Gasoline demand will never recover, says analyst Stephen Schork, and it's not because of the recession. (image: elbowflea via photobucket.com and stephanebura.com)

Gasoline is made is from crude oil. In any logical trading world, gas should be more expensive than crude, owing to the additional processing and transportation costs.

So why then is crude more expensive than gas on the NYMEX? Do traders know something the rest of us don’t?

Not according to veteran industry analyst and commentator Stephen Schork. In fact, it’s quite the opposite. In Schork’s view, covered by the Financial Times on Tuesday, traders don’t know—or simply aren’t paying attention to—what’s manifestly obvious: gasoline demand is down and is never is coming back up again.

Schork does not attribute the decline solely to the recession. In fact, he believes that a recovery has already begun, but that it’s not a return to the status ante quo, or how things were before. Instead, he sees a changed economy, one in which gasoline demand is persistently and structurally lower than before. Schork feels that a significant portion of U.S. gasoline demand has been “wiped off the map and is not coming back.”

If not the recession—at least, not as a cause of long-term declines in consumption—what then? What has caused lower gasoline demand in the United States? Several factors:

• New fuel standards for cars and trucks are improving mileage—and decreasing gasoline usage. By 2016, new vehicles in the U.S. auto fleet will be over one-third more fuel-efficient than today’s vehicles.

• The growth in the number of cars is peaking—just about everyone who can have or wants a car will have one soon. Growth in the number of cars was a major driver of increased gasoline consumption over the past decades, but with the cars: people ratio getting close to 1:1 (it was 844 vehicles per 1,000 people recently), the number of cars is almost at saturation point.

• The increase in alternative vehicle fuels, such as biodiesel, ethanol, plug-in hybrids and fully electric cars, compressed natural gas, hydrogen . . . the number of ways other than gasoline to power cars and trucks is growing.

• Demographics—the U.S. population is aging as the Boomers age. As they age, people drive less. They don’t have to shuttle children to play dates and soccer practice, they take fewer family road trips, and as they retire, they stop commuting.

• The rise of telecommuting, online business, and online shopping—more can be done with less travel.

This doesn’t mean that gasoline will go away as an automotive fuel—the Energy Information Administration, for example, predicts that petroleum products (including diesel) will still provide 88 percent of the fuel for cars and light trucks in 2035. Of course, not that long ago, gasoline and diesel provided 100 percent of automotive fuel, so a 12 percent decline (almost one-eighth) is significant.

Remember, gasoline is made from crude oil. So are diesel, jet fuel, heating oil, and a number of other products. Historically, however, gasoline has been oil’s main product—around 40 percent of each barrel of oil gets turned into gas.

Since nobody uses crude itself—it’s called “crude” for a reason; it’s not fit for use—the demand for crude ultimately depends on the demand for its refined products. Lower gasoline usage equals lower crude demand, or as Schork put it: “Without . . . end demand for [refined] product, crude prices are fundamentally crippled on the upper bound.” That’s a jargon-filled way to say that oil prices can only go so high if less of the substances made out of oil are consumed.

The obvious immediate losers are refiners—the companies that turn oil into gasoline and other distillates. Low gasoline demand hurt them throughout 2009, the result being refinery closures to improve margins and stop massive financial losses.

Longer term, though, decreased oil demand will remake the petroleum landscape. Oil prices can only go so high without gasoline consumption to lift them. Certain technically exploitable—but difficult and expensive—unconventional resources, such as some tar sands and oil shale, will lay fallow from lack of need. A combination of lower crude prices and surplus refinery capacity will help moderate heating oil prices.

Energy and technology more generally may be affected. Lower gasoline demand means lower gas prices; lower prices mean less urgency for alternative fuel vehicles. (Especially given their price premiums—why pay $5,000 or $10,000 more for a plug-in hybrid when gasoline is below $3.00 per gallon?)

The environment will be affected: less gasoline consumption means fewer carbon emissions. Even without anything concrete from Copenhagen, less greenhouse gases should get into the atmosphere. We can still do better, but it’s a start.

