Sunday, March 20, 2005

Gas & Oil: A View of the Future - Part I

Prediction can be among the most foolish of fool's errands. When I read that oil analysts were confident oil prices would be dropping this past week, I took note. After all, how could so many who know so much ever be so wrong? Well, what happened? Oil proceeded to go up by several bucks.

That notwithstanding, being one who is ever so slow to learn, I'm going to stick my neck out and gaze into that crystal ball myself.

From my regular reading about energy markets, the expectations for oil and
gasoline boil down to three scenarios. One, a view seemingly held by a diminishing minority, is that oil and gasoline prices will settle back to pre 2004 levels. Many in this camp, such as Brian Newbacher, of the AAA Ohio Motorists Association, are inclined to blame investor speculation for oil's rise to the mid 50's per barrel.

A second set of opinions, perhaps what's becoming the conventional wisdom, is that petroleum is going to remain essentially at the levels we've been experiencing for the past year or so.

The third outlook is for fossil fuels to skyrocket even more. You know, the talk of $90.00 a barrel oil and $3.00 or more for a gallon of gas.

Contrary to those who believe that oil is due for a colossal fall, it is becoming increasingly evident to me that the world is seeing a stronger and longer standing demand, pushing up against tight supplies. In other words, I think 2 bucks a gallon is here to stay. In the shorter term, say over the next six months, I envision an upsurge in costs, probably to the $2.30 per gallon level for gasoline as the U.S. national average. It wouldn't surprise me to see it hit $2.50. Of course, a change in circumstances, particularly on the demand side, could drive the price of oil far south, but I don't think that's going to happen.

Of course, fuel costs remaining elevated is not my original idea. Among others, it was posed by Jim Jubak of CNBC a while back. Jubak's assertion is seconded in ' The End of Cheap Oil: Cyclical Or Structural Change in the Global Oil Market?' a credible paper put out by the Middle East Economic Survey. Author Herman Franssen explains in detail the restricted growth in oil supplies and why they are likely to remain so. He goes on to elaborate upon a thirst for oil that has surged, to the astonishment of many in the industry, a shift that he tends to think is an ongoing, long term trend, not just a protracted blip on the charts.

Adding fuel to the fire, my conclusions, based upon the more or less technical analysis that I publish early each Tuesday - 'Gas& Oil at a Glance' - supports a climb in cost as well. Both the 'Gas to Oil Price Ratio' that I calculate, and the 'Spread' – what is paid for retail gasoline, after subtracting the price of oil - are at very low levels, relatively speaking.

If these numbers regress towards their historical averages, as I have to conclude they will, the only direction for gasoline prices is up. Also, keep in mind that when gas at the pump first hit $2.06 on May 24. 2004, the going rate for oil was only $42.03, some 14 dollars less than it is now.

Continue to Part II


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