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By James Hamilton on Feb 24, 2012 with 2 responses

Crude Oil and Gasoline Prices: Betting on Iranian Tensions

Crude oil prices this week reached their highest level since last April. What will that mean for U.S. consumers at the gas pump?

The first question to be clear on is which crude oil price we’re talking about. Two of the popular benchmarks are West Texas Intermediate, traded in Oklahoma, and North Sea Brent. Historically these two prices were quite close, and it didn’t matter which one you referenced. But due to a lack of adequate transportation infrastructure in the United States, the two prices have diverged significantly over the last year.

My rule of thumb has been that for every $1 increase in the price of a barrel of crude oil, U.S. consumers are likely to pay 2-1/2 more cents for a gallon of gasoline. The yellow line in the graph below plots the average U.S. retail price of regular gasoline in the U.S. over the last 4 years. The blue line is the gasoline price you’d predict if you applied my rule of thumb to the WTI price (assuming 80 cents/gallon for average tax and mark-up), while the fucshia line gives the prediction if you assume that the U.S. retail price is based on Brent. The three lines were quite close until Brent began to diverge from WTI at the beginning of last year. Since then, the U.S. retail price has tracked the world Brent price much more closely than it has WTI.

Yellow: average U.S. price of regular gasoline, all formulations, in dollars per gallon, weekly Jan 7, 2008 to Feb 20, 2012. Data source: EIA. Blue: 0.8 plus 0.025 times price of West Texas Intermediate, Jan 4, 2008 to Feb 21, 2012. Fuchsia: 0.8 plus 0.025 times Brent price. Data source: EIA, with latest entries from Oil-Price.net.

Here’s a closer look at the data over the last year. Average U.S. gasoline prices fell more than you would have predicted based on the Brent price. They have since come back up. But Brent has surged another $10/barrel over the last two weeks, and gasoline prices have yet to catch up to that latest move. Based on the historical relation, we might expect to see the average U.S. gasoline price rise from its current $3.59/gallon up to $3.84.

One factor that’s been driving Brent and WTI up over the last few weeks has been rising tensions with Iran. But why should threats or fears alone affect the price we pay here and now? Phil Flynn, a senior market analyst at PFGBest Research in Chicago, offered this interpretation:

We’re seeing panic buying in Europe and Asia because they’re absolutely convinced that they’re not going to be able to buy Iranian oil or there’s going to be some kind of conflict that disrupts the transport of oil through the Strait of Hormuz…. there is a lot of hoarding in case the worst-case scenario happens. Asian buyers have been buying up West African crude like it’s going out of style.

Does it make sense for consumers to suffer now just because of something that may or may not happen in the future? If there are significant disruptions, the answer will turn out to be yes. We’ll be glad that we used a little less today, and left a little more in storage, to help us better cope with the huge challenges we’ll be facing in a few months. If the answer turns out to be no, then this is all just a lot of pain for nothing.

And which will it be? Nobody knows. But there’s a strong profit incentive for people who buy or sell crude oil or crude oil futures contracts to try to get it right. If it turns out that Iranian tensions do not escalate from here, anyone who buys oil at a high price today and sells low when tensions ease will lose big. If tensions escalate, those on the buy side will do well.

There’s obviously also an incentive for the world’s leaders to try to keep those tensions from escalating.

Personally, I have more confidence in the market getting this right than the politicians.

This article originally appeared on Econbrowser.

