S&P: Middle East tensions, strengthening US economy continue to fuel oil, gasoline markets

Steven Poruban
Senior Staff Writer

HOUSTON, May 25 -- Continued tensions in the Middle East, a strengthening US economy, and increased oil demand by China and the US are fueling oil and gasoline prices, analysts for Standard and Poor's Equity Research Services said Tuesday during an S&P-hosted teleconference.

"The strengthening [US] economy has increased the demand for oil with powerhouses China and the US pushing it forward," said Beth Ann Bovino, economist with S&P. "The risk in Iraq also drove prices to record highs with oil prices up $10[/bbl] since the beginning of the year and retail gasoline prices up 58¢[/gal]" over the same time period, she said.

"Crude oil prices are over $41[/bbl] reflecting in our view over a $5[/bbl] premium and has nothing to do with fundamentals but rather tensions in the Middle East," noted Tita Vital, S&P integrated oil and gas equity analyst. "Otherwise," she continued, "these oil prices are driven by stronger-than-expected demand in China and the US, which appears to have absorbed new supplies to the market and kept [oil] inventories low."

Vital added that China's economy is booming and that S&P expects a 13% increase in Chinese oil demand this year, half of which will be spent by imports, which subsequently "has led to increased competition in the world market for crude and refined oil products," she said.

Consumer spending
Bovino said, however, that, "While we do believe that the higher prices will slow growth, the impact will be less severe than in 1980. Essentially because energy consumption is smaller and energy is more fuel-efficient since that period in time.

"For example," Bovino explained, "household spending in energy is much smaller with energy consumption today to real disposable income at almost half the size that it was in 1980. Furthermore, jobs are coming back to the economy, supporting household income."

The rise in oil prices will reduce consumer spending, Bovino contends. "With the rise in oil prices, we expect that consumer spending will be reduced by $50 billion, or about one half a percentage point for the year," she said.

Oil price speculation
Based on supply and demand projections from Global Insight Inc., a Boston-based independent economic forecasting firm, S&P said that new oil supplies—particularly from Russia and Saudi Arabia—will likely bring prices down this year, "but 'when' is the question," Vital said.

"We expect prices to remain within $35-40[/bbl] probably before Labor Day [Sept. 6], but added to that could be a premium associated with unrest in various parts of the world," Vital forecast. Based on fundamentals, S&P said it expects oil prices to then drop towards the $30/bbl range, most likely in the fourth quarter, Vital said.

"And anticipating these new supplies we saw earlier this year that [the Organization of Petroleum Exporting Countries] had cut their quota to 23.5 million b/d, but has since overproduced by over 2 million b/d, and prices have remained high," Vital said. Compliance among OPEC members, she said, has "been hard to achieve."

Vital continued, "Recently Saudi Arabia made a call to OPEC to raise [its] ceiling by 2-2.5 million b/d, but we see this call as nothing more than raising their quota ceiling to a more realistic target."

Gasoline price forecast
Vital noted that US gasoline prices, in response to the aforementioned factors, have increased more than $2/gal nationwide, being led by high US West Coast prices. Gasoline prices also reflect strong demand and more-stringent gasoline specifications for refiners this year, which has increased the marginal cost of gasoline and taken retail prices to high levels even before the official May 31 start of the US driving season.

"Typically, gasoline consumption rises between January and August as more people drive, with the typical increase around 8-9%," Vital said. She noted, however, that during refiners' regularly scheduled turnaround maintenance in the first quarter, S&P saw "gasoline inventories around the midrange, but above-average maintenance combined with some unexpected problems with restarts and other difficulties cut into production and stocks, causing price increases."

In addition to this already strained refining market, Vital explained, the market saw at the beginning of this year the switchover from methyl tertiary butyl ether to ethanol as a gasoline additive in some states such as New York and Connecticut, which added even more constraints to the system.

"It's a long journey from the wellhead to the gas pump, and the cost of making a gallon of gasoline varies a lot by producer," Vital said. "Generally, if we're looking at $2.10/gal gasoline, about 45% (or 95¢), goes toward the cost of crude; 23% (or 48¢), to federal, state, and local taxes; 22% (or 46¢) to the refiners; and 10% (or 2¢) to distributors and marketers."

She added, "In response, US refining margins have averaged over $10/bbl so far in the second quarter, which is up from about $6.30[/bbl] in the first quarter and $5.30[/bbl] last year, according to our estimates.

"However, high gasoline prices are not always easy to pass on to consumers and retail marketing margins have dropped, in some cases, to a negative. Overall, we expect refining margins to remain high through the fourth quarter and then decline into next year as new supplies enter the market. We're talking about either oil supplies or new gasoline imports from abroad."

Vital concluded that, in response to these higher oil and gas prices and refining margins—partially offset by lower marketing margins—energy companies' earnings have "really done well, aided by a rebounding economy," increasing more than 60% in 2003 and up more than 40% for the first quarter of this year.

Contact Steven Poruban at [email protected].