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2010 Gas Prediction: $3 a gallon may be the cheapest we see for a very long time

By Charles Langley, Manager, UCAN Gas Project - "Supply and Demand" the two factors that are supposed to set prices in a market economy will have very little to do with the price of gasoline or oil in 2010. In fact, what we expect to see isn't "economics," it is something we call  "gougeonomics." 

In a "gougeonomy" the competitors who bring the least amount of product to market at the highest price are rewarded with higher profits.   

But first, let's start with a basic observation: One year ago today, gasoline was selling for $1.84 a gallon. At that time, oil cost about $1 a gallon ($44 a barrel).   The important thing to note here is that often, the lowest gas prices of the year usually happen in December or January, so this year's relatively high price could be an ugly harbinger of things to come. And at nearly $3 a gallon on average, we are headed into the New Year with the one of highest "low prices" ever.  In fact, the only time gasoline prices have averaged more than $3 a gallon at the beginning of the year was in 2008, the year San Diego gas prices   skyrocketed to $4.63 a gallon.

Will we see gasoline return to its $4.60 a gallon high this year? We hope not, but we are expecting unreasonably high prices for gasoline due to a variety of factors that have more to do with California's gasoline cartel, than the cost of oil or supply and demand. 

Why Supply and Demand will have little to do with gas prices in 2010

At this point the cost of gasoline in the next year will not depend on market forces or supply and demand. It will depend on how much control speculators have on oil prices, and how much gasoline the California Refining Cartel decides to produce.  The industry has learned three vital lessons in the last 24 months.

LESSON #1 Demand is not inelastic. 

For decades the oil industry has operated on the assumption that the demand for oil is not elastic, meaning that no matter how high the price of oil goes up, businesses and consumers have no choice but to pay it. They were wrong. When gasoline hit $4.60 a gallon, Americans changed their habits. Permanently. Now the industry's biggest problem is that it is producing too much oil and gasoline.  

LESSON #2 unstable pricing kills off customers.

In 2008, six major airlines were driven into bankruptcy  because of high fuel prices. The only exception to the rule was Southwest Airlines which hedged its fuel prices and came out ahead.  As a result,  the market didn't reward the best airline with success, rather, it rewarded the airline with the best bean-counters.  High oil prices nearly destroyed the American Airline industry. What's more, it pushed other businesses into bankruptcy, too, and those that weren't bankrupted made permanent changes in their energy use.

Businesses need stable energy prices, and the oil industry can't prosper in the long term by killing off its customers.  Because the oil industry wasn't able to provide price stability, many of its customers are using less oil, or have gone away.  This is one of the reasons we have seen very steady fuel prices in the USA for the last six months. The industry has learned that price stability is more important than cheap fuel.

LESSON #3 Control the supply and you control the costs.

This is why we think gasoline prices will be unreasonably high throughout 2010: Right now oil should not cost $80 a barrel (it closed above $78 today, and tested the $80 level briefly). Fundamental economics of supply and demand suggest that oil should be closer to $40 a barrel. But it isn't. Why?

Three reasons:

First, Goldman Sachs and other traders are manipulating oil prices.

Goldman Sachs and other traders are using a technique called micro-second trading, otherwise known as computerized "front-running."  A tiny fraction of a second before a major oil trade is made on the NYMEX, Goldman Sachs knows about it. Actually - there aren't any humans that know about it, because the trades happen too quickly, but the fact is, Goldman Sachs has computers on the floor of the NYMEX that are so fast that they can execute an impending trade before a rival trader executes his or her trade.  This process gives the big trading houses the ability to manipulate oil prices by programming their computers to react instantly to other trades with a counter trade.  It should be noted that traders like Goldman Sachs never use - or take possession of - any of the oil they trade. Instead they hold the oil hostage.

Second, Oil is being held hostage

When oil hit its record high of $147 a barrel in 2008, Goldman Sachs had been eagerly and greedily predicting that it would climb to $200 a barrel and beyond despite the fact that there was no market justification for such a ridiculously high price. Then, when reality and market fundamentals hit, oil prices plunged back down into the thirty dollar a barrel range in a matter of months.

Of course Goldman wasn't worried. They make money when oil goes up or down. In fact, when oil made its meteoric climb toward $200 a barrel it was estimated that the majority of barrels had been sold more than a hundred times each. Nice work if you can get it.

So how do you prevent oil from dropping to its natural price-point of $40 a barrel? Well, one way is to make sure that there isn't a surplus by storing the oil. Throughout 2008, oil inventories have been at an all-time record high, yet prices have also been obscenely high. There is plenty of supply, and demand is down. In the real world this would mean lower prices, but this isn't the real world. To help solve the problem of too much oil, the industry has been patiently storing its surplus oil in oil tankers. It is estimated that there are millions barrels of oil being stored this way.  

If that oil were put on the market today, global oil prices would plunge to the low thirties - and perhaps even lower.

In other words, the oil industry has created its own floating strategic reserve. What they can't sell, they store, thereby preventing a collapse in prices.

Third: Gasoline will be held hostage

In 2005, the American Oil Industry was claiming that gasoline prices were at record highs because environmentalists hadn't let the industry build any new refineries in 39 years.

That claim was extremely deceptive.  During that time, not a single refinery was blocked from construction because of environmentalists. 

George Bush, however, was gullible enough to believe that America's high gas prices were caused by a lack of refining capacity caused by NIMBY environmentalists. With the stroke of a pen, he made every abandoned military base in the USA available to the oil industry for FREE if they wanted to build a refinery.  No refineries were ever built on military bases because the industry doesn't want to build refineries.

That's because refineries make gasoline. And if you make too much gasoline, the price of gas will drop.

So the industry has developed its own strategy for managing inventory: They are shutting down refineries.

In the last year, three refineries have been shut down in California.  Why? To restrict the supply. 

In fact today, Chevron said that it may shut down its Richmond Refinery, which produces almost 12% of the gasoline consumed in the state of California. Chevron says they might shut it down because of complaints from environmentalists, but that isn't the real reason:  The real reason is to restrict the supply of gasoline. The new industry model is to make less gasoline and charge more for it

If it sounds as though we are screaming heresy in the Church of Capitalism, then you are probably thinking like an economist, or a retailer.

But if you have the capacity to think like a business person, then the gougeonomic model of "demand and supply" where you demand more money for your product while supplying less product makes perfect sense.