  1. By kafantaris on February 24, 2012 at 3:33 pm

    Iran faces a delicate issue.  On the one hand it wants to show the world all it’s got and put it at ease, while on the other hand it fears that such show ‘n tell will give its enemies a roadmap to bomb it.Saddam Hussein faced a similar dilemma ten years ago. Though he wanted the world to know he had nothing to hide, he also wanted to bluff his archenemy Iran into believing Iraq still had WMD. Bluffing did not go well for Saddam, and it might not go well for Ahmadinejad.But since the price tag for ridding Saddam proved high, maybe we ought to reflect what we are asking of Iran now.  On the eve of a threatened attack, we are asking it to take us to the depths of its arsenal and show us all it’s got.  Such great expectations are a sign we have been talking to our friends too long and are in need of a broader perspective.  Exactly when was the last time we asked Pakistan, India, China or Russia to show us their arsenal?“But those countries are not advocating the destruction of Israel.” True, but Israel is not a thorn on their side either.  Surely, however, we can see beyond the hyperboles and figure out their underlying purpose.  Or have we forgotten that not all Iranians are thrilled with Ahmadinejad?He sure hasn’t forgotten. Nor has he forgotten that that his countrymen hate Israel even more.  So he tells them that Israel will be wiped from the face of the earth.  Expectantly, this nonsense unites them against a common enemy. It is even a diversion from the misery and isolation brought on by his theocratic regime. Quite clever work by Ahmadinejad — and not a rial spent or a bullet fired. So why are we letting the crazy talk about destroying Israel get us all worked-up — to the point of turning the world topsy-turvy again.Can we not see the desperate attempts of an unpopular regime simply trying to hold on?

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  2. By Sandro Valecchi on February 28, 2012 at 10:23 am

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    U.S. economy vs. crude price curse

    For some, the requirement is clear: The U.S. consumer will pay
    no more than 50 cents
    on the gallon. This topic is in the election campaign.

    For others it is the way into recession: “This is the dark cloud in an otherwise
    brightening domestic economic picture. It’s something we need to watch right
    now, but not panic about yet,” stated Mr. Webman (Oppenheimer-Funds),
    New York.

    Many consumers are angry as they warily watch gasoline prices at the pump rise week after week. After
    all, a spike in gasoline prices early last year helped nearly knock the economy back into recession.

    Actually
    U.S. gas prices have jumped 8.8 percent since the start of this year, according
    to the Energy Information Agency, topping an average of $3.65 a gallon. This is
    a record for this time of the year when prices are usually on the low side
    because of slow seasonal demand.

    Early
    last year, a combination of strong gasoline prices in the wake of the so-called
    Arab spring uprisings and disruptions to motor vehicle production after a
    devastating earthquake in Japan put the brakes on U.S. growth. Although
    gasoline prices are 41 cents higher than they were at this time last year,
    there are no supply-chain problems disrupting factory production and winter
    this year has been unseasonably warm, giving the economy a mild stimulus.

    “Fortunately
    the U.S. economy is on an upswing, not strong but on the way up. It’s in a better
    shape to deal with the oil prices,” some analysts said.

    Recent
    data ranging from employment to manufacturing have been solid, leading
    economists to temper their expectations of a sharp slowdown in U.S. economic
    growth in the current quarter. The brightening outlook has helped support oil
    prices, although the main driver appears to be fear that a confrontation
    between Western nations and Iran could end up disrupting oil supplies. Actually
    U.S. crude prices hit a more than nine-month high at $106.72 a barrel.

    The rise in gasoline prices poses a threat to
    both inflation and growth. It acts as a tax on households, which are already
    strained by weak income growth, and will likely pull spending away from
    non-energy goods and services. So far, the pinch has been tempered by falling
    prices for natural gas. Natural gas prices
    dropped 2.9 percent in January, their fourth straight monthly decline.

    Sam Bullard (Wells Fargo Securities, North
    Carolina), said even at $4 a gallon, gasoline would not push the economy into
    recession on its own, although it would eat up the benefit of the recent
    extension of the payroll tax cut, which is expected to provide $1,000 in relief
    to the average family this year. “If that is the only thing to happen I
    don’t think that will turn us back into recession,” he is convinced.

    Last
    year when prices breached the $4 a gallon mark, they stayed there for only
    three weeks. Economists argue that if they were to rise that high this year,
    households would likely view the increase as temporary and dip into savings to
    fund purchases.

    A strengthening in the labor market, which has
    enjoyed two straight months of solid job gains, is also seen helping to support
    spending. But higher gas prices do present a fresh headwind that increases the
    economy’s vulnerability to other shocks.

    Ultimately,
    it is
    to explain the
    object of the administration of
    President Obama’s plan: Federal
    Budget 2013.

    Sandro
    Valecchi, Analyst, Berlin

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