In short, all the financial, ecological, and technological assumptions based on rising (or at least flat) gasoline consumption need to be rethought. Oil traders have seemingly not gotten the message yet, but the message is there: it’s a new game.

(image: daylife.com)

As our Kristin Miller wrote January 22nd, refiners are closing facilities, reducing output, and cutting payrolls in response to weak demand for refined petroleum products. This weak demand can be seen in falling profits—and even outright losses—being posted by the refinery operations of major global energy companies, such as Exxon and Chevron.

As MarketWatch reported Friday, Chevron reported a fourth-quarter loss of $613 million in its refining and marketing businesses, contributing to a decline of 37 percent—or $1.82 billion—in profit. For the same period, CNNMoney.com reported that Exxon suffered a $189 million loss in its refining business.

Refiners are caught between a rock and a hard place. Demand for refined or distilled products, including gasoline, diesel, and heating oil, is down, depressed by a persistently global weak economy mired in recession. Less economic activity means fewer goods transported in commerce and less construction (less diesel); high unemployment reduces work-related driving, such as commuting, and also discretionary or vacation travel (less gasoline and jet fuel); and many households feeling the economic pinch are turning the thermostat down (less heating oil). However, at the same time, the raw material that these end products are made from, crude oil, continues to be priced surprisingly high given the weakness or economies around the world. Notwithstanding that supply has outpaced consumption, leading to record-levels of inventory, the average 4th-quarter 2009 crude price was $76/barrel, up more than 30 percent from 4th-quarter 2008’s average price of $59/barrel.

Weak demand for refined products coupled with high prices for the raw material squeezes what’s known as the “crack spread.” This is, in simplest terms, the profit margin per barrel of gasoline, diesel, heating oil, etc. It’s been squeezed down to the point where, for example, Exxon made $2.2 billion less than it had the year before on reduced refining margins.

Fortunately for them, Exxon and Chevron are broad-based energy companies: even as refining margins and profit plummeted, their “upstream” operations—exploration and production (or finding and pumping oil) rose. With the offset from upstream operations, the companies continued to do well, with Exxon shares rising modestly.

Companies more reliant on refining fared significantly worse. Valero, the largest independent refiner, lost $1.4 billion overall and cut its dividend by two thirds.

Because the money is in production, not refining, that’s where energy companies are investing. Exxon increased its capital and exploration expenditures by 21 percent in 4th-quarter 2009, while Chevron has been bidding for access to new reserves in Venezuela.

Since the weak demand for refined products is linked to the weak economy, refiners can’t look forward to resurgence in demand until the economy improves. With unemployment, one of the best real-world indicators of economic activity remaining above 10 percent in the U.S., when that will happen is anyone’s guess. In the meantime, the only thing that refiners can do is tackle the other side of the equation and reduce supply by offlining production and facilities. That, of course, has a host of unfortunate effects, such as unemployment and decreased local tax revenue. Moreover, since ramping up production again is not a matter of simply flipping a switch and placing some want ads, by taking refining capacity offline now, a risk of a refining shortfall in the future (after the economy finally does recover) is created, with a concomitant risk of higher gasoline, heating oil, and diesel prices.

Near term, however, as we discuss in this week’s Heating Oil Price Preview, weak refined product demand should continue to moderate gasoline and heating prices. It also helps to push back against crude prices, since reduced end-product demand reduces raw-material demand. Therefore, while bad for energy companies and their employees, the weak market for fuel should benefit consumers, including heating oil customers.

Diagram of a room stocked with flywheel energy storage devices. (image: cogeneration.net)

One of the big challenges for solar or wind power is that they are intermittent, not constant. The sun only shines half the hours at best (not even counting clouds or rain), and similarly, the wind does not blow continuously. To make these energy sources more practical, efficient power storage is necessary; you need to be able to top up the “battery” when the power is on and then use it to provide electricity at night, on overcast days, or when the air is still.

As reported by the New York Times Monday, a Massachusetts company thinks it has a solution to the problem of energy storage: flywheels.

