Tuesday, September 09, 2008

Oil Prices Fall While Pump Prices Stay High

Oil prices have continued a steady decline as the US dollar has strengthened and hurricanes continue to miss the major oil platforms in the Gulf. Oil is down roughly 29% in just the past 6 weeks!!! If that changed had flowed through to the prices at the pump it would translate into an average price of $2.93/gallon from a peak of $4.11 in July (prices peaked around $4.35/gallon in NNY).

Unfortunately, as you drive around Northern NY you'll notice most prices are down just 10-12% (in fact this is consistent around the country), so what gives?

Well, the unfortunate fact is that we're paying now for the privilege of paying just $4/gallon of gas this summer. Historically, there has been a fairly consistent ratio between the price of gas and the price of a gallon oil Gas has typically cost roughly 2 to 3 times the price of gallon of oil (for the math freaks out there - there are 42 gallons of oil in a barrel). So when oil peaked at $147/barrel or $3.50/gallon if gas prices had stuck to historical norms we would have been paying $7.00 to $10.50/gallon for unleaded this summer. Even with oil at $105/barrel, gas should cost almost $5/gallon if these historical trends held.

However, the demand destruction that would have occurred at those levels would have had dire global economic consequences, so the commodity represented a greater portion of the cost of a gallon of gas and each participant in the gas food chain - refiners, wholesalers, gas stations, etc - saw their profit margins shrink dramatically. The cost of oil, state taxes and federal taxes represented 85%-90% of the cost of a gallon of gas at the peak. The refiners, distributors and retailers divided up the last 10%.

Refiners have seen their profit margins sharply cut during 2008 as a result of an in ability to pass through any higher prices.

However, given that US demand only slipped slightly with gas at $4/gallon, refiners see the current drop in oil prices as an opportunity to recoup some losses and improve their margins.

So, while the news remains good on the oil front for the very immediate future (I think we could touch $90/barrel before some people put an inflation trade on) don't look for much relief at the pump.

While it's easy to try to blame some one or a policy for the pain at the pump, the realities are that the complex and nuanced nature of the oil industry makes simple analysis difficult.


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