How High Can Gasoline Prices Go This Summer?

According to the Energy Information Administration (EIA), the national average price of gasoline (regular, unleaded) reached $2.05 per gallon last week - crossing the $2 a gallon level for the first time since Nov’08. Current gasoline prices are more than 26% above their late Dec’08 levels. Given their critical role in the consumer-driven U.S. economy, gasoline prices are of concern to a lot of people.

So what is behind the recent momentum in gasoline prices? And should we brace ourselves for gasoline prices going even higher, possibly above $3 a gallon as the summer driving season kicks in?

We do not expect gasoline prices to get above the $3 a gallon level this summer, though they are most likely expected to stay above the $2 level. The improvement in gasoline margins from last year’s lows, however, should benefit refiners such as Valero (VLO), Tesoro (TSO) and Marathon (MRO). Historically, a spring trade in the refiners has done well and there is no reason to think differently this time.

The primary driver of gasoline prices is crude oil prices, which have strengthened significantly in recent weeks, though they have been pulling back lately. According to the EIA, the prices of crude oils used by U.S. refiners, on average, have increased by approximately $17 a barrel. That would translate to a roughly $0.42 a gallon increase in gasoline prices, essentially explaining almost all the jump in prices.

Another contributing factor is demand, which appears to have improved from last year’s depressed levels. Gasoline demand was fairly weak last year, primarily due to record prices. Recent data suggests that demand has recovered to year-earlier levels and can be expected to remain flat if the economy does not deteriorate further.

While we believe that oil price have troughed already, we do not expect any sustained rally any time soon. OPEC’s successful supply cuts have roughly doubled the worldwide excess production capacity, which should limit the commodity’s ability to spike.

As such, we are looking for oil prices to essentially consolidate around current levels through the summer. There is also excess production capacity in the U.S. and European refining industry.

In the U.S., the capacity utilization rate has averaged less than 83% in the year-to-date period, roughly 5% below the 5-year average rate for this time of the year. This production cutback, largely due to a combination of weak margins and seasonal maintenance, has brought down gasoline stocks (5% below year-earlier levels).

Given gasoline’s improved fundamentals, we would expect refiners coming out of maintenance schedules to shift to gasoline (instead of the still-depressed distillates). This should cap any further gains in retail gasoline prices, keeping them firmly under $3 a gallon.

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