Why Gas Prices Might Never Drop Below $3 Again

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According to AAA, gas prices have been over $3 per gallon for more than 1,000 days. The last time gas prices were below $3 nationally was the day before Christmas Eve in 2010. Bah, humbug indeed.  

Unfortunately, I think the trends are pretty clear that gas prices above $3 are simply here to stay. I see two factors playing a role here: Elevated oil prices and gasoline exports. Let's take a closer look how both are poised to keep consumers paying more at the pump.

Oil prices matter
U.S. oil production is booming. It's actually at the highest level in nearly a quarter of a century. Despite this, oil prices remain over triple digits. Given that about two-thirds of the price of gasoline is derived from oil's price, high oil prices form a higher base for the price we pay at the pump.

Oil prices aren't likely to slump as two major factors have fueled its rise. First, global oil demand continues to rise by about 1.5% annually. While supply is currently growing faster than demand thanks to production growth in North America, OPEC still really does control oil prices. It's rumored to be considering a production cut in order to keep global oil prices in the triple digits.

In addition to that, much of the supply that is coming online is higher cost. Oil shale plays like the Bakken in North Dakota can cost $10 million per well to drill. To justify those costs, drillers need high oil prices in order to earn a sufficient enough economic return. As an example, Bakken-focused driller Kodiak Oil & Gas (NYSE: KOG  ) needs oil prices in excess of $70 per barrel to earn a sufficient economic return on the $10 million it spends for its wells. The same can be said for the oil sands of Canada, these massive projects require high oil prices to be economical. Put it all together, and it doesn't appear that lower oil prices are in the cards, because as prices drop so will higher cost supply.

Exports will sop up the excess
At the same time, refiners like Valero (NYSE: VLO  ) and Phillips 66 (NYSE: PSX  ) with Gulf Coast refining capacity are exporting increasing volumes of refined petroleum products like gasoline to growing and under-supplied markets. Over the past couple of years the U.S. has actually made the dramatic shift from a net importer of petroleum products to a net exporter. Part of this is due to lower U.S. demand as we're both driving less while also driving more fuel efficient vehicles. This is freeing up gasoline supply that is being exported to places like Mexico and Venezuela.

Exports enable refiners to capture global demand growth while also maintaining high utilization rates for the refineries in operation. It's really about capturing returns that simply aren't available to them in the U.S. marketplace. That's why we'll continue to see both companies add to refining capacity over the next few years. It's that capacity expansion that will act as a headwind or at least keep the floor of gas prices above $3 per gallon.

Final thoughts
The likelihood that triple digit oil prices are the new normal should keep gas prices stubbornly above $3 per gallon. Add to that increased gasoline exports, and that pretty much seals the deal that we won't be paying less than $3 per gallon anytime soon. I do at least have some good news, now that the summer driving season is over, gas prices are at least expected to moderate a bit. Consider that an early Christmas present. 

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  • Report this Comment On September 20, 2013, at 11:06 AM, Schneidku40 wrote:

    Agreed.

    So why are refiners like VLO and PSX commanding such low P/E multiples?

  • Report this Comment On September 20, 2013, at 3:28 PM, TMFmd19 wrote:

    Well, exports are still such a small part and oil prices are still high so while margins have improved (especially along the gulf coast), they still aren't great.

    The other issue is that there is no real growth in refining (other than exports). So, it's just not a business that excites the market, hence the low multiples.

    Matt

  • Report this Comment On October 16, 2014, at 10:11 PM, progers001 wrote:

    "Matt DiLallo" faithfully keeping up the "fool" portion of the Motley Fool ;-)

    http://www.bing.com/news/search?q=Gas+Prices+Drop+Below+%243...

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