Gasoline prices are down - should we celebrate?
Gasoline prices across the United States are down; even in California where prices are typically at the highest levels in the country, it is possible to pay less than $2.39 per gallon. The cheapest states include the Midwestern states and Texas, where consumers can expect to pay less than $1.68 a gallon. The sharp reductions in the price of crude oil have a significant impact on the price of gasoline, but it is less than what one might imagine it to be.
According to the Energy Information Administration (EIA), the average price of gasoline in the US on 25 January 2016 was $1.856, which is $0.188 lower than it was a year ago. When it comes to the composition of regular gasoline prices (as at December 2015), crude oil accounts for 42% of the price, refining makes up 19% of the price, distribution and marketing makes up 17% of the price and taxation the remaining 22%. Diesel (as at December 2015) prices are comprised of 37% crude oil prices, 11% refining, 30% distribution and marketing and 22% taxation. It is clear that the cost of crude oil is significant and is the dominant factor in gasoline and diesel pricing.
For the most part, consumers will be welcoming cheap gasoline prices. In a relatively short period of time, prices have literally halved from over $3.50 a gallon to their current levels. Naturally, this places more disposable income in your back pocket which can be used for things like savings. The retail sector did not benefit as expected from increased personal disposable income in Q4 2015. Savings levels increased, but retail was largely flat. Cheap prices for crude oil are the norm nowadays and with plunging commodity prices across the board, nobody is quite sure where the bottom lies.
The beauty of declining oil prices is that it translates into discernible savings at the pump and that is easily seen by anyone who pays for gasoline. The savings that are generated in this way are substantial. On 30 July 2014 the price of regular gas per gallon in the US averaged around $3.51, and has steadily declined until 17 January 2015 when it was trading in a range between $1.97 and $2.14 per gallon. Thereafter the price of gasoline increased until mid-June 2015 when it was averaging $2.66 – $2.83 per gallon. Since then we have endured a seven-month period of declining prices to its present level at around $1.75 per gallon.
When the price of crude oil hit a 12-year low of $26.55 a barrel, consumers may have been celebrating, but oil companies and equity markets were reeling. There are several factors coming together to make it difficult for markets to rally in the face of crude oil declines. The strong USD is a disincentive to economic growth when emerging market currencies are facing increasing weakness. Dollardenominated commodities, like crude oil, sell less when the USD is strong. This is exacerbated by the fact that the Federal Reserve is looking to hike interest rates further in 2016. While nothing concrete is in the pipeline for March 2016, the statement released by the Fed on January 27 did not rule out the possibility of gradual rate hikes throughout the year.
Whether or not rate hikes come to pass is doubtful because recent economic data suggests that the US economy hit substantial weakness in Q4, 2015. The problem was an inventory build-up which was made worse by a rampant USD. With demand at multi-year low levels, businesses found it difficult to clear stockpiles of commodities like iron ore, copper, steel, crude oil, gasoline and others. GDP spiked by 0.7% annually and major cutbacks in free investment spending by energy companies is resulting in mass layoffs across the board. The Fed acknowledged in recent statements that US economic growth weakened recently, notably in Q4 2015. If the weakness in global commodity markets continues in 2016, the next rate hike will probably be pushed back until June 2016. Without trade and inventories, the economy grew at a rate of 1.6% for Q4, 2015. Crude oil prices are being further weakened by the reality that Iran will be engaged in sales of up to 500,00 barrels of crude oil per day. Already there are some 18 Iranian oil tankers off the coast with upwards of 12 million barrels of crude oil waiting to be offloaded. But there are several other things to consider in the equation, notably the following:
Oil and natural gas companies are losing money at a rate of knots and this is impacting heavily on employment numbers, peripheral industries, major averages and general investor sentiment.
Cheap oil can only continue as long as OPEC and nonOPEC countries continue to oversupply. That is unlikely since Russia and Saudi Arabia are already in negotiations. Most all analysts agree that the price of crude oil is going to increase toward the $60 level before the end of 2016.
China has been stockpiling substantial inventories of crude oil at current price levels; this is leading to high inventory levels which are not being cleared owing to low demand. Shale oil producers in the US have reported losses of $26 bln YoY for Q3 2015 and many analysts are likening what’s happening with crude oil to what happened with the equities bubble that burst.
Crude oil producers are now facing challenges of another kind, with debts that can’t be repaid as a result of falling revenues and profitability. To alleviate these stress factors, banks have to reassess their relationships with oil companies and negotiate more lenient terms. Just recently, Bank of America made $500 mln available for assisting struggling oil companies.