Pain at the Pump

by Justice Litle

As U.S. consumers and the world at large deal with pain at the pump, we are now seeing some modest post storm relief in energy prices. Crude futures have drifted lower approximately 10% percent, and gasoline futures roughly 20%, from their Katrina peaks.

Expectations are that demand will finally start to ease at current price levels, though it’s still unclear by how much. While U.S. consumers are cutting back on unnecessary driving as their discretionary income gets squeezed, a significant portion of demand is nonnegotiable: The American economy is built on a “commuter culture,” with many driving 20 miles or more to work. Similarly, the “big box” retail model lets us enjoy lower prices from the likes of Wal-Mart, Home Depot and Best Buy — but since few want to live near these places, we drive across town, or into town from the suburbs, to get there.

It has been said that the difference between Americans and Europeans is that Americans think 100 years is a long time, while Europeans think 100 miles is a long way. That may yet change.

In the bigger picture, U.S. oil demand has shown a 1.1% drop in August year over year, according the American Petroleum Institute. China showed a decline more than 10 times as large, with imports falling 11.7% for August year over year. Meanwhile, poorer countries, like Indonesia, are struggling to balance the rising cost of fuel subsidies, with the threat of political unrest if those subsidies are cut.

But while demand appears to be slipping, the crude decline is still more of a bottleneck story, as refiners find themselves backlogged with supply. Globally, they are running as close to full capacity as possible, as the “logistical nightmare” continues to unfold in the Gulf.

The shortfall in oil sales from the Strategic Petroleum Reserve highlights the bottleneck. Dow Jones reports:

“The U.S. government announced Wednesday morning it has sold 11 million barrels of crude oil from the country’s Strategic Petroleum Reserve as part of an international effort to mitigate supply disruptions in the wake of Hurricane Katrina.

“The volume of oil sold, however, fell well short of the 30 million barrels that were offered, an indication that refiners are generally well supplied with crude already.”

The outlook for refiners continues to be rock solid, as evidenced by the performance of Valero (VLO:NYSE). Valero was recently upgraded by Credit Suisse First Boston on expectations that margins would continue to be robust.

It’s not clear how much further crude might fall, but the “lack of slack” in the system will likely continue to put a floor under energy prices. The possibility of another supply disruption from some unknown quarter remains all too real, and global demand would likely have to fall sharply and swiftly for the current situation to change.

Editor’s Note: Justice Litle is an editor of Outstanding Investments. He has worked with soybean farmers, cattle ranchers, energy consultants, currency hedgers, scrap metal dealers and everything in between, including multiple hedge funds. Mr. Litle also acted as head trader for a private equity partnership, and made contributions to Trend Following: How Great Traders Make Millions in Up or Down Markets, a popular trading book by Mike Covel (FT/Prentice Hall)