Why Gas Prices of Skyrocketed

Andy Waldock  |

The recent jump in gas prices were expected to be much more gradual. We saw commercial traders as strong buyers of crude oil below $80 as June came to a close. We firmly believed that this would be the bottom of the cycle as the national average fell to $3.30 per gallon. What no one expected were the simultaneous mechanical failures of some of the main pipelines and refineries. This has caused the price of petroleum products like heating oil, gasoline and diesel fuel to skyrocket by 25% in little more than one month.

The refineries here in the U.S. use about 9 million barrels of crude oil per day. The last two weeks has seen nearly 2 million barrels per day taken off supply as unplanned shutdowns due to various mechanical issues and fires have popped up across the country. Further adding to the refinery issues is a cutback in supply that will be coming from Canada due to a leak sprung in the Enbridge pipeline, which has spilled more than a thousand barrels of unrefined crude oil in central Wisconsin. Enbridge (EEP) has fallen under increasing regulatory scrutiny, as this is just the latest of a trail of pipeline failures. The most notable was a 2010 incident, which dumped 20,000 barrels of oil into the Kalamazoo River.

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Mechanically, major refiners near Chicago and San Francisco have both been shutdown. There are two refineries that have been shutdown simultaneously in the Chicago area and both of them are among the 10 largest refiners in the country with the Whiting, Indiana facility ranking 7th and the Wood River, Illinois facility ranking 10th. These outages combined to raise the price of gasoline in the Chicago area by more than $.44 in less than a week. The Chevron facility in Richmond, California is responsible for 10% of the gasoline production on the west coast. Reports are conflicted on the how long these refineries will be out of operation. Estimates range from weeks to months on each individual facility with consensus that the Chevron facility in Richmond will probably be out of service the longest.

Political and fundamental factions had already begun battling over the true value of crude oil from March through July. This is seen as the battle between speculators and commercial traders. Commercial traders had been heavy sellers of crude oil futures from March through May when the market was trading above $103 per barrel based on Iranian threats and general unrest in the Middle East, which led to speculative buying. These threats were competing with a market that was massively over supplied. Eventually, over supply won and the Commitment of Traders analysis generated sell signals at both $109 and $106 per barrel. June’s precipitous declines moved commercial traders to the buy side as they covered short positions and increased their positions by more than 30% during the month of June.

The final fuel to this petroleum rally is the expectation of further government stimulus to the economy. We’ve suggested over and over that the key to the upcoming election is the domestic economy and recent polls concur. The biggest thing President Obama could do to help himself would be to force a resolution in the Eurozone. The markets hate uncertainty and any conclusion to the drawn out death spiral of Ireland, Portugal, Spain and Italy would create a huge relief rally in the stock market. However, since his sphere of influence doesn’t extend far past our shores, he’ll do the next best thing by flooding the market with Dollars, which will lead to nominally lower interest rates and show that he is taking action.

Regrettably we will bear the unintended consequence of higher gas prices as our Dollar is devalued on the global market and our refineries find it more profitable to ship finished petroleum products overseas, rather than sell them on the domestic market.

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