U.S. Economy
Gasoline Prices Soar; Heating Oil Set for Winter Hike

Stephen P. A. Brown looks at the rising crude oil prices and what we might expect in the next few months.

Since early 2003, gasoline prices have risen about $1.20 per gallon, with 60 cents of that increase coming in the last three months (Chart 1). Distillate oil (heating oil/diesel fuel) has increased by nearly as much as gasoline in the past two years. Rising crude oil prices and U.S. refineries operating near full capacity account for the gains in prices for both commodities.

Since early 2003, crude oil prices have increased nearly $40 to more than $65 per barrel. Increased world oil demand pushing world oil production to full capacity is the primary factor driving oil prices upward. Another significant factor is fears of a supply disruption with OPEC close to full capacity. Other contributing factors to rising oil prices have been a weakening of the U.S. dollar and higher tanker rates.

Many market participants believe that world oil demand is likely to continue growing strongly in coming years as industrializing countries such as China and India increase the energy intensity of their economies. With growing consumption, the long-term oil price outlook depends on how much investment is made to expand world oil capacity. The U.S. Energy Information Administration expects capacity additions to be relatively modest over the next few years. Other analysts' claims range from the world is running out of oil to OPEC will have an excess capacity of 7.5 million barrels a day by the end of the decade.

Gasoline Prices Break Away from Crude Oil
Gasoline prices have generally risen with those for crude oil, and nearly three-fourths of the gain in gasoline prices since May can be explained by the increased price of crude oil. With U.S. refineries operating near full capacity, however, gasoline prices are also showing a strong seasonal surge, which has pushed gasoline prices another 13 cents higher than can be explained by crude oil. Another 4-cent gain in gasoline prices is expected for September.

Once the summer driving season comes to an end, gasoline prices are expected to fall back in line with those for crude oil. Even with a normal seasonal decline, spot gasoline prices (for regular unleaded) are expected to remain above $1.75 per gallon, with pump prices averaging about $2.20 per gallon across the nation.

Heating Oil Showing Winter Gain
For many years, distillate (heating oil/diesel fuel) prices have generally tracked those for crude oil (Chart 2). For the coming winter heating months, however, the market shows strong seasonal gains. With U.S. refineries running near full capacity in late summer and shortages of distillate in Europe, there remains a possibility that refineries will be late in switching from their summer mix of products, which is heavy on gasoline, to their winter mix, which is heavy on distillate. It is too early to handicap the outcome, but the futures market shows distillate peaking nearly 15 cents higher than is suggested by crude oil prices.

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