Dallas Fed analysts see reprieve from record-high crude oil prices

World oil prices apparently have been given a reprieve from their early summer peak, two analysts in the Federal Reserve Bank of Dallas' economic research department contend.

Prices pulled back 20% from a record $147.27/bbl on July 11 to close at $118.58/bbl on Aug. 6, Stephen P.A. Brown and Jackson Thies said in their latest quarterly energy update on Aug 14. "Even after the recent decline, prices are almost 60% above year-ago levels and up around 20% year-to-date. The futures market was in backwardation on Aug. 6, with the December 2010 contract closing at $115.95, implying that markets expect the long-term price of oil to be slightly lower," they observed.

Like their counterparts at the US Energy Information Administration, Brown and Thies said that slower growth in demand reflecting a slowing global economy is the likeliest cause of falling oil prices. Reduced fuel subsidies for consumers in China, India and some Middle East nations are adding to downward pressure, although the Dallas Fed analysts noted that such subsidies have been reduced, but not eliminated.

"A large portion of the increase in world oil consumption has been driven by the larger emerging economies of China and India. For instance, in an attempt to further reduce pollution in advance of the Olympic Games, China switched a large amount of its electricity generation from coal to diesel. China is also thought to have stockpiled oil and diesel in advance of the games to ensure there are no shortages due to the influx of participants and spectators," they said.

"Upon completion of the Olympic Games, it is expected that the Chinese will continue to phase out their subsidies, with the goal of eliminating them by the end of 2009. If there is a drop in Chinese demand following the Olympics, there will most likely be further downward pressure on oil prices," Brown and Thies said.

Diesel and gasoline

They said that diesel fuel prices came down in tandem with oil, but strong demand from China and India kept them solid. "One factor contributing to the strength of diesel is that refineries are configured to produce more gasoline than diesel fuel. This configuration is based on past consumption patterns and is making it difficult to get enough diesel out of each barrel of oil," they observed.

US retail gasoline prices have hovered at a national average of $3.90/gal after peaking at $4.12 in mid-July, Brown and Thies continued. But they added that domestic gasoline prices haven't kept their normal pace with crude oil because US motorists are driving less.

"Gasoline inventories are above seasonal norms, which is depressing refiners' margins and holding down capacity utilization. Some of the downward pressure is the result of high diesel margins. With diesel in high demand, more barrels of oil have to be processed, which increases gasoline production," they said.

Assuming that margins recover and crude prices are steady, they suggested that spot gasoline prices would be around $3.13/gal by Labor Day. "However, the futures market is not showing a recovery in refiners' margins and currently projects spot prices at $2.94 by Labor Day. This translates to a national average pump price of about $3.70/gal for regular unleaded," Brown and Thies said.

Contact Nick Snow at nicks@pennwell.com

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