For a brief time this morning, the price of June crude oil futures crossed the $40 level for the first time since the Gulf War in 1991. Ouch! Rising oil prices can't possibly be helpful for the story of a rebounding economy, can it? It must be some sort of conspiracy -- after all, this comes little more than a month after the OPEC cartel announced that it was reducing oil production by a million barrels a day. I should note that given the recent downdraft in the dollar, oil prices seem to have risen substantially here, but if you remonetize in euros, for example, the "spike" is much less severe.
The cost of raw crude feedstock is of course a component of what makes prices at the pump -- and all of the other places oil is used -- higher. But although I'd never want to be accused of carrying water for OPEC, it's not really their policies that have made oil prices skyrocket. It's demand, it's speculation, it's fear of further terrorist attacks on supply in the Middle East, it's the fact that we've put so many potential sources of domestic production off limits. All of these things have costs, and all of them get passed on to the end user.
And perhaps most importantly, it's a whole host of regulations and lack of refinery capacity in the U.S. that have caused such pain among consumers, among airlines, among shipping companies, and so on. This was the thesis I used two years ago in selecting Valero (NYSE: VLO) for The Motley Fool Select, the precursor to Tom Gardner's Motley Fool Hidden Gems. There hasn't been a new refinery built in the U.S. in the last 20 years, as site requirements have made it impossible. As a result, the refiners run constantly at close to 100% capacity. So the 3% increase in oil demand has to come from somewhere else, and that somewhere else isn't the cheapest. It never is, and with many of the U.S. markets getting ready to cut over to summer formulations, that supply will even be less available than at present. Thus, the higher costs.
So when you read articles about Americans' renewed love of horsepower in cars, and you see the Valero chairman commenting that this is the best environment he's ever seen for refining profits, you know that the refining bottleneck is ferocious.
It is generally a net negative for refineries for oil prices to skyrocket as it compresses margins. In this case, though, prices are high, and companies like Valero, ChevronTexaco (NYSE: CVX), and ExxonMobil (NYSE: XOM) have increased their refining efficiency. But it still isn't enough. Saudi officials have even pledged to offer money to invest in two new refiners in the U.S., but a poll of the major refiners already operating here will tell you something emphatic -- the money isn't the issue. And if Valero's figures are accurate, that volume demand continues to increase in spite of rising petroleum product prices at the consumer level. What does that tell you?
Basic laws of supply and demand tell me that the chance of oil prices coming down to OPEC "target levels" of $23-$28 any time soon are fantasy. It also tells me that those $40 tanks of gas I recently complained about may continue to be the norm. I'll think differently only when officials start getting serious about addressing the undercapacity for refining.
Bill Mann owns none of the companies mentioned in this article.
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