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Energy & Precious Metals - Weekly Review and Outlook

Commodities Jun 12, 2022 05:59AM ET
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By Barani Krishnan

Investing.com -- At $5 a gallon or more for gasoline this week, many Americans are probably wondering how much higher the pump price of fuel can go. 

Rather than just pondering about the cost of their next fill-up, it might benefit them to learn about the mechanics of price-fixing by petroleum refiners, wholesalers and retailers that results in that pump price and what they - as consumers - can do to help bring it down.

Yes, there is a “fixing” involved where fuel prices are concerned. But whether that is tantamount to gouging depends on the interpretation of the facts and science involved in pump-price discovery.

Aside from the “unfriendly” or “destructive” fossil fuel policies of Joe Biden and the “Ukraine war” or “Putin price hikes” we regularly read of in the media, energy prices are influenced by summer/winter seasonalities, environmental adherence costs, refinery maintenance schedules, tax increases, dollar strength/weakness, front-month expiry in futures market and, finally, product demand itself.

For the purpose of gasoline, the cost is divided into three stages: crude price, the refiner “crack” or profit and retailer/other markups. 

The crude price - at Friday’s settlement of $120.47 for a barrel of U.S. West Texas Intermediate for July delivery - and the AAA-quoted $5-a-gallon-on-the-average for gasoline is known to all. 

What’s less known is the disparity in prices between one gas pump and another and the mechanics behind the “mystery surcharges” for fuel in California, the state with the highest energy prices in America. More on these two later.

First, let’s take a look at the refiner crack, also known as refiner margin outside of the United States. On Friday, that was at $53.34 a barrel. This means that for every barrel of crude obtained at $120 - we’re rounding down the price of a barrel to make the math simpler - the refiner’s return is $53 or 44%. To make it more relevant to you, the consumer, you’re paying about $173 for every refined barrel of oil - if it’s just based on the crack added to the crude price. The truth is you’re always paying more than that.

Here’s why: The gasoline crack process itself uses a 1:1 formula where every barrel is assumed to produce a barrel of gasoline, or the wider 3:2:1 formula, where every three barrels produces two barrels of gasoline and one barrel of distillates. Whichever the formula, each barrel on the average produces about 20 gallons of gasoline, 12 gallons of distillates that become diesel and kerosene for jet fuel and another 10 gallons of other low-yielding energy products.

In revenue terms, for gasoline this means that the 20 gallons multiplied at Friday’s pump price of $5 per gallon results in $100 per barrel. For the distillates portion, the 12 gallons can best be multiplied by $5.77 per gallon - the average price of diesel from Friday. That’s another $69, rounded up. 

Add the two and you get almost $170, just shy of the $173 for the crude-crack combo tabulated earlier. The balance 10 gallons of assorted energy products in the barrel, even at a crack price of say $3 per gallon, would likely yield $30 more. Add the three and you’d get $200 as what consumers pay for a refined barrel. This shows an $80 premium over a barrel of crude, or a real refining premium of 67%. 

The truth is the fuel refining and delivery industry typically has a combined profit margin of 50% to 80% on a barrel of crude at most times, maintaining that even during the two-year-long coronavirus pandemic.

In April 2020, at the height of the demand destruction caused by the Covid outbreak, the gasoline crack spread was at around $5 while a barrel of WTI crude averaged $18. 

The pump price of gasoline itself in April 2020 averaged $1.50. Under the crack spread, the 20 gallons of gasoline would have meant a consumer cost of $30 a barrel.  Diesel averaged $2 a gallon then, meaning the 12 gallons from a barrel there would have meant a diesel cost of $24 for the consumer. Add the two - without the remaining 10 gallons of other products - and you already get $54. That’s a premium of $36 over the $18 crude price then, or a 100% return.

Even so, this doesn’t necessarily mean there was fuel price gouging during the pandemic. The truth is there was barely any demand for fuel at pumps in April 2020. While there was $36 worth of fuel for a barrel available, the likelihood was just a fraction was sold each day. 

It’s necessary for pumps to charge more than the norm at times because they have fixed monthly costs like leases, wages and maintenance, regardless of whether they sell enough fuel. It’s acceptable that the real premium for a refined barrel had to be higher during the pandemic to compensate for fuel that was not sold. Otherwise, gas pumps would have gone out of business just like some refiners who folded up  — leaving us with today’s inadequate refining capacity that’s partly responsible for the gas price crisis we have now.

What’s not acceptable though is the industry not being forthcoming with its pricing mechanics, creating the impression that price gouging is not just happening but is outrageous now.

