$70 Billion Gasoline Tax

Jim Brown
 
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Gasoline prices have risen +70 cents per gallon since October when prices were $2.80 on average in the USA. For every penny increase in gasoline prices the U.S. consumer spends an extra $1 billion per year for fuel. That 70-cent rise in prices is the equivalent of an undeclared $70 billion tax on consumers that comes directly out of their available cash.

It is not shaping up as a good week for consumers. Gasoline prices in the U.S. averaged $3.47 on Friday and you can bet they will be well over $3.50 on Monday. Cities on either coast are going to see prices over $4 before next weekend. The +19 cent spike in just the last week is the largest weekly increase on record since 1990 when the EIA began keeping records. The average price for diesel was $3.72 per gallon. That is a gain of 86-cents over the last year.

The geopolitical events in the coming week are not going to calm any fears about future production losses. Conditions are only going to get worse until Libya ends hostilities and we get past the Saudi Arabian Day of Rage on Friday. However, WTI prices could decline this week thanks to the roll over of the positions in the USO ETF. It will only be temporary.

Wholesale gasoline prices were $3.05 per gallon on Friday. Add to that taxes that average 13% to 18% and distribution and marketing expenses of 9% to 11% and you get your local retail price. For every $10 advance in crude oil the price of gasoline at the wholesale levels increases by 25-cents.

The current WTI contract has risen from $87 in mid February to more than $104 at Friday's close. That $17 move should have spiked gasoline prices by about 42-cents but the full cost of the latest spike has yet to be felt. Gasoline we are using today was purchased as oil over a month ago or longer. Oil purchased today will not be gasoline at the pump until April.

Refiners and retailers don't wait for the higher priced oil to arrive before they jack up prices. Whenever we see a spike in crude oil the price of fuel immediately mirrors the price increase in oil. When oil prices come back down the price of fuel never seems to mirror the decline and tends to lag crude prices. Retailers are not making windfall profits despite the price fluctuations. Retailers only make a few cents per gallon, normally less than a nickel. They are just protecting themselves against future price swings when they may not be able to sell fuel for as much as it costs them due to local competition and the lagging price increases from the refiner.

EIA Gasoline Price Chart

Retailers hate the price swings because customers don't understand and always believe the retailer is gouging the public and making money off the hysteria. In reality many gasoline retailers consistently lost money in 2008 when prices spiked over $4. It is not a business I would want to run.

For the coming week we will see the headline blast once prices move over $3.50 and like it or not that will cause demand destruction. For me it has already caused me to visit restaurants closer to home and combine more stops into fewer trips and I canceled plans to attend a trade show with a 65 mile round trip. My car gets 15 mpg and I could easily afford the gasoline but it is a mindset that begins to appear when prices rise. I paid $3.29 on Friday (21.9-cents mile), up from $2.65 two tanks ago. (17.6 cents) That means the 100 miles I did not drive last week would have cost me a whopping $4.27 more at current prices. Obviously an additional $4.27 for 100 miles of driving is not a meaningful increase for me. However, the sticker shock at the pump altered my mindset and I consciously changed my driving in a minimum way. It was not the actual extra cost but the perceived extra cost at the pump that subconsciously changed my driving habits.

Now, project this over the 238 million drivers in the USA. This is how demand destruction works on a large scale. Once the civil unrest in the MENA countries passes and production of Libyan light crude resumes the prices will come back down. I seriously doubt they will return to pre crisis levels at $84 but they will drop significantly. Drivers will see gasoline drop back under $3 and they will breath a sigh of relief and resume their normal routine.

That scenario works as long as there is enough light sweet crude around to meet demand. Once that demand can no longer be met with everyone running at full production we will see an entirely different demand destruction process because there won't be a post crisis bump in production. It will be a scenario where higher prices are followed by even higher prices. The only price declines will come when enough demand is destroyed to create a material drop and allow a surplus of oil to build up in the supply chain. Once demand begins to rise again the scenario will repeat. However, demand will NEVER reach its prior highs again. Every time prices rise and fall the recovering demand will be less than the prior demand because people will be making alternative arrangements, changing vehicles and altering their driving habits.

An OPEC consultant told me that OPEC expects demand to slow and eventually peak before peak oil actually arrives. They believe the progressively higher prices will modify demand patterns before they are forced to moderate by the actual peak in total oil production. Of course peak oil to OPEC members means the peak in production in all types of oil. That peak will hardly be noticed because light, sweet crude, the kind we refine into gasoline, will peak first. This Peak Sweet™ event will cause prices for gasoline to rise to the point where demand will decline sharply and the energy recession to accelerate.

Enjoy paying $3.50 for gasoline next week because I guarantee most of us will be paying significantly more over the next couple of years. We will look back on $3.50 gasoline as "cheap" gas.

Jim Brown

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The OilSlick Newsletter is based on the expectations for global oil production of light sweet crude to peak and begin to decline in the 2012-2014 timeframe. I am calling this "Peak Sweet™" instead of Peak Oil. This is the point where global production of conventional light sweet crude supplies can no longer be supplemented by enough oil sands production, deepwater oil production, biofuels and natural gas liquids to offset the decline in existing fields. The roughly 6% annual decline of existing production due to depletion is larger than the rate of new discoveries and new production being added each year. The Peak Sweet™ countdown clock is ticking and time is growing short. Peak Oil will arrive shortly thereafter. Are you prepared?

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