A flywheel is a nothing more than a heavy wheel that rotates or spins freely. If you connect it the right kind of dual-purpose electric motor—some electric motors, like the ones in hybrid and electric cars, can function as both motors and generators—you can use the motor to spin the flywheel up to speed when there’s a surplus of power. Then, when you need energy, you slow down the wheel and convert its momentum back to electricity. If the wheel is heavy enough and spinning fast enough—the ones that Beacon Power is installing near Albany, New York, weigh a ton each and spin up to 16,000 times a minute (267 times a second)—you can store an enormous amount of energy in them.

The facility near Stephentown, New York is not intended primarily for alternative energy use. It’s designed to help utilities generally balance power distribution. With conventional energy sources, like coal, nuclear, or natural gas, efficient generation means constant generation, but demand for power fluctuates during the day. Having a way to store excess power when demand is low and then release it when demand is high makes for better operation of the electrical grid.

However, the same system will work admirably for alternative energy, where supply and demand both vary hourly. There are other ways to store power from solar or wind generation:

• excess solar heat can be used to heat molten salt, which then gives up its heat later, when the sun is down, similar to how a pizza stone holds heat from an oven

• surplus electricity can be used to compress air; when power is needed later, the compressed air can be released to spin turbines

But these methods have their limitations. Molten salt only works with solar thermal systems; and compressed air requires a convenient cavern system nearby, to hold the air. Flywheels are more flexible, in that they can be used with any source of electrical energy; they are highly efficient, returning up to 85 percent of the power placed in them; and they are fast to both charge and discharge.

Good power storage systems may go a long way towards making alternative energy truly feasible.

(image: sixthman.net)

In time for Superbowl season, finance professor Sheridan Titman comes up with an analogy that he feels shows that speculation in commodities futures is not responsible for oil price volatility or spikes: betting on futures is like betting on football games.

The professor’s argument rests on two different core concepts:

1) Financial investors in commodities, such as commodity investment funds, do not actually buy the physical commodities—instead they buy derivatives based on the commodities, such as futures. This means, in his analogy, they’re not playing the game, but are simply betting on it.

2) Financial investors—to again use his football analogy—aren’t players or coaches with the ability to influence outcomes; they’re the guys plunking down $5 or $500 in the office football pool.

Titman’s analogy and analysis are both interesting and helpful; however, they’re not quite as accurate or compelling as he thinks because of a flaw in point 1, above. Before examining that problem, though, let’s start by fully explicating the professor’s line of thinking.

The logic goes like this: the Superbowl’s coming up. Say you bet on the Saints to win. You’re just an average Joe or Jane—you have no connection to the team apart from being a fan. You’re bet does not influence how they or the Colts play; it has no impact on the game’s outcome.

Titman would say that JP Morgan or other financial investors are you: the fan betting on the team. They don’t produce oil; they don’t use or consume oil; they are simply betting on price movements by taking a position, through derivatives, on what the price will be in the future. Similar to you betting on the outcome or point spread of the game, their bet has the potential to make (or lose) them a lot of money, but does not directly affect supply, demand, or pricing.

(The reason for the caveat, that it does not “directly” affect pricing, is that Titman acknowledges that there is informational feedback from futures speculation. Just as players may play harder if they know that everyone is betting on them, bets on future pricing signal expectations about demand and value. In that way, they can influence whether market participants will invest in producing more oil, ramp up exploration, stockpile oil for sale at higher prices in the future, etc.)

Titman distinguishes financial investors from actual “players”—producers or consumers—who may invest in futures in order to “hedge,” or protect themselves, against price movements. Hedging, if you’re an industry participant, is like taking out insurance; it serves a legitimate business purpose. But because industry participants can affect supply and demand, they potentially have the ability to distort the market to cash on big bets. In Titman’s analogy, it would be like if the coach or players bet on their team to lose—the risk of manipulation is obvious.

To Titman, financial speculators are like non-players who bet on football—apart from providing feedback as to expectations, there’s no real impact on the outcome of the game. It’s the industry participants, usually called hedgers, who have the potential to change the game.