Case in point: For more than 20 years, California lawmakers and consumer advocacy groups have called for an investigation into why gas prices in California are consistently higher than prices in other states, even after accounting for taxation differences and the costs of adhering to the Golden State’s strict regulatory requirements.

Over the years, the focus has shifted to questions about why certain name-brand gas stations often charge more than 30 cents more per gallon than stations with less prominent names. Top brand-name gas stations are usually run by oil producing-refining companies themselves. 

Logically, an Exxon, Chevron, Shell and BP station should be able to sell at lower prices since they are one-stop operations with presumably lower costs for acquiring both the raw materials and finished products for their stations. Typically, the brand-name stations advertise their fuel as meeting the highest standards for cleanliness and performance, though they don't officially say if that’s why they charge more.

In October, the California Energy Commission published a report that found that name-brand gas stations charge “higher prices for what appears to be the same product” and that “if competitors decide collectively to fix prices, this may be unlawful.”

“It’s really astounding, the language [the CEC report] used: They [the gas stations] are charging higher prices because they can; it’s the same gasoline, but there’s nothing they [the CEC] can do about it,” Jamie Court, president of the Consumer Watchdog nonprofit advocacy group, told the Los Angeles Times. “No one knows how much these guys are making when they process this crude into gasoline.”

And then there’s the “mystery gas surcharge” that California drivers alone pay, according to Severin Borenstein, energy economist at the University of California, Berkeley.

In a blog post, he defines the surcharge as “the premium of California gas prices above the rest of the U.S., AFTER accounting for the fact that we have higher taxes and environmental fees, and we use a cleaner gas formulation.”

In defense of the industry, Kara Greene, a spokeswoman for the Western States Petroleum Association, told the LA Times that an average of $1.27 of each gallon of gas sold in California goes to taxes, fees and climate programs. Of that amount, 10 cents on average goes toward state and local sales taxes, the latter of which can vary widely, Greene said.

“Municipalities are going to be different. Different places have different excise taxes and that’s the sales tax for gas,” she said. “I live in Sacramento, and they have a much higher sales tax for gasoline than another town might have.”

Borenstein said that while the industry group’s figures appear to be accurate, the mystery gasoline surcharge is a separate charge levied in addition to taxes, fees and climate program costs. And branded gas stations typically charge a disproportional amount more than unbranded ones in California, which drives prices even higher.

“The average differential is 7 cents in other parts of the country, and the average differential between branded and unbranded stations in California is 23 cents. That’s data from five years ago, but it makes the point,” he told the LA Times.

“If people were to shop around more and go to those off-brand stations,” Borenstein said, “it would put pressure on the branded stations to lower their price. But Californians seem less willing to do that.”

Therein is the other problem with gas prices being where they are: unhelpful consumer habits.

The bottom line is gas station proprietors, like other business owners, are free to charge whatever they want. A combination of leasing costs, market forces, local differences and entrepreneurial prerogatives help determine prices from one filling station - or county - to the next.  Branding and pricing strategies often come into play as well.

A related issue for consumers is convenience. Many will pay slightly more per gallon if it means avoiding a U-turn at a busy intersection or not going out of their way.

Here, consumers can start learning from police and other emergency service personnel who have started cutting down on making trips not deemed to be an emergency after all.

"I have instructed the deputies to attempt to manage whatever calls are acceptable over the phone," Isabella County Sheriff Michael Main said in a Facebook post. "This would be non-in-progress calls, non-life-threatening calls, calls that do not require evidence collection or documentation."

Additionally, Lieutenant Bretton Ensfield of the Allegan County Sheriff's Office recently said the department is urging officers to avoid idling their cars and making unnecessary trips. 

"Instead of having a deputy drive 20 miles to go take that complaint, the complaint may have to wait 10 to 15 minutes or so to have the closer car take the complaint, rather than have someone else driving to take the complaint," Ensfield said.

Workers' unions can also push employers for a return to work from home, or WFH, for staff whose presence is not essential on-site. While WFH might mean slightly higher cooling bills for those working from home during the summer, the savings on fuel might still be substantial.

As the saying goes, the consumer is king. Demand destruction in oil will not come at any price if the consumer does not will it.

Good luck at the pump.

Oil: Market Settlements and Price Outlook 

London-traded Brent settled down $1.14, or 0.9%, to $121.93 a barrel on Friday. For the week though, it showed a gain of 1.8% and was up 9% over a four-week period.

On Wednesday, Brent hit $124.38, its highest since 14-year peaks of above $130 reached on March 9 after the invasion of Ukraine that triggered Western sanctions on Russian oil that upended the global energy market. The global crude benchmark is up 57% so far for this year.

