There are many reasons (accusations?) being thrown around to explain the recent increase in gas and diesel prices. The usual suspects – speculators and greedy oil companies – are an easy mark for those who prefer sound bites over substantive analysis and explanation. Many experts are pointing to uncertainty abroad, such as Iran threatening to close the Straits of Hormuz, where 1 of every 5 barrels of oil pass through a narrow corridor, and Israel potentially striking Iran’s nuclear installations. There is a significant potential threat of disruption of oil production and transportation in the region. Domestic uncertainties include regulatory, tax, and environmental attacks on U.S. production, transportation, and refining. What is not getting as much press in the U.S. is the shutdown of two refineries in the Northeast that produced 20% of the gasoline consumed in the region. Sunoco’s refinery in Marcus Hook, PA (Feb) and ConocoPhillips refinery in Trainer, PA (Jan) were shut down due to financial losses and are both on the market. So much for excess profits at these refineries. Nobody is arguing that demand is outstripping supply and driving up prices. In fact supply has been growing and demand has been shrinking or flat through the recession and “recovery”. So why are prices rising?
Forbes produced an excellent article back in 2008 stating that most of the run-up in oil prices in that environment were a result of debasement in the value of the dollar, not measured by other currencies, but measured by its worth in gold. We have used this chart in our industry update presentations since it was produced by Forbes. The chart shows the close correlation between the price of gold and the price of oil between 1956 and 2008. This week, in another excellent article Louis Woodhill of Forbes states that “gasoline prices are not rising, the dollar is falling”. The author states that gasoline would have to rise another 65 to 70 cents per gallon for the ounces of gold per barrel of of oil to return to the long run average (0.0732 ounces of gold per barrel of oil) . Ouch! So far the vast increase in money supply created by quantitative easing (which sounds much better than printing money but has the same effect on money supply) has not led to unreasonable inflation. The concluding paragraph of the article is ominous. “During the 1970s, the toxic combination of a weak dollar, high tax rates, and onerous regulations introduced a new word into America’s economic vocabulary: stagflation. Reaganomics banished this word to the history books. Now, President Obama and Fed Chairman Bernanke are teaming up to give stagflation another try. It is not likely that Americans will like it any more this time around than they did 40 years ago.”
Lately, even the right is bashing the oil companies for causing high prices in the U.S. by exporting more refined petroleum products rather than selling them in the U.S. at a lower price. I came across an excellent explanation and rebuttal in the Consumer Energy Report. The article is titled “What’s So Bad About Exporting Gasoline?” The author, Robert Rapier, points out that fuel exports were our top value export in 2011 at $88 billion dollars. Don’t confuse that with energy independence. We import over 9 million barrels per day of crude oil and export about 3.1 million barrels of refined products per day. But this finished product has a much higher value per barrel than the raw product, so we are importing a raw product, putting people to work in well-paying refinery jobs, and exporting a higher-value product. What’s not to like? The alternative is not to keep the finished product here and sell it for less, since we already have enough finished product to meet current demand. High prices and heavily subsidized and mandated ethanol are dampening our demand for gasoline. The alternative is to shut down the refineries and lay off the workers. Sixty percent of our gasoline exports go to Mexico, the source of 10% of our imported crude. Oil companies are not shipping this stuff to China to drive up our own pump prices.
So will we see $5 diesel? The only thing we know for sure about forecasts is that they will be wrong. In January, The Federal Energy Information Agency said there is only a 6% chance that oil will rise above $125 a barrel and only a 25% chance of gasoline rising above $4. If it happens, EIS believes it would be during the summer driving season. Others predict much higher prices but skeptics point to a prediction by Goldman analysts in May 2008 that oil could hit $200 within six months, only to see it fall to $40 by the end of the year.
Political uncertainty won’t result in $5 diesel but real turmoil in the Mideast could lead to that level of prices. The fear of returning inflation also won’t lead to $5 diesel. The actual return of 1970’s style inflation would certainly lead to much higher fuel prices. Absent a real event, the current supply and demand environment does not support $5 diesel.
Finally, what are you going to do about it anyway? Whether diesel hits $5 or stays near $4 it makes sense to shift truck freight to intermodal where possible. It also makes sense to explore options for natural gas powered class 8 trucks in regional and dedicated operations. You should make sure your fleet and your carriers’ fleets are aggressively testing and implementing fuel-saving strategies. You need to look at supply chain network design to locate facilities in a way that promotes greater use of intermodal. Hedging? Smart hedging is not a gambling strategy of deciding to hedge only when you think prices are going up. Fuel hedging is a useful tool in improving forward visibility of fuel prices and smoothing out spikes. If you are hedging other commodities, a fuel hedging program may make sense but don’t rush into it trying to beat rising diesel prices.