Tuesday, September 09, 2008

Pumped Up Prices

Investors will need to keep their assumptions of rising costs at least as far as fuel requirements. There is not likely to be much of a respite for business that include a heavy transport element in the business model.

A due diligence trip has taken me to the country’s heartland. My economy rental car is begging frequently for a fill up considering that gas prices are hovering around $3.75 per gallon for unleaded gas.

One good sign is that there is more E85 gas available than previously. The high octane mix of gas and ethanol appears to offer better gas mileage but is typically sold at the same price as straight-up gas.

Prices have moderated three to four cents in the last week, a paltry savings considering that crude oil prices have come down dramatically from the July 2008 peak in the high $140s.

It is said that a picture is worth a thousand words. That could not be more the case than with the two graphs below. The first is a graph of light crude oil prices during May to September 2008 provided by AMD Investor Services, Inc. with their Omega Research SuperCharts.

It is heartening to see the retreat to prices near $100 after that peak in July. Yet take a closer look at trading volumes. Those peak prices in May, June and July were achieved on very little volume, suggesting just a few players were involved in the oil market at that time. Trading volume has picked up as prices declined.

Even more interesting is the second graph provided by the American Automobile Association showing average prices for retail and wholesale gas compared to the price of crude oil. For comparability, all prices are shown on a per gallon basis. Although pump prices (shown on the green and red lines) appeared to track the rise in crude oil prices (shown on the blue line) all the way through the July 2008 period, pump prices have not fully respond to the drop in crude oil prices since then. We would expect a lag, but not the disconnection that appears to have taken place since the pullback in crude prices.

According to the AAAs most recent survey of local fuel prices, a gallon of regular gas was selling for an average of $3.668 across the country on September 9th. Crude oil closed at $103.26 per barrel. This compares to an average pump price of $2.814 a year-ago and price of $71.94 for a barrel of light crude oil used to produce that gas. Indeed, the all-important fuel of commerce - diesel - has pulled back only 3.7% in the last month, while oil has dropped back by nearly 20%.

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