Crude Prices Soar: Will Gas Prices Follow?

Oil prices have jumped in the past few weeks, and that normally means higher gas prices are on their way.

WTI Crude Oil Spot Price Chart

WTI Crude Oil Spot Price data by YCharts

But the old norms in oil and gas haven't been holding true recently, and we can't automatically assume gas is on the way up. In fact, over the past few weeks we're actually seeing some relief at the pump. So is it only a matter of time before gas surges higher, or should we not be worried about high oil prices?

The good news
Some of the factors that have driven oil higher probably won't last. The Middle East is in the news again as civil unrest spreads, but if the trends of the past few years hold true, that scare won't last long. Plus, the U.S. has become an oil-producing powerhouse that can increase production when prices are high. Shale drilling, in particular, picks up when prices are high and fall when prices are low, acting as a stabilizer to the market.

It's also true that the rise in oil prices doesn't necessarily mean gasoline will be more expensive overnight because of the rest of the supply chain. Refining capacity has become the limiting factor to gas prices domestically and that is what drives prices.

Earlier this summer, high gas prices in the Midwest were blamed on two refinery shutdowns near Chicago. That helped keep gas prices elevated even when oil fell below $90 per barrel.  

So rising oil prices will have little effect on gas prices short-term, especially if they stay below $120 per barrel. But there are long-term challenges that should worry everyone paying to fill up at the pump.

The bad news
One of the reasons we're not feeling pain at the pump recently is that gas prices were already relatively high. As I mentioned, they stayed high in the spring because of refinery shutdowns, which exposes the long-term problem. The U.S. hasn't built a significant refinery since 1977, and refining capacity, not oil prices, are now the limiting factor in the gasoline market, driving prices higher when supply falls or demand spikes.  

In this respect, consumers get the worst of it no matter whether oil is rising or falling. We didn't see relief when oil fell, and if oil rises high enough we'll see costs at the pump go up. But I don't expect oil to directly affect gas prices until we reach $120 per barrel or so, which isn't far off at this point.

How to play it now
When oil prices go up and gas prices don't, it squeezes margins for refiners. So, after a nice run-up it might be time to take some profits in Valero (NYSE: VLO  ) and Tesoro (NYSE: TSO  ) , which generate most of their earnings from refining.

VLO Total Return Price Chart

VLO Total Return Price data by YCharts

A good way to play high oil prices is by buying the companies that supply equipment to the drilling industry. SeaDrill (NYSE: SDRL  ) and Transocean (NYSE: RIG  ) own rigs that are leased out in long-term contracts that can be for as much as $600,000 per day. They also pay lofty 8.5% and 4.6% dividends, respectively.

In The Motley Fool's "3 Stocks for $100 Oil" we go more in-depth into how Transocean will benefit from oil prices and reveal two others that will make investors money as oil prices rise. For free access to this special report, simply click here now.


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  • Report this Comment On July 14, 2013, at 7:28 PM, pdcorcoran wrote:

    Your article would have been more insightful if you had a look around during the last few days. In eastern Mass., gasoline prices have soared 20-25 cents a gallon during the past week.

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