Who is to Blame For High Gas Prices?

With only the possibility of John McCain and Barack Obama, I would say that whose to blame for high gasoline prices has been the most played news story across every media network over the last month or two. The national average for gasoline peaked earlier this month around $4.11 per gallon or regular 87 octane and has recently come down to about $4.03 per gallon. This obviously is a stark increase from the price range around ~$2.50 that we had seen during 2006 and 2007. The issue becomes even more important than “just an extra” $2.53 per gallon as our economy and lifestyle are based on the consumption of gasoline for transportation. The biggest question on everyone’s mind is who is to blame and how can we fix the problem? Like many other questions concerning energy, the answer is not nearly as simple as the media would have you believe. Warning: The information you are about to read may be completely foreign to you as none of the 6 major media networks have ever reported truthfully on this topic in the past.

It must be the E&P companies, right?

Not as much as you would think. While it is true that the exploration and production companies have to make some profit, when you look at the numbers the results are not as horrifying as you may have previously thought. Let’s take a look at the profit margins of some of the larger E&P companies (all of the numbers are for the trailing twelve months):

* Apache Corp. APA – 29.95%

* Anadarko Petroleum APC – 3.78%

* EnCana Corp. ECA – 14.77%

* Occidental Petroleum OXY – 29.2%

* Suncor Energy Inc. SU – 17.98%

* Microsoft Corp. MSFT – 29.26%

Now its time to play the which one of the above is not an oil and gas E&P company game? If you guess Microsoft, you probably have a bright future ahead of you and I wish you my sincerest congratulations.

This is only one example, Goldman Sachs GS has a profit margin of 23.68% and Intuitive Surgical ISRG has a profit margin of 24.68%. Many of the energy companies actually have lower profit margins than companies in other sectors. They are not the ones that are charging you too much for the goods you rely on, they are just participating in the free market economy and helping you achieve economic satisfaction more so than most of the other companies in the world.

Well then it has to be refiners?

This is definitely the last person who is causing your wallet to thin. The refiners (excluding the major integrated companies that incorporate refining and marketing activities into their overall business structure) bring the least to the bottom line when compared to the other sub-sector of the energy universe. The problem with the refiners is that since they do not produce the oil, they are reliant on spot market prices for the input of their product. This difference is called the crack spread. The crack spread is the margin refiners make when the take a barrel of crude oil and “crack” it into another form, either gasoline, heating distillate, diesel, or a number of other products. Generally crack spreads are quoted in the 3:2:1 ratio, or 3 barrels of crude are cracked into 2 barrels of gasoline and 1 barrel of heating distillate. Recently the crack spread has been in a state of free fall as highlighted by the stock prices of Valero Energy Corp. VLO, and Tesero Corporation TSO falling more than 45% each while the rest of the energy sector rallied.

Gas station owners, thats it!

Unfortunately for gas station owners, they fall into a similar category as the refiners. They do not produce the gasoline, so their input prices are out of the control. Because there is a high level of competition and a bunch of stingy consumers, they are not able to raise prices as quickly as they would need to in order to maintain historical profit margins. More than 1,000 gasoline stations closed in the United States last year, many of which were actually losing money every time they sold you a gallon of gasoline because of the rate at which gasoline spot prices were rising over the last year and a half. You should expect more gas station closing through 2008 and maybe into 2009. The business has become so unprofitable that Exxon Mobil Corp. XOM has recently announced that they are planning to sell at least 2,500 of their company owned gas stations in the United States during the next year, mostly likely at steep discounts to their worth even 3 months ago.

What about the government?

If you read my article concerning McCain’s Gasoline Tax Holiday you would know that the government sponsored gasoline tax really has little to no effect on the price of gasoline that consumers pay at the pump. The government definitely has an indirect effect on the price of gasoline due to the current drilling policies. If all United States territory was opened, not only would the markets discount this news into the future and lower energy commodity spot prices but the supply that would come online within 2-3 years would cause the price to be pushed downward in the long run. There is also a counter argument that some day we may actually need those reserves for something truly important, not just saving you a few dollars per fill up. That type of ethical issue is one that is difficult to address because facts will not allow either side to be completely “right” or “wrong” no matter how long the topic is argued. I’ll let you make your own decision on that one.

Wait a second, it can’t be my fault can it?

Actually, yes it can. The unfortunate news is that we as consumers are the cause for almost all of the rise in gasoline price. It is not just “us,” it is actually consumers all around the world who are driving up the price. Because crude and gasoline trade on global exchanges, it is not just the United States thats affects the prices, contrary to popular belief. Increased demand from India and China as well as the rest of the developing world is one of the major factors contributing to the price inflation. For example, an American used 25 barrels of oil per year while the Chinese only use 3 barrels per person per year and the Indians only use 1 barrel per person per year. Gasoline prices could become really frightening if the rest of the world would demand even 25% of the consumption that we have grown accustom to over the past century.

Another important factor is worldwide inflation. Inflation rates are growing at historically fast rates around the world. The United States has year-over-year inflation growth of 5% (if you believe the government data which many experts are suggesting you should not), China is over 8%, Russia is over 9%, so on and so forth. With all of this extra money, it is easy to see that a good portion of the price appreciation is do to the fact that people have more nominal dollars to spend, even if each one is worth less and less every day.

Our modern American economy is so heavily based on petroleum products to function that there is only a certain amount of demand that can be destroyed at these low levels of gasoline prices (I know that sounds ridiculous to say, but bear with me). Children have to go to school and adults must go to work, no matter the price of gasoline. Use yourself as an example. Would you quit your current job because of gasoline prices? At what price would you consider quitting your job? At what price would you have no choice but to quit your job? For most of you, these numbers are going to be much higher than the current price of gasoline. Many of you would be shocked to believe that gasoline spending per capita is actually only half of the historical high percentage that was reached during the 1910s and the 1980s. Do not believe for any moment that gasoline prices cannot or will not appreciate from here.

So what can we do? Are we doomed?

We are not doomed. I for one am long on the idea that the United States will be able to innovate and solve this problem. The solution won’t come from the government, but from the free markets. Only time and extreme necessity can drive us closer to the solution, but I assure you that one day it will come. I will discuss the solutions in another later article, but you should not feel as if there is no hope for America because there most certainly is going into our bright future.

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