Slip and Slide at the Pumps: Why Gas Prices Are Up

June 5, 2018 Marija Majdoub

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You may have noticed that prices at the pumps have shot up recently, especially if you were gassing up during Victoria Day weekend. Oil prices have been steadily rising over the past 12 months with global benchmark Brent Crude climbing past US$80 a barrel earlier in May. Some pundits have predicted that prices could climb back up to US$100 a barrel, but recent news and falling prices have put that to rest, at least now.

 

What’s up with gas prices?

There are a few contributing factors that pushed prices higher:

  1. Higher oil prices due to geopolitical events and the resulting short-term imbalance in demand and supply
  2. A relatively strong U.S. dollar
  3. The lack of refining capacity in Canada
  4. Higher federal and provincial taxes

 

Limited upside

Could oil prices rise further? From a macro perspective, we believe that prices have limited room to move higher despite the recent activity aside from short-term fluctuations due to geopolitical events.

Venezuela, for example, is suffering from hyperinflation, economic collapse, and international sanctions which has affected production in country. The U.S.’s exit from the Iran nuclear deal and threatening of sanctions has also temporarily boosted oil prices.

 

Ramping up production: OPEC, Russia and North America

Moving forward, we believe that prices will move lower based on recent indications from OPEC, Russia, U.S. shale and Canadian producers. Russia and OPEC member Saudi Arabia have discussed raising oil production by 1 million barrels per day to help counter the potential supply shortfalls from Iran and Venezuela. This is a change in policy for OPEC and Russia, which have been curtailing production by 1.8 million barrels a day since early 2017.

U.S. and Canadian producers have also increased production with an increase in American rig counts and inventories coupled with Canada’s investment in new pipelines. So, barring a major geopolitical crisis, oil should move closer to the consensus estimates of US$65 per barrel.

 

The impact of a strong U.S. dollar

A strong U.S. dollar will also cap oil prices (which are U.S. dollar denominated) as an expensive U.S. dollar makes oil more expensive for non-American buyers and more profitable for non-American producers.

 

Who wins? Producers and refiners

Despite the lack of refining capabilities, Canadian oil producers will still benefit somewhat from the rise in prices as Canadian oil remains significantly discounted and highly dependent on the U.S. to purchase and refine. The recent purchase of Kinder Morgan Canada Ltd.’s Trans Mountain oil pipeline by the Canadian government will help Canada relieve a transport bottleneck, move more oil and diversify its exports. 

The clear beneficiaries of higher gasoline prices are U.S. and multinational refiners and integrated oil companies (all of which have refining operations) as they enjoy robust refining margins at this time. This is partly the reason we’ve reduced our tactical underweight to the U.K.

 

Who loses? Consumers

On the flip side, the rise in price of refined products has hurt the largest consumers, most notably airlines and shippers, via increased operating costs.

You and I have seen increased costs at the pump, and should this trend persist, the impact could spread to companies in retail and leisure as consumers reduce discretionary spending.

 

Cheaper gas for summer trips?

For the time being, our view is that oil prices (and gas prices as a result) are superficially high based on short-term demand and supply imbalances due to previously mentioned geopolitical events and production bottlenecks. However, over the longer term, we believe prices will level off and move lower, which hopefully will translate to some relief at the pumps.

 

About the Author

Marija Majdoub

Marija Majdoub, CMA, CFA, is Vice President with the Investment Strategy team at MD Financial Management. She leads the team of portfolio managers and investment professionals responsible for managing the firm’s mutual funds and investment pools, and developing MD’s investment views.

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