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Thinking About a Gallon of Gas

July 25, 2005

On this lazy summer Monday, as I watch the unleaded gasoline Sept 05 futures (Ticker: HUU5) contract trade on the NY Mercantile Exchange this morning trade at a price of $1.664/GALLON and seeing that Sept 05 Crude oil was trading at nearly $59/Barrel on the NYM (Ticker: CLU5) or if you broke it down about $1.07 per gallon of raw crude, I started asking myself: maybe it makes some sense to “outsource” our refining and production of petroleum based products in the name of saving the consumer from eternal sticker shock every time they go to the pump. After all, if our economy is 2/3s driven by consumer spending, do we want an exponentially increasing portion of their disposable income going into their gas tanks?

As our prices move towards those of our allies in Europe where fuel prices already exceed about $5 per gallon in most countries, why don’t we try here in the U.S. to “Wal-martize” this industry in the name of saving our future economy. The petroleum business is one of the very few industries in America where the manufacturing (refining, in this case) of its raw material (crude oil) to the end product of unleaded gas for your car is entirely processed on shore in the good ‘ol U S of A. Think how different our consumer spending habits would be if gas were already $5 per gallon here. Think how differently our auto industry will look as prices continue to climb. Think how lucky we are that we don’t have to fill our cars with milk; which is already above $5 per gallon (oh yeah, that is produced on shore too)!! Perhaps “health care costs” and retirement benefits for cows are almost as prohibitive as for unionized oil workers.

Gasoline prices as measured by the futures contract on the NY Merc have risen by about 90% since July 25, 2003. Crude oil has risen by about 138% during that time. No surprise then that the energy stocks have tremendously outperformed the broader market as measured by the S&P 500. Historically when energy stocks have led the market for an extended period it has foreshadowed tough economic times. In other words, the sustained higher prices of energy force the economy at large to adjust to that price shock. That adjustment period is often very painful. Throw in rising interest rates and a slowing domestic economy, and I can see why Fed Chairman Alan Greenspan is glad he’s retiring in Jan 06. See ya in Jackson Hole.

Currently, given the escalation in global terrorist attacks, short-sighted fiscal policy by the current administration, exhausted monetary stimulus in the form of low interest rates and a one time tax cut, a slowing world economy, and a stagnant job market; I think history has a decent probability to repeat itself. Post bubble economies like the one we are now in ultimately have a hard landing after the reflation trade takes place. The reflation in our case was the re-financing/home equity loan boom we’ve seen here in the U.S. housing market and president Bush’s tax cut in his first term. Those stimuli are largely played out; it is up to consumer to keep it going. The obvious question is whether the consumer is already adjusting spending around higher energy prices or will it be the final nail in the proverbial coffin in the months to come?

Stay tuned...

On July 25, 2005 3:17 PM, weewill said:

Great piece Mr. Smith. Clear and in understandable lay language for those of us who aren’t good with numbers! Scary but very clear. We’ll stay tuned so keep this kind of tracking coming to the blog. Thanks


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