summer 2008, when the price of oil hit $140 a barrel. Last year gas prices approached $4, hitting an average of $3.98 in April, before falling.

Higher gas prices could pose a serious threat to the fledgling economic recovery, which has shown signs of strength recently. Typically, $4 a gallon tends to be the point at which the price of gas starts to eat into economic growth.

"Anytime the economy spends 4 to 5 percent of GDP on oil, then you're getting close to stall speed," says Jason Stevens, an equity analyst at Morningstar. "We saw this last year when Libya and Japan blew up, and prices went through the roof. Demand pulled back a bit, but growth certainly slowed."

Strangely, the current run-up in prices comes despite sinking demand in the U.S. "Petrol demand is as low as it's been since April 1997," says Tom Kloza, chief oil analyst for the Oil Price Information Service. "People are properly puzzled by the fact that we're using less gas than we have in years, yet we're paying more."

Kloza believes much of the increase is due to speculative money that's flowed into gasoline futures contracts since the beginning of the year, mostly from hedge funds and large money managers. "We've seen about $11 billion of speculative money come in on the long side of gas futures," he says. "Each of the last three weeks we've seen a record net long position being taken."

Refineries have also been getting squeezed by higher crude prices over the past several months, forcing some of them to shut down rather than operate at a loss, says Stevens. "The price that refineries have been paying for crude was roughly flat, while the price they were getting for gasoline was lower than what they needed to make their crack spread," he says. A crack spread refers to oil refineries' profit margins and is roughly the difference between what they pay for crude oil, and what they make by "cracking" crude into petroleum products such as refined gasoline. As the U.S. refining capacity has decreased, prices have begun to rise.

But prices aren't high everywhere. For example, the average price of gas in Wyoming is $2.90 right now, nearly a dollar cheaper than the average price in California. That's largely due to the relatively cheap amount of crude that's coming into the upper Midwest from Canada. "There is more diversity between crude prices now than I've ever seen in my career," says Kloza. "It's extraordinary."