Bill Schmick, a Berkshires investment adviser, is a student of global markets — and author of a weekly financial affairs column in The Eagle. We asked him to give us his forecast on today’s eye-popping oil and gas prices.
Yes, he thinks the world price of crude oil can and will go higher.
And, no, he doesn’t believe gas prices will fall any time soon.
Q: Bill, how many different factors play into today’s gas prices?
A: Inflation, refining costs, transportation costs, production, marketing costs.
Q: How much is the war in Ukraine to blame?
A: At the outset of the Ukraine war, oil was trading at $100 a barrel. Since then, the supply and demand imbalance has gotten a little worse, so maybe $20 per barrel or so is attributed to the war.
Q: Why was oil at $100 a barrel this winter? Is this the inflation thing?
A: Oil reached $100 a barrel this winter due to inflation, and reduced output by OPEC and after the demand destruction caused by the pandemic. The re-opening of the global economies caused a huge surge in demand for energy that producers could not accommodate.
Q: To what degree is price-gouging to blame for gas and diesel prices here in the Berkshires?
A: Price gouging, while a popular subject in times of high prices, has little impact, since energy is not a monopoly but subject to a lot of competition. Oil companies and gas stations know how others are setting prices and they adjust prices to match competitors. The risk in raising prices or maintaining higher prices is low when everyone is doing it.
Reducing prices, however, before the next guy does it could cause you the business. Besides, price gouging is very hard to prove and gas stations know it.
Q: Why do gas prices seem to rise quickly, but fall slowly?
A: While the published price of oil may fluctuate quickly, it takes price declines a long, long time to make their way to the pump. Part of the explanation may be attributed to the limited supply or scarce inventory of gasoline. In California, for example, environmental standards are costly and add to refining costs.
Another factor is that people in general need to drive back and forth to work every day – and so they can’t really protest sticky prices by searching out the cheapest gas station. That reduces the competitive pressure to keep prices as low, if not lower, than the next gas station.
Still another factor is the marketplace. When oil prices spike and then drop rapidly, gasoline sellers have no idea whether the decline will be permanent. Usually it is the opposite.
Q: In 2008, when gas prices hit $4 a gallon, West Texas crude was selling for $130 a barrel — about $10 more than today. So why are we a dollar per gallon higher on gas prices now?
A: A month or so ago, West Texas Intermediate, as it’s called, dropped to $90 a barrel from $120. Now it trades at $122. Tomorrow it may fall by $5 a barrel – for a day, a week or a month.
In a situation like we have now, with an imbalance between supply and demand, most traders would expect the price to recover but continue to go higher.
The uncertainty is such that gas pump prices will remain high until a time when station owners and oil companies can with certainty reduce prices, confident that prices will remain down for the foreseeable future.
The answer to why gas prices are higher today than in 2008 is simple: The dollar is worth less today than it was in 2008.
Look at the price of a Big Mac, for example, or what you paid for your Netflix service.
Q: Did President Biden’s release of oil from the Strategic Petroleum Reserve help curtail price increases?
A: The release covered a few days’ supply of oil consumption. Political ploy.
Q: So, not a good move to release that oil for sale?
A: At this point we are down from 36 days of supply in the Strategic Petroleum Reserve to 29 days of
How low is the government willing to let that fall? Traders know this – and are watching this carefully. Will the U.S. be forced to go out on the open market and buy oil in the future, at even higher prices, to refill the reserve?
This dilemma acts as a “put” on the price of oil until this situation is resolved. A put on the price of oil is the belief that at some lower level of the oil price, the Strategic Petroleum Reserve will come in to replenish their reserves, thereby supporting the price of oil from going lower.
Q: OPEC recently increased production. But some analysts say rising demand from China will offset that. Do you agree?
A: Yes, I agree. As China demand comes back, prices should rise even higher, offsetting the increase in supply.
Q: A key OPEC member said this week that oil prices are “nowhere near” their peak. How high might they climb?
A: The Street is talking about oil prices reaching $150 a barrel. Could we hit that sometime this year? Yes. However, while it may make a good headline, the chances of oil remaining at $150 a barrel for more than a few days is remote, in my opinion.
Q: Will it take a recession, and a sharp drop in demand, to see gas prices fall?
A: Oil prices will fall when a few things happen. One: A concerted increase in production which can only happen as new investment develops additional energy properties and production increases. That will take several years.
Two: Demand for oil must fall. So yes, the easiest, fastest way for that to happen would be a recession.
Third: Alternative non-fossil fuels could continue to replace oil and gas. But, once again, you are talking years.
Q: What are other aspects of the supply problem?
A: It’s a myth that what we need is another big oil discovery, or for OPEC to simply pump more oil.
Why? Oil needs to be refined and the U.S. does not have the needed capacity to refine raw crude into refined distillates such as gasoline and heating oil.
The reality is that we had 250 refineries in the U.S. in 1982 and by 2019 the number dropped to fewer than 150 refineries. Distillate capacity peaked in this country in April 2020 at 19 million barrels a day. This April, that number dropped to 17.9 million barrels a day.
Even if we had more oil today, we do not have the capacity to refine it. We have not built a new refinery in this country since the 1970s. A new refinery would cost billions of dollars and take 10 years to be up and running.
And that is if we had the engineering skills and expertise to build one, which we don’t. It will require retraining and the political will to build refineries in a country that pledges to uphold the principle of “not in my backyard.”
Bill Schmick, a registered investment adviser, is a partner with Onota Partners Inc. in the Berkshires. He can be reached by phone at 413-347-2401 or by email at firstname.lastname@example.org.