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- Phil Flynn

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June 12, 2007

Get daily research letters from Phil Flynn of Alaron Energies

Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide. Now you can get this highly sought after analysis with your daily research newsletter from Phil Flynn. Learn more about this complimentary offer and sign-up today.

There is joy in Mudville and other cities and towns across this wonderful country of ours. America, a country that is connected by super highways from sea to shining sea, is reveling in a bonanza that has put a smile on the face on every driver from coast to coast. From Wall Street to Main Street and on just about every street in America, we are singing out with glee and are just giddy about the recent drop in gasoline prices. Gasoline prices that have surged week after week since mid January have finally dropped 8.1 cents last week to finally give Americans some relief. Some have even gone as far to infer that our long national nightmare of rising pump prices is finally over. Americans have never expressed so much hope, optimism and excitement for paying a national average gasoline price of over $3.08 a gallon. I don’t want to ruin their mood by reminding them that prices are still up 91 cents from the beginning of the year. But why ruin the mood? Paying $3 a gallon for gas somehow never felt as good.

Of course for traders of gasoline or RBOB as the contract that tracks gasoline is called, it raises the larger issue as to whether or not the price of the future has indeed topped. There is no doubt that we have seen a large correction from the spectacular RBOB high of $245.50 set on April 30th of this year to current levels around $215.00. Some would say that is evidence that the current downtrend in price will continue. Some say chart formations are topping and many expect that better days are ahead. Yet as we look forward, are all the fundamentals on gasoline really pointing to lower prices in the next few weeks? Have all the problems that drove prices to record high prices at the pump been solved?

We have seen gasoline supplies increase over the last few weeks and the joy of that increase has pressured RBOB prices. And because the price of gasoline has dropped many are saying that the top is in and the good old days of gas guzzling have returned and its back to letting the good times roll. In fact the way people are getting all excited you might think that gas fell to a buck and a half a gallon. But the national average for gasoline is still about $3.15 a gallon. How did we get to this point? And for traders of gasoline is this the time to sell the market or is this latest correction another buying opportunity?

Of course the reason for the price spike in the first place was rabid demand and the lack of spare refining capacity. This year has been the worst in recent memory when it comes to refinery runs and gasoline production. It seems refineries are breaking down at an alarming rate. Last week the Department Of Energy Reported that refinery runs have come in at a dismal 89.1 percent, which is far below what is normal for this time of year. Refiners normally should be running at 93% to 95% of capacity. Gasoline production in this country is averaging 9.2 million barrels a day compared to a daily average consumption level of 9.5 million barrels a day. That is a concern but it is a larger concern because gasoline inventories are running at 201.5 million barrels of supply. Optimally you would like to see inventories at about 215 million barrels. Last year with less demand gasoline supply was at 214.3 million barrels of supply. That puts the forward demand cover at a historically low 21 days for this time of year. What that means is that gasoline supply is more vulnerable to a price spike than at any time last year. The only reason gasoline prices have been able to rise is that imports have been coming in at a historically high 1.5 million barrel of oil a day. But can that continue?

Demand in the world is rising. Despite lower crude prices in the US world prices of oil are rising. Once again the IEA admitted that they had underestimated world oil demand and upped its demand forecast. This time the IEA says that world oil demand will grow to 1.7 million barrels a day which was up about 200,000 barrels a day from its previous forecast. The IEA cites higher than expected demand in Indonesia, Yugoslavia, Venezuela and Singapore and continuing violence in Nigeria. They might also want to point out that the US economy seems to be bouncing back a bit stronger than expected and that should foreshadow increasing demand.

The IEA is warning OPEC not to be complacent on production and despite the fact that world oil inventories rose by over 9 million barrels in April OPEC would have to increase production by more than 200,000 barrels a day to stop them from falling 1 to 1.5 million barrels in the third quarter. The IEA warns that could push the forward stock cover towards the lowest levels seen since prices spiked in 2004.

Iran joined Saudi Arabia in saying that OPEC saw no need for a production increase so if the IEA is right or if they are just underestimating demand again, the oil market should be getting ready for another run. OPEC fearing the competition from bio-fuels has chosen to dismiss the warnings from the IEA and for RBOB traders that is in and of itself very bullish! 40 to 50% of the cost of a gallon of gasoline is dependent on crude prices. If crude supplies are going to become tight then the RBOB most likely has a price floor.

If Americans believe that $3 per gallon gas is a good deal, then the chances of U.S. gasoline demand hike is even more of a distinct possibility.

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Now it’s obvious that the growing US dependency on gasoline imports is a swelling vulnerability that could cause a price spike at any moment. As we said before the market has a solid floor and the upside could be huge if we have the right type of event. One not need to be reminded that hurricane season has just begun and the geo-political situation is questionable at best. And with the American consumer easily adjusting to a new world with gas prices above $3, a spike to $4 may be what it takes to slow demand.

The Department of Energy also warned that the recent drop in prices could be short lived as the majority of the summer driving season is still ahead of us. The truth with RBOB is that the recent sell off is a correction in a very strong bull market. And gas of another flavor looks interesting as well.

The natural gas has been holding its own despite large supply injections. We are looking for the market to feel the vulnerability of this market as well if Mother Nature plays any cruel tricks. Mother Russia may decide to play a cruel tick as well. The Financial Times is reporting that the UK Supplies are threatened by shortages in the next decade as electric companies build more gas power stations and domestic gas production declines, according to a report commissioned by the industry. And as a result, gas prices are likely to rise well above where they are today. The Warning comes as EON in the UK warns that it has reached ‘Five minutes to midnight” in its effort to provide Britain with the electricity it will need in the next decade. And you thought that only the US had natural gas problems. In many ways Europe is more vulnerable to natural gas from a geo-political aspect than we are. With Russia moving to dominate the world energy supply and use its dream to use its energy as a way of yielding its power and influence around the globe risk premiums have edged higher in the natural gas market.

Which brings me to a very interesting article about Russia and energy in the Chicago Tribune written by Alex Rodriguez: “A new Klondike may be waiting at the top of the world, where geologist believe a quarter of the globe’s undiscovered oil and natural gas lies trapped within the rock strata underneath the ice-encased Artic Ocean.”

“It’s a trove of energy wealth that sits unknown and unexplored, a bonanza being readied for a rush of claims thanks in part to climate change.”

That’s right, Global warming. It seems that as the earth warms all of that energy under the Artic ice for many years could now be available to whoever has the technology and wherewith all to get it. And the Tribune says that in Russia a team of scientist is working to prove that energy is rightfully owned by Russia. And if they prove that claim it means that Russia will add about 10 billion tons of Artic oil and natural gas to their already vast array of natural resources.

And we are worried about $3 a gallon gas. It’s obvious that we have other things to worry about. The Recent correction in this bull market should provide opportunities across the energy spectrum and a good time to enjoy the good old days of $3 a gallon gasoline.

Get daily research letters from Phil Flynn of Alaron Energies

Phil is one of the world's leading energy market analysts, providing individual investors, professional traders and institutions with up-to-the-minute investment and risk management insight into global petroleum, gasoline and energy markets. Phil's market commentary, fundamental and technical analysis, and long-term forecasts are sought by industry executives, investors and media worldwide. Now you can get this highly sought after analysis with your daily research newsletter from Phil Flynn. Learn more about this complimentary offer and sign-up today.