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By John W. Schoen Senior Producer
msnbc.com
updated 4/12/2007 3:08:23 PM ET 2007-04-12T19:08:23
COMMENTARY

Last week’s seizure and release of 15 British soldiers by Iran sent oil prices on a tear. That got Bill in Pennsylvania wondering: When will oil prices stop going up? Beats us. But if you'd like to play armchair oil price forecaster, here's how to get started.

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Where will the price of oil stop?
Bill M., Mercersburg, Penn.

The Answer Desk crystal ball starts smoking and throwing off sparks every time we ask it that one.

In theory, there is no upward limit on the price of oil. But rising prices of any commodity are supposed to encourage more production and/or cut demand — and stop prices from rising.

Oil is traded globally, based on imperfect data tracking actual supply and demand along with buyers' fears about shortages and sellers' fears about oversupply. Both sides are placing bets second-by-second whenever the trading pits are open in various time zones around the world.

In the short-term, traders in the middle of these transactions seize on whatever hard information they can. The Energy Department’s weekly statistics on crude oil inventories, for example, are watched closely and can have an immediate impact on prices when they're released every Wednesday morning. But even this “hard” data comes with a big asterisk: only U.S. production, imports and inventories are counted. There’s a big world of oil out there that is largely invisible to accurate measurement.

Worse, the impact of news like last week’s seizure and release of 15 British soldiers is much harder to quantify. Did the capture increase the risk of military action against the second largest OPEC producer? Does increased hostility toward the West raise the prospect that Iran will use oil as a weapon? If so, how do you quantify that risk?

Once you’ve come up with those odds, you’ve got to translate that into the dollar equivalent impact on the next barrel sold. Oh, and by the way, you need to do this standing in a tight pack of screaming traders — where noise levels are so high you have to rely on an arcane system of hand gestures to strike a deal worth more than most people make in a year. And make the trade before the next piece of news sends the market moving away from you.

A geopolitical event like the standoff between Britain and Iran is just one of a long list of risks that get wrapped up in the daily bets that collectively set the price of oil. So if you’re going to come up with your own armchair oil price forecast, here are some other questions to chew on:

1) Will the current, relatively high price of oil encourage energy conservation, easing the growth of demand — or will consumers just pay the extra price and keep driving their SUVs? Assuming that supplies remain constant, the continued growth in demand means prices move higher.

2) Will supplies continue to move through the global distribution system without interruption from terror attack, hurricane, pipeline mishap, etc.? If any link in the supply chain snaps, factor in price spikes accordingly.

3) Will oil production continue to rise as new oil discoveries come on line faster than older oil fields are depleted? Or will the pace of discovery and development fall behind the rate of depletion of existing productive oilfields? If production keeps up with demand, shave your price forecast accordingly. If not, bet on prices going up.

4) How much oil is under the ground in Saudi Arabia? Can Saudi producers make good on their claims to be able to continue to provide enough extra supply to meet global demand growth for the foreseeable future? Or, as some industry watchers suspect, are they hiding serious problems with existing reserves that could soon bring a production decline?

5) How rapidly will the economies — and oil consumption — of developing countries like China and India continue to grow? Will they begin "cooling" to a growth track similar to developed countries like the U.S.? Or will their demand for oil continue to expand at the current rate indefinitely?

If you want to give your forecast a professional look, come up with a formula assessing the impact of these risks on your price model. Plug them into a spreadsheet and tweak it constantly.

You might even be able to charge people a fee subscribe to your updates. If so, congratulations: you’re an oil analyst.

I have read there is plenty of oil on the market but the real problem with gas prices is refining capacity. This has been supported by recent news reports. Why do we not see investment in refining capacity given the high price of gasoline?
— W.F., Columbia, S.C.

We do see investment, but not in brand new refineries. One reason is that it’s very hard to get the permits and approvals to build a new gasoline refinery close enough to the people who need the gasoline.

Some of that investment, though, doesn’t produce more gasoline — it produces cleaner gasoline. Refiners recently completed a round of hundreds of millions of dollars of investment to upgrade their equipment to produce low-sulfur diesel in order to meet new, tougher clean air rules.

Refiners do, however, constantly upgrade their plants to squeeze a few more gallons out of each facility. To do that — putting in a new unit to squeeze more capacity or installing bigger pumps to move that product through the system — they’ve got to shut the plant down. That means a temporary drop in production — usually in late winter/early spring when the heating oil season is winding down and the driving season hasn’t year heated up. This year, those planned shutdowns dampened production even though demand remained fairly strong.

So while there are no new refineries, the capacity of the existing ones has been steadily rising. At the start of 1983, U.S. refineries churned out 6.2 million barrels of gasoline a day. By the beginning this year, production reached 9.2 million barrels.

Unfortunately, that still hasn’t been enough to keep up with demand. At the end of March, American drivers burned through about 9.5 million barrels of gasoline a day — or more than 400,000 barrels more than this time last year, according to the latest Energy Department data.
When demand is stronger than supply, prices go up. Last week, pump prices were up 9.7 cents to 270.7 cents per gallon, according to the Energy Dept. — the ninth consecutive increases. Prices are now 11.9 cents per gallon higher than at this time last year.

And that’s a national average: on the Gulf Coast, where about half of U.S. refining capacity is based, pump prices were up 12.3 cents to 256.5 cents a gallon; on the West Coast prices rose 8.0 cents to hit 309.6 cents a gallon. In California, which requires a special blend that not all refineries can produce, prices were up 7.6 cents to 322.8 cents per gallon. That’s 48.5 cents per gallon above last year's price.

Usually, higher U.S. gasoline prices bring in more imported gasoline as foreign producers try to cash in on the rise in pump prices. Imports have been rising in the past few weeks.

Meanwhile, higher oil prices do have a big impact on gasoline prices. Crude oil — the raw material used to make gasoline — accounts for about half the price of each gallon that comes out of he refinery. So new refineries wouldn't help much there.


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