Well folks it is that time of year again when gas prices are making headlines. Turn on the TV and you are sure to find a story on rising gas prices and what should be done to combat this phenomenon. Even President Obama has been addressing the issue to deflect any implications that his administration is to blame for the pain at the pump. The underlying fundamentals of supply and demand combined with speculative trading have driven prices higher. These same fundamentals and speculative trading will also cap the price rise and eventually bring prices crashing lower.
The main seasonal drivers for increased gas prices January through April are: shifts by refiners in their product mix percentage to an increase in distillates production with a decrease in mogas production and a shift in refiners production of higher winter RVP gas to lower summer RVP gas. Hedge funds are well aware of these supply issues with gas production and pile into RBOB futures and options pushing gas futures higher, which ultimately pushes spot cash gas markets higher.
These seasonal supply fundamentals have been exasperated this year by additional price drivers. Israeli/Iranian tensions, the closing of several refineries in the US, Caribbean and Europe and Nigerian crude production decreases, have created current and potential future supply crimps.
All of these forces coming together at the same time are creating a higher level of long speculation. At the same time sellers have become more fearful to sell positions. This has caused the futures and options markets to go into runaway mode, where normally patient traders who only buy on pull backs, are forced to buy whenever they get an inside trading day and are even buying on up days to make sure they get their long orders filled.
Traders have to keep in mind that the underlying demand for petroleum products are falling due to the worldwide economic slow down. Year-to-date, the first 40 or so days of 2012 have seen gasoline demand that is about 7% below last year, if you look at Energy Information Administration (EIA) reports. If you look at MasterCard data, you witness a year-on-year decline of about 5%. These are huge numbers for demand destruction. And, within this calendar quarter, crude oil output in North Dakota will surpass crude oil production in Alaska.
As world prices for light sweet crude advance above $120 bbl, the fear begins to shift to the buyers. They may perceive that this rally is getting long in the tooth, recognizing that global demand destruction takes place when crude prices are in a $120-$130 bbl range. When the fear of falling prices finally takes hold, crude futures are likely to take a quick elevator ride down $20 to $30.
