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Get Ready For Higher Gasoline Prices

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Get Ready For Higher Gasoline Prices

The national average for gasoline hit a record $3.41 on Thursday. Can it actually go higher? Crude hit a new record of $115.54 on rumors of supply disruptions and expiring Nymex crude options. Will it continue higher as well?

The answer is yes on both counts. Crude may correct at any moment now that the options have expired but we also have crude futures expiring next Tuesday. The CFTC said the open interest for crude contracts rose 40% in the last two weeks. That is a phenomenal number and can only be due to increased speculation or hedging. For whatever reason those same contracts will have to be closed by Tuesday so we can expect volatility to be huge. We could see prices at $110 or even $120 by Tuesday's close depending on how that open interest is closed. Either way gasoline prices will go higher but it is not entirely due to the price of oil.

Everybody has been hearing about gasoline going to $4 in May. Everyone assumes it is due to the price of oil but in reality driving demand in May is relatively light. With gasoline inventories just coming off 15-year highs why will gasoline prices go higher?

The answer is due to the different blends of gasoline needed in the summer. Gasoline will evaporate faster in higher temperatures and that contributes to smog and to greenhouse emissions. The EPA mandated many years ago that gasoline in summer had to have a higher evaporation point to avoid it turning into fumes in your tank and evaporate like crazy when you are fueling.

The gasoline evaporation rate is measured according to the Reid Vapor Pressure (RVP) scale. At temperatures around 100 degrees the evaporation point of normal gasoline is around 14.7 on the RVP scale. This is also different according to the altitude in the consuming region. The EPA requires refiners to blend other components into the summer gasoline in order to lower the RVP to something less than 9.0 or even 7.8 in some areas.

Refiners do this by adding things like Ethanol and removing components like butane. In the winter the refiners can add butane because it is a cheap filler and actually expands the volume of gasoline. Once warm weather arrives that butane component evaporates rapidly and you can actually end up with less gasoline than you actually bought.

Without getting too technical the winter gasoline blends are relatively generic. They can be used in almost any area and can be easily transported to regions that have low refining capacity. In the summer this is not possible. Refiners have to produce specific gasoline densities for each individual area they serve. Gasoline for one area may not be acceptable for use in another.

The EPA rules say the gasoline in the system must qualify under the summer guidelines on May 1st. That means all the winter gasoline must be out of the system by May. That could be tough to do this year with inventories coming off 15-year highs. This is also why refiners have only been putting the bare minimum amounts of gasoline into the system for the last five weeks.  To make it even more difficult the requirements change again on June 1st as the weather gets warmer.

The refiners make this switch to summer blends in March and April along with routine maintenance. They start producing summer blends in April and that gasoline has to go into the system behind the existing winter blend. Remember, it is also not generic like the winter blends. It is blended for a specific region and that is the only place it can go.

By removing the generic component the gasoline becomes essentially branded for that region. We all know how generic prescriptions work. They are always cheaper than the name brand. This is the same problem with summer gasoline. As the generic brand leaves the market the branded versions, blended with expensive components to meet the vigorous EPA restrictions for that region, the costs go up and it commands a higher price. As the cheaper generic gasoline already in inventory in April is consumed and replaced with the branded versions we get the biggest price increase of the year. Baring hurricane disruptions like we saw with Katrina, May is the most expensive month of the year for gasoline.

Jim Brown

OptionInvestor.com 

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