Energy Source with Sharon Epperson

Guest Blogger Tom Kloza: Why Oil Prices Are Going So High

Chief Oil Analyst, OPIS
Tom Kloza

This post is from guest blogger Tom Kloza. Tom is Chief Oil Analyst at OPIS (Oil Price Information Service) and has his own blog.He has been writing about downstream oil markets since 1975 and was among the founders of OPIS over 25 years ago.

Within the next few days, America will cross a benchmark that I thought to be possible, but not necessarily probable this Spring. Well before Memorial Day weekend, U.S. motorists will spend more than $1.5-billion per day on gasoline.

Today’s back-of-the-envelope estimated bill, calculated against a national average price of $3.787 gal, is $1.486-billion. When we get to $3.82 gal nationally, we’ll cross $1.5-billion. That level is a virtual certainty based on recent wholesale price advances. It may even occur this weekend.

How does this compare to previous years?

The per diem charges Memorial Day last year saw motorists pay about $1.285-billion. In 2006, the cost was $1.122-billion; and in 2005, it was $832-million. If one goes back to 2002, the daily cost of gasoline was about $534-million. Before prices top out, we could be making $1-billion more per day in gasoline payments than we made six years ago.

The Crude Fraternity
One of the highlights of my life was the time I spent as “Prytanis” when I headed up a college fraternity. Our group made Delta House (from the movie "Animal House") often look like the Vienna Boys Choir. One might say we stretched the limits of crude behavior, with antics that ranged from the tame (relay races with cinder blocks) to the sensational (we stole the Punxsutawney groundhog one year and put him on ice in our freezer).

A different kind of crude fraternity has emerged this May. First, Goldman Sachs told the world that the chances of a superspike to $150-$200 bbl were quite good (see my Superbad post from May 7, 2008). Then this week, a couple of new pledges joined this not-so-exclusive fraternity. Comments came from the top commodities’ analyst at JP Morgan (the investment bank, and not the Gong Show judge) as well as the UBS analysis team.

This just in: Goldman today revised its forecast for the average price of crude in the second half of 2008 to $141 bbl.

I suspect that this fraternity will soon find many new members, but I have opted not to join for now. I still believe that world demand for crude is not exceeding supply, but maintain that paper demand for paper oil contracts is the primary culprit behind the surge.

Speaking of Paper Markets
This week saw Congress easily pass a bill that would keep a lid on additions to the Strategic Petroleum Reserve (SPR). A separate bill would swap out some expensive sweet crude in the SPR and replace it with cheaper sour heavy crude.

I have ambivalent feelings about the SPR. My instincts have suggested from day one that taking a potential SPR sale of crude off the table was a poor negotiating tactic by the Bush administration. Regardless of whether one believes a SPR sale that might temper prices is appropriate, or effective, one would think that a posture that keeps all options in play would seem to carry much more leverage.

But the paper world of oil has swelled to many many times the size of the physical oil world. And, I’m not talking about the dark markets, where oil and other commodities trade in over-the-counter arenas where there is little regulatory scrutiny.

Paper trading in the visible universe, and in particular on the New York Mercantile Exchange, continues to expand in explosive leaps and bounds. Consider that yesterday, we saw more than 500,000 futures’ contracts change hands for June and July WTI (West Texas Intermediate) crude. Since each futures contract represents one thousand barrels, that transaction number calculates to 500-million barrels of crude trading for just two months in one 24 hour period.

The SPR has about 702-million bbl of crude in salt dome storage in Louisiana and Texas. So on Thursday alone, the paper markets traded a volume that represents nearly three quarters of the barrels stored in the domes.

We added 700,000 barrels of crude to the SPR last week. It literally takes less than a New York minute to trade that much oil on the NYMEX these days.

In case you missed it, the Consumer Price Index (CPI) released earlier this week said that energy costs were flat on a seasonally adjusted basis. Huh? What’s that?

I’ve mentioned before that the folks at the Energy Information Administration (EIA) have my utmost respect. They do great work in gathering most of the data sets for U.S. refining, supply, and to a lesser extent, downstream demand.

But perhaps the Department of Labor (which releases the CPI) recruited their data gatherers from FEMA. Our own data, which follows well over 100,000 specific sites throughout the country shows that gasoline prices are up 40 cts gal in the last month, with diesel and jet fuel up 36-40 cts gal. And there is more to come, so do not assume for one moment that inflation is under control.

Questions?  Comments?