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Dan Dorfman

Dan Dorfman

Posted: February 25, 2011 06:50 PM

Risky Roadmap to $7 a Gallon Gas


Like you, I have no idea how far the outbreak of the political unrest will spread. Not so the experts, who basically echo the signature line of the late comedian, Jimmy Durante, "You ain't seen nothin' yet."

Simply put, that means, some Persian Gulf watchers say, more political uprisings, swelling strife throughout the Middle East, tougher times ahead for self-professed dictators, likely oil supply disruptions, higher crude prices and a bigger bite at the gas pump, perhaps as much as $7 a gallon.

One of Wall Street's premier energy analysts, Oppenheimer & Co.'s Fadel Gheit, tells me the market really doesn't appear to grasp the gravity of the situation. "There is no cure for what's going on," he says. What we're looking at, he believes, are likely internal conflicts in such oil-producing countries as Saudi Arabia, Kuwait, Oman, the United Arab Emirates, Qatar and Iran. In total, the six produce about 21.2 million barrels of oil a day, a huge c hunk of the Persian Gulf's daily output or 27 percent of global oil supply.

These countries are trying to buy time, says Gheit, but their promises of some reform and handing out money to some of the disenchanted just won't work. What the people in these countries want is substantial change -- namely freedom and the heads of the regimes to pack their bags and scram. And unless that happens, he says, there will be more internal conflicts and more protests, accompanied by rising oil prices.

"The question," says Gheit, "is how long can the rulers keep the unrest in the closet? The answer: not long, they really can't anymore."

How soon is the next crisis? "Only a matter of time," says Gheit, who thinks things could get especially violent if any unrest were to take hold in Saudi Arabia, which he believes would be met by a major crackdown on any rioters.

Michael Larson, a market strategist, at Florida-based Weiss Research, takes it one step further, citing additional anguish from the unrest and demonstrations that are creating higher oil prices, In particular, he points to adding more fuel to the inflationary fires and the slowing of global economic growth. Fred Dickson, the chief investment strategist of D.A. Davidson & Co. in Great Falls, Montana, tosses in another ugly aspect of higher oil costs, notably as it relates to the market -- pressure on second and third quarter earnings forecasts -- which he says would likely temper those booming stock prices.

Apparently, it already is, with Wall Street waking up to the mounting threats stemming from higher oil prices, which it practically ignored during the Egyptian protests and then became fearful of during the Libyan uprising. Indicative of this, the U.S. stock market has gotten whacked in recent sessions, with the Dow skidding 322 points on three consecutive losing sessions.

Speculation is rife about how high we're likely to see oil prices rise. Take your pick. The numbers are all over the lot. In recent days, we've heard again from the energy experts that oil -- which recently ballooned to a 2.5-year high and is currently trading at a tad under $100 a barrel-- is on its way to between $110 to $130. And maybe to new highs, it's said, should the unrest spread to oil biggie Saudi Arabia, which produces nearly 10 million barrels a day and has said it will make up for any shortfalls due to the turmoil in Libya. The peak in oil, $147.27 a barrel, occurred in July 2008.

There are also some flamboyant forecasts around that oil could shoot up to $200 to $300 a barrel, but the general thinking is that such numbers would require serious supply disruptions from major names in the Persian Gulf, such as Saudi Arabia, Kuwait and Iran. Nomura Securities offers another perspective, warning that the price of crude could reach $220 if more production is halted in Libya and Algeria.

At the moment, the general view is that the oil price, justifiably, carries about a $10 to $15 a barrel risk premium.

What about prices at the pump? Here again, take your pick on how high is high. The preferred media number seems to be that the nation's roughly 200 million licensed drivers are looking at about $5 a gallon down the pike. That's essentially the figure that's making the headlines these days. The national average is $3.17 a gallon, Triple A tells me, but it's likely higher now as you read this, given the recent jump in oil from the turmoil in Libya. By spring, Triple A figures the price at the pump will climb to between $3.50 to $3.75. A fatter price -- between $4 and $4.25 a gallon -- is envisioned on July 4 by Dickson, who feels market nervousness over what's happening in the Mideast is bound to drive oil prices higher. Ditto at the gas pump.

An even heftier price tag -- $6 to $7 a gallon, which would mean a sudden big jump in oil -- is viewed by some energy trackers as a realistic possibility should things get out of hand in Saudi Arabia. One of them, Hong Kong trader Selwyn Ortz, says "I wouldn't rule that out even though there's no shortage of oil right now." "If Saudi Arabia is subject to the same kind of demonstrations and riots that have taken place in Egypt and Libya, a $30- to $40-a-barrel increase, maybe $50, is very plausible. No one can say it can't happen because nobody knows, not in an era of revolutions. And if it does," he says, "$7 a gallon could be a low-ball forecast."

As a rule of thumb, Gheit says, every $10-a barrel rise in the price of oil eventually equates to about $0.25-a gallon increase at the gas pump.

Meanwhile, there's no getting away from the severe impact of higher gas prices. As West Coast economist Madeline Schnapp recently explained it to me, every penny boost at the pump draws an estimated $1.5 billion out-of-household cash flow. In her neck of the woods, gas runs $3.40 a gallon, up from $2.90 about six months ago, or $75 to fill up her SUV. That increase, she notes, adds up to a $60 million national tax on consumption.

In other words, the chaos from the Mideast mess -- be it militarily, financial, the unknowns from regime changes, a prelude to higher inflation numbers and otherwise -- would seem to be far from over. It's also worth poiinting out that 10 of the past 11 recessions since World War 11 can be directly related to sharply higher oil prices, which we're now experiencing.

What do you think? E-mail me at Dandordan@aol.com