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High Gas Prices Investment Opportunities

Commodities / Crude Oil Jul 11, 2008 - 12:51 AM GMT

By: Hans_Wagner

Commodities Best Financial Markets Analysis ArticleInvestors who seek to beat the market look for opportunities that indicate changes in market sector trends. The recent rise in the price of oil and along with it the price of gasoline is causing serious problems for people and the economy. In the past we when we have experienced spikes in the price of gasoline, it eventually fell back down as supply outstripped demand. However, there are forces in place that will keep this happy event from taking place this time. As a result, you should consider adjusting your investing themes to recognize that the price of gasoline will remain high, and likely go higher from now on.


Figure 1 depicts two gasoline pumps divided into segments of what we pay for in a gallon of gasoline at the pump. The pump on the left is for years 2000 to 2007 average: 12% goes for distribution & marketing; 16% goes for refining costs & profits; 24% is for Federal & State taxes; and 48% is for the crude oil, itself. The gasoline pump on the right for 2007 average and shows 10% for distribution & marketing; 17% for refining costs & profits; 15% for Federal & State taxes; and 58% for the cost of crude oil, itself. For more information, contact the National Energy Information Center at 202-586-8800.Most people believing that the price of oil is the primary determinate of the price of gasoline. According to the U.S. Department of Energy , the price of crude oil averaged 48% of the average retail cost of gasoline from 2000 to 2007. Federal and State taxes were the next highest cost factor averaging 24% followed by Refining Costs and Profits, and then Distribution and Marketing. In 2008, the proportion of crude oil rose to 58%. Other state and local taxes are not included in this analysis.

Actually, what determines gas prices is a bit more complicated. To help understand this it is helpful to look at the four determinants of the price of gasoline, which are supply, demand, inflation and taxes. Supply and demand get the most focus and blame for the high price of gasoline. I will look at those a little later. Not many people think about inflation and taxes, so let us examine them more closely.

Inflation and Taxes

In the past inflation and taxes have been the biggest driver in the price of gasoline.

  1. Inflation causes everything to increase in price. An item that cost $1.00 in 1950 would cost about $8.78 in 2008. In 1950, gas cost about $0.30 per gallon.
  2. Adjusting it for inflation, a gallon of gas should cost about $2.64, assuming taxes, supply and demand stayed the same.
  3. The tax on a gallon of gas in 1950 was approximately 1.5% of the price.
  4. In 2008 the federal, state and local tax on a gallon of gasoline between 15 and 20% of the price. This means that taxes have added $0.49 to the price increase in a gallon of gas, making it cost about $0.49 per gallon assuming there was no inflation, nor any change in the supply or demand.
  5. This brings the total price of a gallon of gasoline to $3.13 in 2008 due to inflation and taxes.
  6. Since oil is priced on U.S. Dollars, the decline in the value become part of the reason for the inflated value of oil.

All this without any change in the supply or demand part of the equation.

Supply

According to various studies, today's proven reserves total 1.3 trillion barrels, with the U.S. Geological Survey estimating the world's remaining conventional resources at 2.6 trillion barrels. Canadian tar sands boost the estimate to 2.8 trillion barrels.

The global economy, including the China and India, require about 85 million barrels a day. At current rates of use, 2.8 trillion barrels should last 90 years. Most likely, oil use will continue to rise, but conventional resources and tar sands should still be sufficient for 60 to 70 years. Other unconventional oil resources, such as shale oil, will greatly extend the time horizon at which we run out of oil, once we have the technology to develop them.

Oil does not come out of the ground in the same form everywhere. The price for oil that is widely quoted is for light/sweet crude. This oil is easier to refine into useful end products by refineries. Since it is easier to refine this type of oil is in high demand. As oil gets thicker, or what is called heavy, it requires more processing to ship and refine into end products. Add in impurities such as sulfur and it requires additional refining. This heavy/sour crude is widely available in Canada and Venezuela. The problem there is not sufficient refining capacity to process this heavy/sour crude, since it requires more expensive capital investment. Much of the additional oil Saudi Arabia is making available is heavy/sour, however, since there isn't sufficient refining capacity to process this oil is either not being sold or is going for much lower prices. This is one of the reasons the Saudis say there is sufficient oil available on the market.

Demand

Demand for oil has been growing at an annualized compound rate slightly more than 2 percent in recent years. As expected this growth is highest in the developing world, particularly in China and India (each with a population in excess of 1 billion) and to a lesser extent in Africa and South America. This growth is primarily due to rapidly rising consumer demand for transportation via cars and trucks. The United States consumes about 21 million barrels of oil each day.

The growth in demand is coming from the new economic growth of China and India with their growing middle class. According to the China Petroleum and Chemical Industry Association, China's consumption of oil rose 17% in the first quarter of 2008 alone, According to some estimates China's oil consumption will increase by 62% over the next decade. This would mean they would be using at least 12 million barrels of oil a day by 2020 compared to the 21 million barrels currently consumed each day by the U.S.

China is building 42,000 miles of new interstate highways over the next twenty years to accommodate the all the new car sales in China. The U.S. has about 86,000 miles of interstate highways. China expects to have 10 million new cars in 2008. Their sales of cars are expected to grow between 15 to 20% per year. In comparison the U.S. is expected to sell 14 – 15 million cars in 2008. India has plans to construct another 25,000 miles of expressways. Cars driving on those highways are going to consume more gasoline.

Prices help to allocate scarce goods. Although demand for gasoline is more elastic in the long-run, in the short run, small disparities in supply and demand (in either direction) will have a large impact on prices. This inelasticity means that if prices go up, demand goes down, but not by very much. The problem is people are locked into their existing life patterns for the near term. While they can change their fuel consumption by buying more fuel-efficient vehicles, or move closer to work, these things take time. They can also take public transit where it is available. The point is rapid price increases tend to have only a small impact on the demand for fuel over the short run. Longer term they change patterns of behavior and the investing opportunities that are available.

The Bottom Line

There are many obvious investing opportunities if you believe that he price of gasoline will remain high from now on. Green alternatives are one sector that many people are chasing. Any transportation company that can offer a relatively lower cost way to move goods should benefit. This is one of the reasons Warren Buffett bought into the railroad industry.

Some less obvious sectors include the copper miners. It takes about twice the amount of copper to help power a hybrid or electric car than the traditional car today. Airline manufacturers should also benefit as the airline companies remove their high cost planes from their fleets and buy more fuel-efficient planes that are made of lighter materials and use gas-sipping engines. T. Boone Pickens has articulated an energy strategy that calls for use of natural gas as a transportation fuel rather than generate electricity. He advocates substituting wind energy to generate electricity. If this concept takes hold, it would offer new opportunities to help create the necessary infrastructure. Since the cost of heavy/sour crude can be substantially lower than the widely quoted light sweet crude, the refiners that are capable of processing this lower cost crude will have a cost advantage. Other refiners will spend additional capital to construct the necessary facilities to process this lower priced crude creating opportunities for engineering and construction companies.

There will be numerous opportunities for investors that exploit the permanently higher gasoline prices. The secret is to incorporate them into your investing themes.

By Hans Wagner
tradingonlinemarkets.com

My Name is Hans Wagner and as a long time investor, I was fortunate to retire at 55. I believe you can employ simple investment principles to find and evaluate companies before committing one's hard earned money. Recently, after my children and their friends graduated from college, I found my self helping them to learn about the stock market and investing in stocks. As a result I created a website that provides a growing set of information on many investing topics along with sample portfolios that consistently beat the market at http://www.tradingonlinemarkets.com/

Hans Wagner Archive

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