It is a useful distinction make, as Dallas News columnist Jim Landers notes in a column he wrote Tuesday. However, while supporting much of Titman’s analysis, Landers is not fully persuaded as to the essential harmlessness of financial investors or speculators, writing, “[m]anipulation [may not be] the same thing as driving up prices by driving up the demand for paper trades of oil . . . [but] other academics (from Rice, MIT and Princeton, for instance) have concluded that speculators betting on the future have done just that.”

There is substantial evidence for speculation’s role in driving up prices, including the fact that with weak global demand and an oversupply of oil over the last nine months (that’s why inventories kept increasing—there was more oil being produced than the world needed), it certainly was not fundamental forces causing prices to rise.

There’s a problem with the first leg of Titman’s analysis: his likening of investment by speculators to the bets placed in the office football pool. Titman hangs his analysis on the fact that financial speculators don’t take delivery of actual, physical oil—they instead buy derivatives “like forwards, futures, and options.”

The main mechanism for betting on future commodities prices is the futures CONTRACT. If a financial investor—either directly, or through an exchange-traded fund—buys a contract, the investor is undertaking a binding legal commitment to purchase and take delivery of oil at a future date. The investor doesn’t want to do this, of course, and will dispose of the contract before that happens; but there is no legal difference between the futures contract taken out by a financial speculator and a futures contract taken out by an airline (a hedger or “end user” of the product) that wants to lock up the right to buy fuel at a certain price. Both are enforceable obligations that encumber a certain amount of commodity by committing a supplier to provide it and a purchaser to take it.

To switch analogies—say I enter a contract to buy a new home. Even if the contract does not close for 6 months—in other words, it’s a future contract for the home—the home is encumbered; it can’t be sold again to another person. The supply of homes on that street or in that town has been affected. There is an impact on the market.

Getting back to the football analogy: a futures contract for oil is not like placing a bet on whether the Saints or Colts will win. It’s more like taking out a contract with the players that the Saints have to deliver at least a 5 yard gain on a certain down. It’s something that affects the game. The sort of bet Titman is talking about as having no impact would instead be if JP Morgan went to Las Vegas and found a bookie to cover a $1 billion bet that oil prices will top $85 per barrel on February 12th. That’s the sort of bet that has no affect on commodities pricing. But taking out a futures contract—an instrument also used by market participants who want to hedge—does.

Titman reminds us that financial investors and market participants are different animals, with differing abilities and ways to influence the market by their speculative behavior. That’s useful to remember. However, while analogies can be useful to illustrate a point, they can be dangerous when confused with an underlying reality that does not precisely match their conditions.

IEA Executive Director Tanaka feels that continuing to allow unbridled energy speculation is a losing proposition. (image: dlcache.indiatimes.com)

Bloomberg reported Wednesday that the International Energy Agency intends to meet with OPEC, banks, and regulators to discuss ways to curb speculation’s impact on oil prices. The proposed meeting, called for next month in Tokyo, was instigated by the IEA’s Executive Director, Nobuo Tanaka. Among other attendees, Tanaka has specifically invited CFTC head Gary Gensler, whose agency recently proposed position limits on energy futures.

There has been a rising tide of concern over the impact of speculation on energy markets. It’s based in the belief espoused by many market participants, including OPEC, that oil prices are higher than they should be in the face of persistently weak economic fundamentals; the cause, many believe, is speculation by financial investors. The concern is that speculation has led to unjustifiably high prices that have harmed consumers and the economy, such as 2008’s peak price of $147.27 per barrel. However, another fear is that market volatility caused by speculation increases the likelihood of wild price swings and disrupts the stable investment climate needed for massively expensive, long-term energy projects. In this view, the problem is not that oil prices are too high or too low, it’s that energy investment is “adversely affected by oil price volatility. . . when long-range commitments of adequate and timely investment flows are need to ensure future supply,” in the words of Saudi Arabia’s oil minister.

To put it another way: how can you engage in vital long-term planning when the economic basis for your plans—the price of your commodity (oil)—can double, then fall by three quarters, all within less than a year?

It may be time for speculators and financial investors to stop opposing regulation. So far, all they’ve had to deal with are CFTC proposals widely denounced—even by members of the President’s own party—as anemic and largely ineffectual. But with most large market or industry organizations and regulators embracing the need for limits on speculation, and with President Obama calling for major changes in the ability of banks to engage in proprietary trading (including in commodities), it might make sense for the financial industry to support meaningful but manageable regulation now, rather than continue to oppose all regulation and risk a backlash that sweeps in truly draconian limits.

