Pumped-up prices: $4 per gallon gasoline may be coming in 2010

Has this been a trying decade for the average American, or what? It's bad enough that we've have had to cope with stagnant wages and tax increases at just about every level. But in the months ahead, we may have to deal with yet another nightmare: surging gasoline prices.

Factors are lining up that could end up pushing gas prices back over $4 per gallon sometime next year. If you're already exasperated about prices at the pump, you're not the only one. Gasoline demand in 2009 has been comparatively low -- take 7.6 million Americans out of the workforce through layoffs -- yet gasoline's price has gone up, not down.
It's risen about 20 cents per gallon in the past month to a U.S. average price of $2.65 per gallon for unleaded regular, according to data compiled by gasbuddy.com. This, when we're heading into December and the winter season -- a time when gasoline demand historically has been at its lowest.

Gasoline demand down, but the price is up. What's going on here? Well, part of the reason is the price of oil, currently around $80 per barrel. Oil -- boosted by the weak dollar and by likely increasing global oil demand during the economic recovery -- has essentially doubled since hitting a post-leverage boom low of about $35 per barrel a year ago.

The other part concerns the business of refining and the nation's refinery system. With oil prices high and gasoline demand low, the "crack spread" -- basically the difference between what refiners pay for oil and the total revenue received for products created from a barrel of crude -- has been low. That's prompted many refineries to reduce capacity: if a refiner can't earn a decent profit refining crude into gasoline (and other products), the company stops refining it.

According to U.S. Energy Information Agency data, refinery capacity utilization was at 80.6% for the week ending Oct. 30, compared to 81.8% for the week ending Oct. 23. Even allowing for normal, seasonal maintenance that decreases refining output, capacity utilization, in normal times, would be closer to 90%. That reduced refining activity also has helped boost gasoline's price.

But the real problem with the above concerns the gasoline market's condition when demand ramps up for seasonal (summer driving) and cyclical (at some point, the U.S. economy will start creating jobs) reasons. Assuming oil prices remain at a high level ($70 to $80 per gallon), rising gasoline demand will cause prices at the pump to jump about 40 cents to 50 cents per gallon.

The spike could be larger in high-cost metro areas like New York, Boston, Los Angeles and San Francisco. A $3.25 national average for unleaded regular would occur in short order.

And there are more-sobering scenarios. Patrick Kerr, managing director of Amerifutures, a commodity and options broker, told DailyFinance Wednesday that $3.25 per gallon could prove to be a low price in the quarters ahead, if the factors he argues are boosting gasoline prices remain in place.

Kerr said six factors are likely to continue to put upward pressure on gasoline prices in the U.S.: 1) more weakness in the dollar 2) increasing oil demand in China, 3) no readily available vehicle fuel substitute for gasoline in the U.S., 4) geopolitical tension, 5) inelastic gasoline demand in the U.S. (people can reduce gasoline consumption only so much), and 6) a lack of new, more efficient refineries in the U.S.

"A $4-per-gallon price is possible by the end of this year, but I think we'll definitely see $4 per gallon in 2010," Kerr said.

The United States is heavily dependent on gasoline. Although alternate fuels are gaining market share, gasoline will continue to make up the bulk of the U.S. residential transportation budget. That points to the need to increase vehicle efficiency. Absent increased efficiency and conservation (reduced driving), consumers' disposable income will be reduced even more, which will act as a drag on U.S. gross domestic product growth.

Bottom Line: Any national economic policy that assumes -- or counts on -- low gasoline prices long-term is inherently flawed.
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