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Gas Demand and Destruction

April 25, 2007

Gasoline prices have come back up to around $2.80 per gallon, and will probably go higher based on what prices are being paid in other parts of the country, reported by a friend in California who says gas is $3.30 a gallon in his area.

Many theories exist to blame the price of gas on politicians and greedy oil companies, because we all know that it is an elaborate plan for Dick Cheney to make more money off the backs of the working poor, and for the large oil companies to line their pockets with money from the sweat of our middle class. May I throw another remote concept into the theory pool? How about supply and demand. Supply and demand is a basic economic theory which, in layman terms states; the more supply and less demand of any commodity, will lead to lower prices for that commodity. The more demand and less supply will result in higher prices for that commodity.

China and India are massive users of energy which is imported from all over the world.
North America is also a region which uses a tremendous amount of refined products based on oil. Oil prices are up, but not nearly as much as unleaded gas, primarily because of the extra refining gasoline requires.
Many commodity traders place a “crack spread” to make money on this extra cost to refine crude oil products approaching the spring and summer driving season. This spread consist of a long (buy) unleaded gas position and a short (sell) crude oil position.
The same types of trades are used with heating oil and crude.

The most interesting and predictable phenomenon, in my opinion, is what happens to gas prices after they go up to uncomfortable levels for a certain amount of time. That supply and demand theory kicks in again in the form of lower prices due to less demand, or demand destruction. Simply put this demand destruction is explained by the fact that we as consumers use less gas because it cost to much, and we find ways to cut down on demand or use.
Many politicians believe that higher prices for energy is a good thing for us in the long run, because it will help the environment and we will use less non renewable energy sources and maybe work to become less dependent on non renewable foreign energy sources.
Whenever fuel prices are high, we seem to hear a lot about conservation of resources and renewable energy. But as soon as prices subside, due to demand destruction, we as consumers go back to our fuel hungry ways. Sounds like a never ending cycle.

Mark Patterson is a registered investment advisor with MHP Asset Management LLC, and commodity trading advisor. Mark can be reached at 447-1979 or Mark@mhp-asset.com