Evaporating Panic at the Pumps

The planets seem to be lining up for a solid drop in prices

When the national average price for regular unleaded gasoline spiked 20% in six weeks to hit a record $1.71 in mid-May, headlines warned that prices might reach $3 a gallon by July 4, when Americans hit the roads in force. Springtime inventories were at their lowest level in seven years, and refineries were running at full capacity. The runup in prices lent some weight to President George W. Bush's argument that more refineries are urgently needed.

Suddenly, though, the crisis atmosphere has evaporated. Over the past five weeks, wholesale gas prices have fallen 38%, to 71 cents a gallon, their lowest level in 17 months. Prices at the pump, in typical fashion, are falling more slowly, but the national average was still down to $1.54 in the week ended June 22, a decline of 17 cents. Now, with refineries still running at a high rate and gasoline imports from Europe and Asia on the rise, this summer's biggest potential drag on the economy and travel--sky-high prices--seems to have been averted.

Why the sudden shift? Prices soared this spring for two main reasons. First, refiners let gasoline inventories get too low because they were focused on refining heating oil last winter. Second, margins on all petroleum products were so good last year that many refiners postponed maintenance so they could keep pumping. By spring, repairs could be delayed no longer, and lots of refineries went out of service at once--resulting in panic buying.

Now, those problems are over. Refineries have finished their maintenance cycle and have had time to rebuild stocks. Meanwhile, the U.S. slowdown has kept demand for gasoline roughly even with a year ago. And economic weakness in Asia and Europe has left refineries there with lots of excess capacity. So they've increased shipments of finished gasoline to the U.S. Gasoline imports recently hit record levels, averaging 725,000 barrels a day in the two months ended June 15, 20% higher than a year ago.

That may not sound like a lot, but it takes time for foreign refiners to redirect output to the U.S. And once they do, it can tip the balance of power from seller to buyer. "The bottom line is, refining is a global business. Gasoline will tend to find its way to the U.S.," says Paul B. Ting, an analyst at Salomon Smith Barney in New York.

Will the good news last? It looks that way. Gasoline supplies have been rising faster than analysts' expectations and are 8% larger than they were a year ago. So even a disruption such as a big refinery fire wouldn't have the impact it had last spring when inventories were depleted. And that's not the only good news. With weak worldwide demand, crude oil prices have fallen to around $26 a barrel from roughly $30 in January. That's likely to feed through to still lower wholesale gasoline prices.

WHY BUILD? But even if the cost of wholesale gasoline doesn't go any lower, prices at the pump are clearly headed down. True, retailers have been eager to keep prices high as long as possible to compensate for the spring, when rising wholesale prices sliced their margins. But in the coming month, competition between gas stations will force prices downward 10 cents to 15 cents, predicts Fred Rozell, retail analyst for OPIS Energy Group in Lakewood, N.J.

That means the likelihood that more refineries will be built anytime soon, as the Bush Administration advocates, is fading fast. The sky-high gross profit margins of $12 a barrel that refineries were earning on gasoline last spring have rapidly shrunk to about $4 a barrel, says Ting. So refiners will be less motivated to build refineries, which can cost $1 billion or more and require years of bureaucratic wrangling over permits. Plus, with pump prices falling, it will be even harder for the President to drum up enthusiasm in Congress for measures to speed the approval of refinery sites.

On the other hand, the plunge at the pump is good news for the economy. It frees up money for consumers to spend on other things, while giving the Federal Reserve more confidence that its quarter-point rate cute on June 27 won't rekindle inflation. Guess folks had better be prepared for lots of traffic jams this summer.

By Peter Coy in New York

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