Relief at the Pump ... But for How Long?

Every year gasoline prices usually peak prior to the Memorial Day holiday weekend.  So far this year has been no exception.  This past spring the price was close to $4 for most of the US with many forecasters predicting $5 gas for the summer driving season.  So now that oil prices have started falling and prices at the pump have started to ease, what can the US consumer expect to pay for gas this summer and what are the factors that will move prices either higher or lower?

Currently, the threat of $4 gas has subsided ... for now.  I believe the average price for a gallon of gas across the US will likely remain in the $3.20 - $3.70 range for the summer, but there are still geopolitical risks around the globe that could quickly put us above $4 and higher.

The first variable is Iran.  Iran presents the greatest geopolitical risk to oil prices.  The sanctions placed on Iran by the international community have already posed a difficulty for Iran to manage.  On July 1^st the bulk of the EU sanctions on Iran will go into effect, causing further strain on the Iranian economy.  This could further increase tensions between Iran and the west.  In response, Iran will likely keep the US and its allies coming to the bargaining table for talks.  It will also certainly seek to wrangle some concessions or easing of sanctions from the west as a reward for its willingness to have a dialogue.  These actions by Iran will buy it precious time and will allow it to keep its nuclear program running full tilt towards its goal of achieving a nuclear weapon.  By paying attention to how the US negotiates in this situation, Iran will know that the US has long rewarded these types of diplomatic overtures with inaction, decreased sanctions, or even rewards - think North Korea and Iraq under Saddam Hussein.  The US also has an incentive to keep Iran at the bargaining table; the Obama administration is very interested in keeping gasoline prices away from that $4 level.  It will want to keep things calm and the oil markets stable and moving lower.  A lower perceived risk of conflict with Iran will weigh on oil prices, pushing them lower.

The wild card here is Israel.  In the past Iran has vowed to wipe Israel off the map, so the Israelis are very concerned about Iran building a nuclear weapon.  Benjamin Netanyahu has publicly stated that Iran will not become a nuclear power on his watch.  If Israel chooses to take unilateral action against Iran’s nuclear program, there are a few things that are certain: it will act without warning and attempt to inflict maximum damage immediately and as a result oil prices will spike, most likely a 20 to 30 percent jump initially.  And remember, high oil prices = high gas prices, so the price at the pump will almost certainly move into the plus $4 a gallon range.

The ongoing conflict within Syria also bears a close look.  Right now the crisis is contained within Syria.  Any widening or spreading of the conflict throughout the region would cause concern in the oil markets.  However, as bad as the situation in Syria is, it is very unlikely the US or any other nation will intervene in the ongoing conflict.  Unless something dramatic happens to escalate the conflict beyond its current boundaries, oil prices will remain largely unaffected.

Lurking in the background of any discussion of oil prices is OPEC.  OPEC’s next meeting is a planned brief meeting scheduled for June 14^th.  Previous comments from OPEC have indicated that it is very comfortable with $100 a barrel price tag.  The key member of OPEC is Saudi Arabia.  The Saudi’s ability to ramp up production with their spare capacity has provided the world’s oil markets with a measure of comfort when faced with supply shortages as the result of lost production (Iraq, Libya, Nigeria, etc.) or sanctions (Iran).  With the recent decline in the price of oil into the high $80 range, speculation has increased that the Saudis will decrease production to support prices.  Unless oil drops below $75, I think it is highly unlikely we will see much reaction from Saudi Arabia or the rest of OPEC.  Currently all of the production levels within OPEC are voluntary and there is a long history of OPEC members serving their own interests and ignoring quota levels.  Keep in mind also that the Obama administration has been reportedly reaching out to the US’s oil producing allies to keep the oil flowing and prices moving lower.  Abundant oil supplies means lower gas prices for the US consumer and lower gas prices are an electoral plus for President Obama heading into November.

The bottom line here is that there are a lot of factors working to keep oil and gas prices stable and moving lower, bringing much welcome relief to the US consumer.  However the threat of a geopolitical event disrupting the status quo in the Middle East is still very real and will keep prices from falling too far.  All that is necessary is for one of aforementioned variables to erupt and oil and gas prices will spike higher immediately.  Remember, there is an old adage among energy traders ... "Gas prices shoot up like a rocket but come down like a feather".  Let's hope the only rockets we see this summer are at the local 4th of July celebration.