Whether or not next month’s meeting results in any enforceable or effective limits, it should be viewed as evidence that sentiment against speculation continues to mount.

Logo of New England heating assistance program. (image: penquis.org)

As the Massachusetts news blog Wicked Local reported on Saturday, heating assistance is available for the most vulnerable members of our society—the elderly, and families with low incomes. This help is provided by a wide array of community and service organizations, and underscores some of the finest traits of our nation—volunteerism, charity, and compassion chief among them—at the same time that the fact that so many residents of the world’s wealthiest country need help just to stay warm while Wall Street rewards itself with outsize bonuses points to serious inequities and moral challenges.

However, leaving the larger picture aside—after all, when you’re cold, the “larger picture” is how you’ll warm up—the Wicked Local article points out that resources are available for those in need. Indeed, at first blush, the article makes it sound as navigating the array of help available might be one of the larger challengers: in the space of three pages, a dozen or so organizations or local chapters of organizations are mentioned as heating-assistance resources for Massachusetts residents.

Of course, it’s not just Massachusetts residents who need help. As we’ve written about extensively, public and private institutions in states throughout the Northeast, from New Jersey to Maine are providing heating assistance to those in need. And not just in the Northeast: from Pennsylvania to as far south as Alabama, people need heating assistance this winter.

Most heating assistance comes from LIHEAP, which—as much as it sounds like a Long Island organization—stands for Low Income Heating Assistance Program. While it’s a federal agency, assistance is not administered at federal or the state level; it’s disbursed to state agencies or partners, who in turn get it to the people who need it. Since LIHEAP is the nation’s main provider of heating assistance for low-income people, if you need help, your best bet is to contact your state’s LIHEAP grantees—the state organizations which have access to the funds.

However, not everyone qualifies for LIHEAP assistance. As we’ve written, the program has income-related criteria to determine eligibility. Since the program is administered on a state-by-state basis, the qualifying income levels vary, too. For example, in New Jersey you can earn up to 225 percent of the federal poverty level, or $47,700 for a family of four, and qualify; while in Vermont, qualification is limited to 125 percent of the federal poverty level, which is only $26,508 for a family of four.

LIHEAP and its state grantees are not the only gateway to heating assistance, however. As the Wicked Local article writes, distressed Massachusetts residents also received assistance from a number of different local organizations. Many of these organizations then distribute funds that ultimately trace back to LIHEAP; they also provide assistance with resources raised from local governments, charitable donations, corporate grants, and even in-kind assistance (e.g. donated heating oil) from energy and fuel companies.

These other organizations are not primarily about or for heating assistance. Instead, they tend to serve some defined, in-need constituency, and heating assistance is just one way they do that. For example, elderly residents could look to their local Council on Aging, which are municipal organizations that provide a variety of services to the elderly. The Burlington, MA COA discussed in the Wicked Local article is one example of such a constituent services organization stepping up to the plate.

Therefore, as an alternative to contacting your state’s LIHEAP partner directly, if you or family members belong to some group that has organizations helping or serving it, you could try contacting those organizations—they may themselves provide heating assistance, or they may at least be able to direct you to an organization that does. As mentioned above, elderly in need of heating assistance might try their local Council on Aging or the equivalent senior services group or organization. Veterans or families of veterans might try an Office of Veteran’s Services, like the Burlington office that helped provide fuel assistance, and families with children might try Youth and Family Services.

Other possibilities include various other community service or charitable organizations—for example, also cited in the Wicked Local article, Community Teamwork of Lowell, MA and the Burlington Community Life Center arranged for heating assistance for in-need residents

Since these are all very local organizations, we don’t mean to suggest that you can necessarily call a Burlington or Lowell group for help—not unless you live there. But we mention these organizations both to salute them for helping out at a time of need, and as examples of the types of organizations that may be available in your community, to provide assistance to those who can’t keep the heat on without help.