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Why Gasoline Prices Could Keep Moving Higher

Drought in the U.S. Midwest and rising tensions in the Middle East could keep upward pressure on gasoline prices this summer.

A worker pumps gasoline into a car.
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A worker pumps gasoline into a car.

Retail gasoline has been rising daily since late June, with the national average reaching $3.44 per gallon Friday, up from $3.38 the week earlier, according to AAA.

While still expected to ease in the fall, prices at the pump this summer will be higher than expected, in part due to the sharp jump in ethanol prices and rapid increase in crude prices, as tensions between Iran and Israel have once more increased.

Nymex crude gained 5 percent in the past week to $91.44 per barrel. Oil has risen in seven of the past eight trading days.

As the drought has driven corn prices higher, ethanol, made of corn, has also been on the rise. Spot corn rose above a record $8 a bushel in electronic trading Thursday. December corn futures, representing this year’s harvest, is up 24 percent this month, and was trading at $7.78 per bushel Thursday. (Track commodities here)

Ethanol has risen from just under $2 a gallon in the beginning of June, to $2.75, said John Kilduff of Again Capital.

“There’s open debate about whether or not the ethanol mandate will be suspended if things get much worse for the corn crop,” said Kilduff. The mandate, run by the EPA under the Clean Air Act, was signed into law in 2007 by President Bush, and also embraced by President Obama. Ten percent of every gallon of motor fuel is ethanol.

Kilduff expects crude to continue to reflect Mideast tensions, as the outcome in Syriais unclear. Traders have been concerned that the potential fall of the Syrian regime could be more destabilizing, since it is closely allied with Iran.

“Ethanol was contributing to a lower price for gasoline than we would have paid earlier in the year. Now that discount has disappeared thanks to higher ethanol prices,” said OPIS analyst Tom Kloza. He said gasoline could get back to the $3.60 level in August.

“If you measured it for the second quarter, at the beginning of the second quarter, ethanol was contributing to lower the fuel price by 10 or 12 cents,” he said. “Now it’s contributing to no real depressing impact at all…most spot gasoline is right in the same (price) neighborhood.”

The U.S. Department of Agriculture expects 4.9 billion bushels of corn, nearly 40 percent of this year’s projected total crop, to go to the ethanol industry, the biggest user of corn. Grain feed is second, expected to total 4.8 billion bushels. The USDA still expects this year’s crop to be one of the largest ever, but it has downgraded its projection or a total crop of 12.97 bushels.

Agriculture Secretary Tom Vilsack told reporters Wednesday that ethanol demand is not a problem now. “There is no need to go to the EPA at this time based not the quantity of ethanol that is in storage,” he was quoted as saying.

Andy Lipow, president of Lipow Oil Associates, said he believes about four to five cents of the recent rise in gasoline is from the jump in ethanol prices. Ethanol production had been cut back as industry margins suffered in the spring. “These guys just can’t catch a break. The price of corn has risen so fast. The ethanol price hasn’t moved up as quickly, so you see a number of ethanol plants’ profitability under pressure,” he said.

He said the EPA has never reacted to corn prices, and it a request to drop the mandate would have to come from elsewhere if corn prices become too high.

“You don’t have to worry about drought so much when you’re talking about petroleum prices,” said Kloza. “You have to worry about geopolitics and conspicuous consumption. But in agriculture, you do have to worry about a food versus fuel debate, and there will probably be a lot of disinformation there.”

Dennis Gartman, commodities analyst and editor of the Gartman Letter, said the total corn crop is likely to be less than 12 billion bushels, well below the USDA’s original forecast this spring for a bumper crop of 14.8 billion bushels.

“That doesn’t mean the ethanol mandate will be dropped,” he said. “They can’t talk about doing away with it during an election year.”

Ethanol has been a good source of revenue for farmers in key agricultural states, which are politically important such as Iowa, Ohio and Michigan.

Livestock farmers, however, are being severely impactedby the drought’s impact on grazing land and on feed prices. So it is likely meat prices will rise sharply as will foods made with corn, such as cereal and soda, made from corn syrup.

“We went from looking at the best crop in American history and the strongest farm community that we could have possibly imagined to something that is demonstrably weaker on all fronts,” Gartman said. Farmers planted the corn crop early this year, on a record number of acreage, when a mild, wet spring made for ideal conditions. At the same time, livestock farmers added to herds, expecting cheap feed.

Gartman declined to forecast how high corn prices could go. There is some expectations that it will cool off when livestock producers trim more of their herds, but some traders expect to see $9 a bushel or higher.

“All you can say is the trend looks to be from the lower left to the upper right, and it will continue until it stops,” he said.

Follow Patti Domm on Twitter: @pattidomm

Questions? Comments? Email us at marketinsider@cnbc.com

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  • Patti Domm

    Patti Domm is CNBC Executive Editor, News, responsible for news coverage of the markets and economy.

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