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The rollercoaster ride in jet fuel prices

jetfuelWEB EXCLUSIVE

The rollercoaster ride
in jet fuel prices

During my 47 years in the business I have seen Crude Oil prices as low as $ 2 per barrel and as high as $ 147 per barrel but the rise to the high has not been a straight line.


May 13, 2009
By Bob Tebbutt
jetfuel  

May 13, 2009 – During my 47 years in the business I have seen Crude Oil prices as low as $2 per barrel and as high as $147 per barrel but the rise to the high has not been a straight line.

The future for energy prices looks just as bad as the international political events, terrorism, hurricanes and economic swings will continue to make it difficult to determine direction and impossible to determine timing.

At the present time, we have energy prices showing some signs that they have fully discounted the economic turmoil caused by the banking community and their investments in sub prime loans. Even though the statistics show that we may not have seen the bottom in the stock markets and in the general economy as a whole.

And it will take some time for the economies of the world to recover to their levels seen in the early part of this decade. That timing may be as much as ten years but could be as short as a year.

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For the present though we have seen that the slowdown in demand for commodities has closed some refineries, postponed some refinery upgrades, and made it difficult for those companies seeking new fields to postpone or even stop completely any searches for new fields to make up for the inevitable decline in reserves.

At the same time, inventories of Crude Oil, Gasoline and Distillates have soared with Crude Oil stocks at the highest in 15 years and with product inventories at very high levels as well.

On the retail side, it is interesting to note that while Gasoline demand is higher today than it was a year ago, the price of Gasoline, at the pumps is over 40% lower.

Distillate demand is lower, mainly because of the recent relatively mild spring weather and also because of the serious slowdown in truck traffic. Compared to last year, demand is down about 8% while prices are down over 50%.

How about for the future?

With the cutbacks in exploration budgets, we will, when demand picks up again, as it eventually will, find ourselves in a world where existing Crude Oil fields will be depleting reserves and there will be fewer new fields coming near to development.

Canada’s Tar Sands is a classic situation. The price of Crude Oil at $50 is well below the minimum price needed to make those fields profitable with some estimates that they need as much as $70 per Barrel to be profitable.

Indeed part of the problem is that they are using Natural Gas to run the plants to extract the Crude Oil out of the tar sands which is relatively expensive and causes pollution. A switch to nuclear plants to provide the cheap and clean energy needed may be decades away.

While Saudi Arabia boasts that their cost to extract Crude is $10 per Barrel, they use the income from Crude Oil to provide infrastructure for their country and that adds up to them needing $75 per Barrel for their country’s balance sheet.

The development of refineries, presently stalled because of the economic situation, will be held up, in North America, by NIMBY (Not in My Back Yard) protests and environmental regulations and even if all of those hurdles are overcome, it still takes another 5 years to complete a refinery.

This will mean that even with delays because of the economy, the difficulty of building refineries in North America will result in them being built offshore in more politically unstable areas and therefore will cause some leverage problems in the future.

For example, at the present time, Venezuela, with its leftist, anti-American government, does sell Gasoline to the US.  However, there is always a possibility that President Chavez will hold the Americans ransom in the future to make a political point.

On the other hand, even if autos, in the United States are radically more efficient and ethanol reduces the amount of Gasoline needed to meet the demands of 300 million Americans; there are two countries, China and India with 1.3 billion people and one billion respectively, who are growing richer and demanding all of the appliances that modern society has available.

During the first two months of 2009 China sold 25 per cent more autos than in the first two months of 2008 and with their stimulation projects, designed to promote growth in their domestic economy, the growth in auto sales will continue and the demand for fuel oils will grow as well.

So, Chinese demand is going to continue to grow exponentially and when the rest of the world shows a stronger economy China will even grow faster.

The Chinese factor alone could drive the markets higher for everything including energy, food and base metals.  Adding India’s growth potential to the mix will impact markets as well.

And we have not even discussed India’s growth potential, while starting behind China, still has a lot further to go to catch up.

Another factor that will drive prices higher is inflation. In order to get the economies of the world expanding, virtually every country has primed the money printing presses.  While the US money growth stands at 15% and other countries have even higher numbers.

Therefore, fundamentals say that demand will increase, supplies will be restricted and inflation will inevitably drive prices up.

So, how do you protect against higher prices?

The New York Mercantile Exchange offers energy option contracts that offer protection from rising prices while still allowing firms to benefit from lower prices.

Essentially the market offers an insurance policy against rising prices much like fire, health or accident insurance protects you against any of those disastrous occurrences.

Call Options on Futures state that, for a premium, you are locked into the current market prices and protected against the effects of rising market prices over a period of up to two years.

While the upfront premium cost is about 20 per cent, the net premium, when liquidated is about 4per cent.

If the market price for fuel is rising at your location, it would also rise a similar amount on the New York exchange where the Options are traded.

Thus, your increase in costs would be covered by selling your option at an increase in value.

The profit would be wired to you and would reduce your cost back down to the price it was when you put on the trade.

While there are different and more complicated ways of doing this, I have outlined the simplest and am happy to talk to you at any time to give you more details.

Bob Tebbutt
Vice-president, Risk management
Peregrine Financial Group, Canada, Inc.
1-866-220-0247
rtebbutt@pfgcan.com