by Calculated Risk on 10/20/2005 04:19:00 PM

Two weeks ago I looked at the short run oil and gasoline market dynamics and concluded:

"it is not unexpected to see oil prices fall - and they may fall some more. However there is a danger of much higher gasoline prices (and heating oil prices) if demand stays strong."

Since then oil and gasoline prices have fallen significantly. November crude closed at $61.03 and November unleaded futures at $1.61. Both are below the pre-Katrina levels.

The fall in the price of oil was expected. But its worth looking at the gasoline market to understand why gasoline prices have fallen.

There are four key numbers for gasoline from the Department of Energy: Stocks(S), Domestic Production(P), Imports(I) and Demand(D). We can write a simple relationship:

Change in S = P + I - D

If S is falling below the normal range, the price will rise leading to a drop in demand and probably more imports. If S is stable or rising then the price will fall.


Click on graphs for larger images.

NOTE: These graphs are intended to provide a comparison between 2005 and 2004. The Y-axis may not start at zero.

Gasoline stocks rose in the most recent week and are close to the levels of 2004.


Part of the reason for the increase in stocks is that domestic production has recovered somewhat from Hurricanes Katrina and Rita. The dip in 2004 is from Hurricane Ivan.

According to the Energy Information Administration's Daily report, a significant quantity of refining capacity is still off-line in the gulf.

"Refinery shutdowns in the Gulf of Mexico region total approximately 1.27 million bbl/d as of October 19, 2005."

This means other domestic refineries have made up a portion of the difference, probably by postponing maintenance.


Another factor in lower prices has been the quantity of imports. Imports of gasoline jumped significantly in the last month to about 1.5 million bbl/day. It is not clear how long this level of imports can be maintained.

And the last graph shows demand. Demand dropped sharply after hurricane Katrina, and is still below 2004 levels. It also appears demand is recovering as prices fall.


The Department of Energy wonders: How Much Has Oil Demand Dropped? After reviewing the data, the DOE asks:

"... what is really happening with petroleum product consumption? And, with retail prices headed toward pre-hurricane levels, at least for gasoline, are consumption and/or product supplied likely to rebound in tandem? Certainly, the latter shows signs of a rebound as this week's estimates rose well above the most recent four-week average. Although we hesitate to make too much out of one week's worth of data, product supplied is likely to continue to rebound, as Gulf Coast refinery production continues to recover. The question is, how much? Coming weeks' data may shed more light on this important issue."

If the economy weakens, I expect demand to stay below pre-Katrina levels even with lower prices. However, if the economy stays healthy, demand will most likely recover and once again put upwards pressure on oil prices. Stay tuned.