A New Spike at the Pump?

A gas-price rise may be in the offing, thanks to a rule change affecting a smog-fighting oxygenate. Refiners are scrambling to deal with the situation

Another spike in gasoline prices could be around the corner. And this time it may not be caused by a major natural disaster like Katrina -- or ever-present geopolitical tensions -- but a decision made by bureaucrats in Washington. The Environmental Protection Agency has lifted a regulation that requires the presence of smog-fighting oxygenates like methyl tertiary butyl ether (MTBE) in gasoline amid questions about the additive's safety.

The new rule could affect gasoline supplies as refiners scramble to adjust, at least in the short term, says John Kingston, global director of oil at energy-market information outfit Platts, which like BusinessWeek Online is owned by The McGraw-Hill Companies (MHP). He sees the lifting of the oxygenate requirement as the leading cause of the 12-cent-per-gallon jump in the New York Mercantile Exchange's gasoline contract on Mar. 14.

Kingston recently spoke with BusinessWeek Online reporter Alex Halperin about why the government is changing the rule, how events in Iran and Nigeria could affect prices, why OPEC is losing influence -- and how all this could affect your next trip to the gas station. Edited excerpts from their conversation follow:

What do you see as the key factors involved in the surge on Mar. 14?

The key factor involved over the next few months is going to be the change in oxygenate rules. It basically means that you no longer have to put an oxygenate in gasoline. Normally, the elimination of a rule tends to bring prices down. In this case, as you take out the oxygenates you have a problem -- you need to inject something that provides octane.

There are two oxygenates: MTBE and ethanol. Lawyers for these refiners and blenders are saying stay away from MTBE -- it's a litigation cesspool. It's going to be like the new asbestos. In some states, it's banned but nationally it's perfectly legal. The only thing that really provides octane in sufficient quantities beyond [MTBE] is ethanol.

So we're asking the questions now: Do we have enough ethanol, and do we have the logistics for ethanol? It needs an entirely different set of logistics [from the oil industry].

A Wall Street Journal story said that a lot of the nation's power generators are having trouble getting coal from their rail suppliers. Ethanol is moved largely by rail. If the coal problems spill over into ethanol you've got another factor here. There's plenty of crude but you have to look at the probable elimination of MTBE and what you're going to replace it with. It sounds esoteric but it's very key.

So MTBE causes health problems?

MTBE has some not-nice things about it. It shows up in particularly large percentages in groundwater. It's a possible carcinogen. I don't think the science on this is particularly proven out but that's not the issue here. The corporate attorneys are saying, "once the oxygenate rule goes, any legal cover that it may have given us is gone and we don't want to touch this."

There are some signs that the refiners may be winning out. They may be saying to their lawyers "look, we're going to have some real problems meeting our supply requirements if we don't ease up on this." If that's the case, then I think maybe we're going to have a smooth transition rather than an abrupt transition.

When and how do you see this hitting prices at the pump?

It'll hit prices at the pump as soon as it hits the commodities exchange, and we had a 12-cent move on Tuesday [Mar. 14], which I think is related to this. The market doesn't know which way to go. There are two gasoline contracts on the NYMEX: one with MTBE, one with [ethanol]. And when you look at the relationship between them, it makes no sense. The market is completely confused, and that is a recipe for havoc.

It's important to remember that the pricing for everything is done on margin, and that last unit sold is going to be the key driver for setting the price down to the street.

About how long do you see this lasting?

I'll give a Pollyannaish answer here: markets find a way around problems. My guess is if we have a chaotic spike in April or May, it will run its course in a matter of months, if not weeks.

This seems relatively divorced from current events.

It's divorced from the current events that have tended to grip the market recently. It's certainly divorced from the Iranian situation, the shutdowns in Nigeria, and the whole tenuous nature of the Iraqi industry, but it's still very important.

Remember all pricing tends to come off of what goes on in the U.S. You've got three contracts on the NYMEX -- the crude contract, the heating oil contract, and the gasoline -- and everybody around the world tends to look at that. So if you've got chaos in the U.S. gasoline market because of this switch, it really doesn't matter whether, let's say, Iraqi production ratchets up 200,000 barrels a day or we lose another 300,000 barrels a day from Nigeria because of rebel activity. The gasoline market in New York is really going to set the pace, not forever, but for a while.

What about other refined products such as jet fuel?

They will all go on the back of other products. Right now, you have another requirement coming in, and this is a new requirement rather than the elimination of an old one -- and that is ultra low sulfur diesel (ULSD) That's hitting the U.S. market on June 1. And it's been interesting that the logistic concerns about gasoline have pushed the ULSD issue to the back.

Remember that heating oil, jet fuel, and diesel are all part of the distillate pool. If you've got a sharp spike in diesel prices as a result of the transition to ULSD that will pull jet prices up with it. It cannot stay walled off in its own little corner.

You mentioned that the Iranian and Nigerian situations aren't necessarily factoring in, but what about OPEC?

Let me go back and say that the Iranian and Nigerian situations are factors, but these are such big global issues and here you've got a U.S. regulation that seems to be taking control of the market.

OPEC right now has very little to do. It was set up in the early 1960s as an organization to restrain output because the market did not need all of the oil that could be produced. That's not the situation now. The world pretty much needs all the oil that OPEC can produce, so they don't really have all that much to do.

The only thing that might change that is that we have this massive buildup of inventories, which I personally think the world will need in the third and fourth quarters. If, in fact, demand slows down and the inventories are not drawn down, it could put some downward pressure on the market.

If you look at those inventories you've got to scratch your head and wonder "why isn't there downward pressure on the market?" And the reason comes back to what we talked about earlier: the gasoline situations in the U.S. and tensions in Iran and Nigeria.

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