Released on July 20, 2005
(Next Release on July 27, 2005)

Speculating On Speculation
Over the past month, there have been several days in which crude oil prices have moved more than $2 per barrel on the near-month futures contract, or the gasoline and heating oil near-month futures contracts have moved more than 5 cents per gallon. Reasons given by oil analysts for these large daily price movements have ranged from news about hurricanes, to concerns about oil demand later this year, to simple profit-taking by funds following a significant rally. This has led some analysts, politicians, oil ministers, and the press to speculate that prices are high due to speculation, as opposed to fundamental factors such as actual or expected supply and demand conditions. Is speculation a major factor in prices going from the low $40s a year ago to the high $50s and even $60 crude oil prices now?

Before answering this question, it is instructive to determine what is meant by speculation, as different people may define it differently. In the United States, oil market speculators are often referred to as the non-commercial traders (i.e., traders not identified as being directly associated with ongoing commercial entities doing real transactions in the oil business) on the New York Mercantile Exchange (NYMEX). But rather than using arbitrary groupings of traders, it may be more instructive to look at the reasons behind trades made on the NYMEX. In this context, one definition would be that speculation refers to those traders that buy and sell crude oil futures on the basis of mathematical trends they discern in recent price paths or for reasons unrelated to oil markets. Using this definition, speculation may be a very small part of the reason behind the long run-up in oil prices, but it is not clear that it has added much, if any, to where prices would be without these particular traders in the market. Perhaps an even more useful way of defining speculation would be trading activity that caused “unwarranted” price changes due to seemingly innocuous news. For many people, it is this definition of speculation that is used. For example, over the past month (June 20-July 19), the settlement price of crude oil in the near-month futures price has varied by as much as $4 per barrel, with the minimum and maximum prices over this time period actually occurring within a week of each other. The same holds true for the gasoline and heating oil near-month futures contracts, with the minimum and maximum prices also occurring within the same week. For gasoline, this meant a range of more than 23 cents per gallon, while heating oil changed by as much as 19 cents per gallon. How can prices move so much in such a short period? Speculation (using the definition of “unwarranted” price changes due to innocuous news items) must be behind these dramatic movements, right?

What is missing from this logic is recognition that oil markets are currently very tight. That is, there is very little flexibility in the system to react to potential supply shortfalls or demand surges. EIA currently estimates that global spare crude oil production is only about 1 million barrels per day. As many as 20 different countries currently produce at least 1 million barrels per day. Downstream capacity is also relatively tight, with refinery utilization rates consistently above 90 percent in the United States and near or above that level in other countries. Recently, oil demand has grown faster than additions to global refinery capacity, making refineries push their utilization rates higher and higher. While it is true that inventories have increased some over the first half of 2005, providing somewhat more cushion than seen over much of the relatively low stock period since 2000, flexibility in oil markets is very limited currently in the sense of capacity to produce significant incremental volumes of crude oil or light products. Under these conditions, it is not too surprising that traders would bid prices up and down substantially on what may, on the surface, appear to be insignificant news, but nevertheless, change expectations about what the future may hold. This is why oil prices can increase as fears about the damage a hurricane might inflict arise as the hurricane approaches, only to see them fall as the hurricane turns away from the oil facilities in the Gulf of Mexico region. Or why concerns about having enough oil on hand when total product demand peaks in the winter cause prices to go up in the summer. When oil markets are this tight, relatively small changes in the actual or perceived supply and demand picture, which may result from seemingly innocuous news items, can have a magnified impact on oil prices.

U.S. Average Retail Gasoline Price Declines
For the first time in seven weeks, the U.S. average retail price for regular gasoline declined, falling by 1.1 cents from the previous week to 231.7 cents per gallon as of July 18, which is still 38.9 cents higher than this time last year. While the U.S. average declined, in some regions of the country, prices continued to increase. The East Coast, Rocky Mountain, and West Coast regions all saw increases, while the Gulf Coast and Midwest regions saw prices decline on average. The Midwest saw the largest decline, dropping 4.8 cents per gallon from last week, while the Rocky Mountain and West Coast regions saw increases of 1.9 cents and 1.7 cents per gallon, respectively. The highest regional price remained on the West Coast, where the average price of regular gasoline sold for 249.6 cents per gallon, with prices in California even higher at 253.8 cents per gallon. The lowest regional price was in the Gulf Coast region, where the retail price for regular gasoline averaged 222.5 cents per gallon.

Retail diesel fuel prices were down 1.6 cents last week to 239.2 cents per gallon, the first decline seen in eight weeks. Regionally, price changes were mixed throughout the country, with the Rocky Mountains seeing the largest regional increase of 2.2 cents to 243.0 cents per gallon, while the Gulf Coast saw the largest regional decline, falling 2.4 cents to average 233.1 cents per gallon, the lowest regional price in the country. Prices in California remained unchanged at 258.9 cents per gallon, while New England, the West Coast, and the Central Atlantic were the other regions that saw average retail diesel prices above 250.0 cents per gallon, averaging 253.5, 253.0, and 252.1 cents per gallon, respectively.

Propane Build Continues Relatively Strong
U.S. inventories of propane continued to build at a relatively strong pace last week as inventories reached an estimated 57.6 million barrels by July 15, a gain of 2.1 million barrels over the prior week. At mid month, propane inventories have attained about two-thirds of the most recent 5-year average build for July, possibly indicating the fourth consecutive month of above average stockbuilds. Despite the robust weekly build, inventory gains were skewed towards the Gulf Coast region with a reported 1.5-million- barrel increase that was partially boosted by strong imports. The Midwest posted a relatively modest 0.4-million-barrel gain last week, while East Coast inventories lost 0.2 million barrels during this same period. The combined Rocky Mountain/West Coast regions moved higher by 0.2 million barrels. Propylene non-fuel use inventories continued to build with a weekly increase of 0.1 million barrels, but accounted for a smaller portion of total propane/propylene inventories of 9.0 percent, compared with the prior week’s 9.2 percent share.

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