Tuesday, November 11, 2008

Cheap Gas is Back

Unfortunately I have the responsibility to admit that I was wrong about gas (and oil price) futures. My contention on September 16th was that oil prices had stabilized and the U.S. would continue to see gas prices in the $2.50 to $3.50 range for the foreseeable future. At that time oil was hovering around $90/barrel.

Oil prices have now fallen to below $60/barrel and the Diamond Shamrock at 80th and Kipling was advertising 85 Octane for $1.99/gallon. The model I used somehow fell apart. A new model is attached below which reflects crude oil representing 50% of current prices and also incorporates crude prices into distribution costs using the 60 factor. For example at $120/barrel, distribution costs would double. There is also a 10% demand x-factor included which would spike in the summer time and during other demand cycles.

While the world wide recession will certainly reduce demand for crude, I believe the current prices are as exaggerated to the negative as $140/barrel prices were exaggerated to the positive. In commodities there will always be hedgers and speculators. Hedgers will lock in current prices to smooth their income statements and speculators will bet on future prices in to make money on the difference in price between now and the term of the futures contract.

I do not believe current oil reserves and refining capacity will bring oil back to prices seen in the late 1990’s therefore, I am still long on oil, but have to admit that cheap gas has returned to the U.S. consumer and has created a mini-stimulus package.

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