In recent days there has been much discussion in the press about what might happen to gasoline prices in the coming year.

Cognizant of the fact that retail gasoline is currently running nearly 30 cents per gallon higher than it was in January 2008 the year when prices topped out at a national average of $4.11 and that gasoline futures have risen by 30 cents a gallon in the last few weeks, there is reason for concern. Typical of the stories is one from the Los Angeles Times that quotes Tom Kloza, long-time chief analyst for the Oil Price Information Service and the go-to guy when one needs numbers and forecasts on gasoline prices.

Kloza notes that for the last decade gasoline futures prices, which ultimately determine pump prices, have risen from an autumn low to a spring high by an average of 83 percent. During these years, the annual winter-spring price surge has varied anywhere from 52 to 169 percent making higher prices by summer a fairly sure bet. This year the 2011 low for gasoline on the NY futures market likely will turn out to have been $2.44 a gallon on November 25. If one does the arithmetic using the average price jump of 83 percent, futures prices could be expected to top out in the vicinity of $4.46 a gallon next spring. Adding in the additional 60 cents to get the gasoline taxed and to the nozzle of your pump, we could theoretically be paying a national average on the order of $5.00 a gallon before the 4th of July. This of course assumes that nothing bad happens in the Middle East that restricts or seriously threatens the flow of oil exports and sends prices much higher.

The $5 scenario is too much for Kloza so he settles for a fall-to-spring increase of only 40-45 percent this year which has pump prices topping out between $3.90 and $4.25 a gallon. An increase of only 40-45 percent, of course, would be the smallest winter-spring price rally in this century, but $4 a gallon is something the average American has seen before and can comprehend – forecasting $5 gasoline for six months from now is simply not acceptable considering the economic and political havoc it would be likely to cause.

If the price spike of 2008 obtains, $4+ gasoline is the breaking point for many Americans. Driving will drop, new car sales will plummet, trucks and airplanes will be parked, and with them a big piece of the American economy will grind to a halt. Four years ago, the drop in gasoline consumption was so sharp that it sent prices down $2.40 cents a gallon to an end of the year low of $1.65 thereby freeing up billions of dollars that were going into gas tanks in July and saving the economy from much more serious trouble.

A lot has happened in the past four years that will affect gasoline prices in 2012 so this year is unlikely to be a repeat of 2008. Europe and the Middle East are coming unstuck and at this stage, it is impossible to say which will have the most influence on prices. A European recession will moderate the demand for oil and possibly spread the contagion over much of the world. An interruption of oil supplies from the Middle East would instantly send prices higher to much higher depending on the nature and duration of the interruption.

We also have a looming refinery problem in the U.S. and Europe coming up this summer. As demand for gasoline has dropped, refining has become less profitable, causing refiners to shutter or if possible sell some of their less-profitable refineries — some 2.6 million barrels a day (b/d) of refining capacity has been closed in the advanced economies. In Europe, the continent’s largest independent refiner is shutting down three refineries halting about 250,000 b/d of refining. In the northeastern U.S. however, the situation is much worse. Three large Pennsylvania refineries, which can refine 550,000 b/d and which constitute half the refining capacity on the East coast, are for sale. Two have already been shut down and the third is due for closure if a buyer cannot be found. While this loss of US refining capacity can be made up by increased shipments of refined products from Europe and the Gulf Coast, there will likely be added costs and delays that could result in shortages and higher prices.

Short of a supply disruption, it is hard to imagine U.S. gasoline prices going to $5 a gallon this year, although $4 looks like a good bet. The economic and political turmoil that would ensue as gasoline climbed beyond $4 without any obvious cause would be unprecedented. With the US in the midst of federal elections, pressure on the administration to do something as more and more people were forced out of work would be unprecedented. The same sort of demagogy that we witnessed four years ago would be out in force with politicians blaming speculators and environmentalists for the problem and demanding releases of oil from strategic reserves and the removal of restrictions on drilling.

High gas prices are the remedy for high gas prices. As they did before, consumers would cut back on consumption, but this time it is different as much of the "fat" (discretionary travel, recreational driving by teenagers, etc.) has already been wrung out by the weak economy. U.S. oil consumption is currently down about 2.3 million b/d since 2005. Wringing out the next 2 or 3 million b/d is going to be much more painful especially if the cuts have to happen in weeks or months rather than decades.

Although rarely admitted, it is obvious in hindsight that the $2.40 a gallon plunge in gasoline prices during the second half of 2008 played a major role in keeping the recession relatively mild as compared to what happened in the 1930s. It is difficult to see prices falling this much after the spring run-up this year. There is simply too much Arab Spring in the air that will continue to add risk premiums to oil prices even if the various confrontations do not worsen.

Originally published January 10, 2011 at Falls Church News-Press

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