Thursday, May 05, 2011

As $4+ a Gallon Gas Sends More People To Public Transit, Has ExxonMobil Peaked Out?

People around the country are feeling a simmering rage every time they go to fill up their gas tanks. How so? They played by the rules and got stuck with paying 47% more for gasoline than they did last year. But more of those people are getting mad as hell and deciding not to take it anymore. They're leaving their cars in the garage and taking public transportation. And that could be bad news for ExxonMobil (XOM) shareholders.

Why have oil and gasoline prices gone up so much in the last year? After all, supply is unchanged and demand has dropped. Libya's 1.5 million a day supply has been curtailed due to the civil war there, but Saudi Arabia has made up the difference. Meanwhile, Japan's earthquake and tsunami has reduced its daily consumption by a million barrels a day as it shut down 29% of its refineries.

The culprit for higher oil and gasoline prices can be found in the Chicago commodities trading pits. Back in 2009, the Commodities Futures Trading Commission (CFTC) that regulates the pits found that the reason oil prices peaked at $147 a barrel in July 2008 was that 81% of the trading volume was controlled by speculators -- an investment pool that puts in 6% of its own money and borrows the rest to buy oil futures contracts while selling short the dollar. Thanks to near 0% interest rates, the U.S. government is backing this low risk bet with free money.

The average American might have trouble understanding why, after bailing out Wall Street with $23.8 trillion in cash and guarantees, she must now continue to prop up those speculators by paying $1.30 more a gallon for gasoline. It would be fairly easy for the government to stop the speculators -- they could simply raise the amount of their own money that they have to set aside for each oil contract they control from around $6,000 to $18,000. That would force speculators to take more risk and they'd decide it was smarter to move their craps table elsewhere.

There are two little problems with the speculators' oil bet. First, one of their ranks can decide that it's time to get out. And if that exit is well publicized, it can scare everyone else out of the trade. Goldman Sachs (GS) issued a report in April recommending investors exit commodities, such as oil. And Wednesday The Wall Street Journal reported that George Soros, who famously made $2 billion betting on a drop in Britain's pound, was out of his commodities bet -- on gold and silver.

When a commodity rises on momentum -- e.g., following what other traders are doing -- the exit of a prominent trader can have a snowballing effect -- particularly when high levels of borrowing force traders to sell their positions in order to repay their gambling debts.  All this selling results in a vicious and rapid downward cycle. And while that appears to have happened in silver, it could also happen with oil.

Second, people can stop buying as much gasoline. With only 19% of trading volume being controlled by companies that actually use oil, like refineries, that impact is relatively small. But still, Thursday's Boston Globe reports that the use of public transportation in Massachusetts was up 5% to 1.3 million passengers in the year ending March 2011. It's no coincidence that since March 2010, gasoline prices have risen $1.30 a gallon from $2.75 to $4.05.

This brings us to ExxonMobil. It reported $11 billion in first quarter 2011 profit last week, so why has the stock lost 3.4% of its value since peaking on April 29 at $88 a share? I don't know but if the combined effect of lower demand for gasoline and a withdrawal of traders from the bullish side of the oil trade lead to lower prices at the pump, ExxonMobil will face negative earnings comparisons in 2012.

It's unwise to sell short a stock that is not in near-term danger of going bankrupt. And I don't see that happening to ExxonMobil. But that does not mean that its stock is not heading down on expectations of lower gas prices. This is one I'd avoid.


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