New York-traded West Texas Intermediate crude settled down $1.04, or 0.8%, at $120.47 per barrel, after a three-month high of $123.15 on Wednesday. For the week, the US crude benchmark rose 1.8% and was up 18% over a seven-week period. Year-to-date, WTI is up more than 60%.

Sunil Kumar Dixit, chief technical strategist at skcharting.com, said WTI was in a “potentially bearish DOJI formation.”

“Positivity in the weekly stochastic reading of 73/68 and the Relative Strength Index of 68 stand in technical contrast with bearish DOJI weekly closing,” said Dixit.

Going into the week ahead, he said a sustained move below $120 can push oil down to $118 and $115 while a move above $120 can show a limited upside to $121.50.

“We see minor possibilities for a retest of $123 but if this upward move is established by price action, look for bullish attempts at $126 and $130,” said Dixit.

“On the higher probability is a downward correction; a decisive break below $118 can expose WTI to $115 and even lower to $113.”

Gold: Market Settlements and Price Outlook 

Front-month gold futures for August on New York’s Comex rallied to a four-week high on Friday just shy of $1,880 an ounce. It eventually settled at $1,875.20, up $22.40, or 1.2% on the day. 

For the week, the benchmark gold futures contract was also up 1.2%.

Dixit of skcharting.com noted that gold pulled off one of its best weekly gains amidst high volatility triggered by data showing U.S. inflation at new 40-year highs.

“Gold plunged to $1,825 critical support, which attracted buyers and bears running to cover shorts as the metal strengthened above $1,850 level, taking the run up to $1,876 above the 50-Day Exponential Moving Average of $1,970,” Dixit said.

He said gold’s weekly stochastic reading of 29/25 and RSI bullish position called for further upside with some consolidation between the $1,855-$1,845 for next leg higher at $1,893.

“Once gold’s stability is seen above $1,893, this $1,850-$1,870 area will become support aiming at $1,910-$1,935,” Dixit added.

“Any rejection above $1,893 can hurt the short-term bullish breakout structure and the metal can plunge into the $1,855-$1,840 area, below which a bearish trend can resume.”

Disclaimer: Barani Krishnan does not hold positions in the commodities and securities he writes about.

