Hurricane Update

There have been many predictions about what the price of crude oil will do as a result of Hurricane Gustav, which is expected to make landfall very close to where hurricane Katrina did. Gustav is also expected to make landfall as a category 3 storm (Katrina had been a category 5 but weakened to Category 3 before making landfall).

Idle Production
Currently, nearly all oil production in the area is shut in, with all personnel evacuated. According to Bloomberg, "96 percent of offshore oil output and 82 percent of gas production" is currently idle. The Gulf region produces a quarter of U.S. domestic oil production and 14 percent of natural gas production. Nearly all operations personnel have been evauated while many refineries and piplines in the area have also been closed.


A couple of days of reduced supply isn't enough to raise prices significantly. The large price spikes in 2005 were due to the damage in the aftermath of Hurricane Katrina that took months to fix, rather than these temporary shut-ins. It's also quite likely that this increased idling simply means oil producers are better prepared and less damage will ensue from the hurricane season this time around. Any production lost due to downtime and minor damages can easily be replaced with oil from the strategic petroleum reserve, which was intended for--and only capable of--replacing temporary and unforeseeable supply disruptions like Hurricanes (rather than to stabilize normal market price volatility, a purpose some people thought of it earlier this year).

Up Or Down?
Sixteen economists polled last week were split almost evenly three ways (I don't recall which poll). About one third said prices would simply fall after the hurricane passes. Another group said prices would remain about the same. The last third of these economic experts said prices could rise significantly. Prevalent Canadian economist Jeff Rubin of CIBC's World Markets thinks gas prices could hit $1.75-a-litre if this year sees "[a]ny replays of the 2005 hurricane season". Ultimately though, what happens will depend on Mother Nature (or global warming for those who speculate that this is the case). Many others think this scenario is unlikely.

Inflation Outlook
If the most active part of the hurricane season does create major disruptions to energy supply in the Gulf, the resulting increase in energy prices could kill the plans of the U.S. Federal Reserve Bank to hold rates steady this year. Ben Bernanke expects to see inflation moderate from an annual pace of 5.6% in July if oil prices remain relatively low compared to their all-time highs of $147-a-barrel. The Fed does not want to raise interest rates until some parts of the "financial storm" passes, which include the housing crisis and credit crunch, high commodity prices and a low greenback.

My Prediction
I'd say there are several indicators that show the markets are comfortable with a crude oil price in the $110-$120-a-barrel range for the next couple months, with some spikes possible. Even with a spike, a repeat of Katrina is unlikely and therefore the odds are that the price won't stray too far outside this range, up or down. It also seems like a stable and sustainable range as an OPEC official has said his organization will cut production if oil falls below $85-a-barrel (Iran has less clout but their oil minister wants OPEC to set this floor at $100); on the high end, airlines and car manufacturers start failing if oil goes above $150-a-barrel (Zoom airlines failed last week with oil below $120). My prediction also translates into gas prices in the range of $1.15 to $1.35 for the fall, depending on what the loonie does relative to the greenback.

Meteorologists are about as good as predicting the weather tomorrow as energy analysts are at predicting crude oil prices next week, even without a hurricane. It seems we'll just have to wait and see how these factors come together. At least the one certainty is that the loss of human life this time around won't be anywhere near as bad, assuming that lessons were learned from Hurricane Katrina.

Gas Prices

In May of 2005, I remember wondering how gas stations would display their price when it hits the century mark. A couple months later I was watching images of Hurricane Katrina on CNN. The damage to billion-dollar oil platforms in the Gulf was enough to push gas prices from 90 cents a litre to well over the century mark. At first, many gas station displays showed 00.0, but it wouldn't take long for gas stations to put in the capital and upgrade their signs to be capable of showing prices north of the 99.9 cents per litre mark. Apparently they realized these prices were the new norm.


Why are gasoline prices so high?
Crude oil prices.

The price of oil on NYMEX at the time of writing is $126 a barrel (May 9, 2008). That's about double the price a year earlier and will ultimately translate into an average gasoline price of about $1.32/L in Canada and $3.78/gallon in the U.S. (I expect prices at the pumps to be in this range entering the long weekend).

The chart below shows normalized crude oil prices compared to normalized gasoline prices in real Canadian dollars from January 1987 until May 2008.

large size

(you will need a Google account to access the source link)

As the chart shows, the price Canadians pay at the pumps has actually lagged quite a bit behind the crude oil price since 2004. The break is mostly thanks to the increased value of the Loonie compared to the Greenback (American gasoline consumers are not as fortunate in this regard).


What about price gouging right before long weekends in the spring?
This is probably due to speculative commodity traders. In anticipation of higher demand, they buy more oil and the price gets to consumers before the demand is actually there. An energy analyst I heard on CBC the other day said there is no evidence of any price gouging. I haven't seen any conclusive numbers myself that would either confirm or deny this claim.


Would boycotting gas stations help?
Yes and no. Reduced demand means improving the supply/demand balance and subsequently lower prices. But reducing demand doesn't seem to be the objective of the "boycott oil company X" initiatives I've seen on the Internet and in emails. This strategy will not work unless a significant number of people actually reduce demand and not just buy gas from somewhere else or wait until after the weekend to fill up. Toronto is the largest Canadian market and has the lowest gasoline prices in the country thanks to the so-called 'gas wars'. Torontonians pay even less on average than Calgarians who save about five cents per litre in lower provincial gas taxes. Smaller, more remote regions such as Halifax are amongst the highest in Canada. This is a pretty good indication that free-market competition forces are working as they should.


sourced from Natural Resources Canada



Can we petition government to put a cap on prices?
Sure we can. But I don't think this is a good idea. Part of the reason oil prices are so high is because of increasing demand from China, an emerging economic power that subsidizes its oil price to stimulate growth. China's economy can afford the higher price mostly because per capita consumption is only about 1/6^th of a barrel of oil per month. Here in North America, each of us use over 2 barrels per month. The approach makes sense for an emerging economy like China's but for the established economies of Canada and the United States it's an unsustainable Band-Aid approach.

In Canada, the taxes on gasoline at $1.25/L range from 25 cents to 40 cents depending on the province [detailed breakdown]. Most of these taxes are dedicated towards transportation infrastructure. Ultimately the question becomes who is going to pay to repair roads and bridges under a tax holiday or even a price cap. The most likely answer is taxpayers. Tax shifting can be good policy but I don't see why it would be in this instance.


Canada has a lot of oil and gas. Why are we selling so much of it across the boarder with such high prices?
We are essentially committed to free market prices under international free trade policies such as NAFTA. In 1980, the Trudeau government decided to regulate prices in with the National Energy Program. It was not very popular in the west and polarized the country. With tens of billions of dollars lost from the Alberta economy,^[*] I don't think we'll see a repeat of this policy anytime soon.


How high will crude oil prices go?
Stay tuned. I'll discuss this in my next post.