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More Fun With Fuel: Price of gas props

5/1/06

 

With the recent upsurge in the price of gas I was hoping that there would be another opportunity to bet on petroleum markets. Pinnacle pioneered the "price of gas" props last year during the price spike after Hurricane Katrina, and my clients were able to turn a nice profit on the wager. So let's look at the prop and then we'll talk about why this time around I have no interest in getting involved:

What will gas prices per gallon reach by June 15? $4 or greater +300 $5 or greater +800

The first problem with this prop is that it's the old "one sided" proposition wager where you can only bet on the affirmative (that gas will exceed the specified amounts) and not in the negative (that it won't). That's crucial here, since I think that's the right side which we'll discuss momentarily.

The second problem I have with this bet is the way it is worded. When Pinnacle posted lines on the price of gas last year they made it very clear which "average price" would count for purposes of the bet-the price of regular unleaded at fuelgaugereports.com. YouWager is using the "average price of all fuel grades" at fuelgaugereports to determine the outcome of the bet. This immediately raised a red flag due to the fact that the website also tracks the price of diesel fuel. The way I read this bet-the logical way-is that if the average price of the three grades of unleaded fuel go over $4.00 a gallon I've got a winner. My concern is that the book might come back and say that the price of diesel fuel is also factored into the average-that's a concern since typically diesel is a fair amount lower than gasoline.

Now I'm not saying that YouWager is setting this bet up to sandbag winning players, but I like there to be a clear cut result on anything I'm betting on. The way the bet is structured, there's just too much "grey area" open to subjective interpretation. Throw in the fact that you can only bet one side of the proposition and YouWager's price of gas prop is essentially a "sucker bet"

WHAT WILL HAPPEN:

So what will happen with the price of unleaded gas going forward? While I wouldn't touch the YouWager prop for the reasons outlined above, just in case any other books offer a similar wager here's my analysis on the current state of the petroleum market place.

You know it's an election year with all of the ranting and arm waving that our elected officials are doing over the price of gas. To anyone who knows anything about basic concepts of supply and demand, let alone the petroleum marketplace, their demagoguery is maddening. Most infuriating is the politicos calling for a "probe" into fuel costs. This underscores just how clueless and out of touch those in Washington really are-the only "probe" they need is to turn on CNBC for an hour or so or to read the Wall Street Journal. Assuming that their brains are capable of getting around a few simple concepts, it would all be explained.

As we learned the last time I discussed fuel prices, the price of gas at the street level is determined by three factors: price of the underlying commodity necessary to make gas (eg: crude oil), the cost of bringing the product to market (refining and transportation costs) and the basic concept of supply and demand.

The cost of crude oil is at a historic high due primarily to the world geopolitical situation. By coincidence or not, most of the world's trouble spots also happen to be rich in oil reserves. Everybody knows about Iraq and Iran, but there's been a lot of political unrest in other important oil producing countries like Nigeria and Venezuela. That's driven up the cost of oil, which eventually gets back to the cost at the street level.

Part two of the equation is also a problem, though this time you have meddling bureaucrats and not a natural disaster to thank. The Federal government recently mandated a change from the gas additive MTBE to ethanol. While there's a coherent case to be made for a greater emphasis on ethanol, the current fractional amount is little more than a cash grab for Archer Daniels Midland. More importantly to the discussion at hand, it necessitates that refineries retrofit their facilities to accommodate the new mixture. This has resulted in a fair amount of refining capacity offline in the short term and any middling student of Econ 101 knows that when supply goes down prices go up. President Bush on Tuesday (4/25) directed regulators to ease rules on the ethanol mix, which should further ease prices as the transition is being made.

Finally, despite prices of gas going up demand has remained high. People have started to bitch about the $3.00 gallon of gas but at this writing they've done little to modify their driving habits. As long as demand is high for a product with diminished availability prices will go up.

So what will happen? This time, fortunately, the issue of refining capacity isn't as much of a question mark as it was post Katrina. In a matter of weeks the refineries will work through their technical issues and with the relax EPA standards announced by the amount of refining capacity online should increase throughout the summer. Assuming that nothing cataclysmic happens to disrupt the availability of crude, I expect prices to crest in the next week or two (if they haven't already) and drop to around $2.50 or lower with in the next month or so.

Bottom line-you can't play it at YouWager but the "NO" is the right side of the gas prop this time. As the prop is written here, however, it's not worth touching at all.

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