Energy & Precious Metals - Weekly Review and Outlook
 

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Comments (10)
David Getchell Sr
David Getchell Sr Jun 13, 2022 6:19AM ET
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Attacking the Biden Admin at the start shows your bias. Big oil has had a rope around our necks for 50 yrs. squelching progress toward a better energy source. You should report on that. They don't make incredible profits by being fair to the consumer, they complain about everything else except their own greed. Can't wait for these aholes to die off. Yield to a cleaner and less dependent energy source.
jason white
jason white Jun 12, 2022 8:13PM ET
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Well written. Re: the oil / has supply chain profit margin it would, would also be interesting to study the capital reinvestment. My research indicates capital improvements and maintenence have suffered greatly in recent years, and a substantial % of that margin is being committed to catch up in these areas.
Barani Krishnan
Barani Krishnan Jun 12, 2022 8:13PM ET
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Thanks much, Jason 🙏🏽. Yes, capex went down too much in the past two years and the industry is loathe to invest for fear prices will collapse again before the return is in.
SunilKumar Dixit
SunilKumarDixit Jun 12, 2022 8:13PM ET
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True that drop in Capex is due to potential drop in fuel prices when supply bottlenecks ease and risk premium dilutes.
Ivan Radusic
Castor8888 Jun 12, 2022 5:08PM ET
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Great article Mr. Krishnan. Thank you so much.
Barani Krishnan
Barani Krishnan Jun 12, 2022 5:08PM ET
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Castor, you're most welcome, sir. Thanks for the feedback. 🙏🏽
trevor hron
trevor hron Jun 12, 2022 12:33PM ET
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Thanks for the article. Its been a wild market. I have gotten into the Gold GDX and Silver SIL ETF’s and hoping for a nice come back. It seems almost absurd that we have some of the highest inflation in history yet the USD remains extremely strong. Causing precious metals to stay subdued. Im still amazed that so many find the USD as their safe haven asset. What do you think the methodology is behind that?
Barani Krishnan
Barani Krishnan Jun 12, 2022 12:33PM ET
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The rate hike expectations are too strong; as of Friday, fed funds futures were back up indicating 75 bps. The fact that the latest CPI came so close to Wednesday's rate decision has got markets in tenterhooks, wondering what Powell is going to do. I doubt a 75 bps wil happen for June but July likely.
Abhay Agrawal
Abhay Agrawal Jun 12, 2022 11:23AM ET
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Barani sir I think the bounce in gold and silver is a result of short squeeze.after the release of the anticipated CPI data everyone was bearish on gold and silver.so their prepaid Stop losses are hit on the other side of their trade.the bond markets are always right as the bonds sold off spurring the yields to their highs.inflation is not a thing which can be brought down overnight.it takes time and the fed actions of rising rates and reducing its balance sheet will definitely result in controlling price rise because it will discourage speculative demands and control unwanted spendings.the USA citizens have forgotten to save money for their bad times like we Indians do.they are used to easy credit money which gives them power to buy everything whether needed or not.now the fed is tightening for the first time in decades so the results will be fruitful but with a bitter taste.
Barani Krishnan
Barani Krishnan Jun 12, 2022 11:23AM ET
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True, Abhay. We'll see how this pans out.
trevor hron
trevor hron Jun 12, 2022 11:23AM ET
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Barani Krishnan It’s almost amazing we’re dealing with some of the highest inflation in history but yet the USD has rallied to multi year highs. Why do you think that is?
Barani Krishnan
Barani Krishnan Jun 12, 2022 11:23AM ET
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Apols belated reply, Trevor. See my response to your earlier question above.
Dave Jones
Dave Jones Jun 12, 2022 10:54AM ET
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Buy physical silver and thank me later. What's going on with palladium anyway? More to PMS than just gold. Platinum also. Explain how that is going down in the midst of soaring demand, lack of supply and increasing production costs?
SunilKumar Dixit
SunilKumarDixit Jun 12, 2022 10:54AM ET
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Dave Jones. Very true. And if you allow me to add some more to it, surging margin calls triggered by falling stocks often cause unwinding of positions which otherwise should not see sell off.
Jim Stramoski
Jim Stramoski Jun 12, 2022 10:52AM ET
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excellent article, very thorough explanation of the pricing of fuel! keep in mind that a barrel is not the standard of 55 gallons of other industrial products but 42 gallons.
Barani Krishnan
Barani Krishnan Jun 12, 2022 10:52AM ET
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Yes, Jim, it's always 42 gallons a barrel. One should remember the mix. Thanks for the compliment on the article and bests!
Murali Krishna
Murali Krishna Jun 12, 2022 10:07AM ET
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Such a long explanation is not required. Crude oil will be the last to get tamed. First stocks have to go down much more and are going down slowly. That stocks money is going into gold pushing gold higher. After stocks go down all the way, and no more to go, rates will have to go higher to tame crude oil. Then gold will start crashing with gold holders rushing to buy cheap stocks. gold will go to $640 eventually. then crude oil will come off. until then, what you think and say is irrelevant and immaterial. okay?
Barani Krishnan
Barani Krishnan Jun 12, 2022 10:07AM ET
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Murali, stop spamming the comments field here. You've already had your say once and Sunil has responded to you, and it's a very appropriate response from him, I'll say. I don't want to get the administrators to block you. Understand?
SunilKumar Dixit
SunilKumarDixit Jun 12, 2022 10:07AM ET
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Barani sire, that's how the icebreaker gets snowballed hahaha
Andrew Ulferts
Andrew Ulferts Jun 12, 2022 9:46AM ET
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We should coin a new term- Califlation. Everything costs more in California because people can and will pay more for it. I always say CO is the new CA, but thank God we have a lit of catching up to do in many ways. I like when our real estate values go up sharply though!
Andrew Ulferts
Andrew Ulferts Jun 12, 2022 9:46AM ET
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* a lot*
Barani Krishnan
Barani Krishnan Jun 12, 2022 9:46AM ET
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Andrew Ulferts  It is what it is. It still remains a desirable place for many Americans, despite the costs and forests fires. Haters can remains haters but the charms of Frisco, LA and Hollywood still rule.
Murali Krishna
Murali Krishna Jun 12, 2022 8:01AM ET
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Such a long explanation is not required. Crude oil will be the last to get tamed. First stocks have to go down much more and are going down slowly. That stocks money is going into gold pushing gold higher. After stocks go down all the way, and no more to go, rates will have to go higher to tame crude oil. Then gold will start crashing with gold holders rushing to buy cheap stocks. gold will go to $640 eventually. then crude oil will come off. until then
SunilKumar Dixit
SunilKumarDixit Jun 12, 2022 8:01AM ET
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Murali Krishna. Really? . Such a long story too much for your cosy read, eh. Especially for those like 'Oh I know it all' nah. Nonetheless your $640 sounds like Avogadro's hypothesis but we take it with a pinch of salt anyway lol.
Barani Krishnan
Barani Krishnan Jun 12, 2022 8:01AM ET
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SunilKumar Dixit  "Avogadro's hypothesis!" Good one, LOL :) Murali never gives up trying to get his $600 gold, does he? It's the only reason he ever comments in any story. Sigh.
 
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