Gas prices: No relief in sight
Demand has cooled a bit, but with a robust economy and limited inventories, don't expect good news for drivers - or investors.
By Nelson Schwartz, FORTUNE senior writer

NEW YORK (FORTUNE) - First, the good news: U.S. gasoline prices may come down by a dime or so in the next month.

Now the bad news: That's about as much relief as we're going to get.

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Although wholesale gas prices have dropped from $2.10 a gallon to $1.98 in the last week, experts say still-tight inventories and reasonably healthy demand mean there will be no significant drop from retail gas prices of $3 per gallon or more in many parts of the country.

"Over the next few weeks, we may get a little relief," says Larry Goldstein, president of the Petroleum Industry Research Foundation in New York. "But it's not likely to have any legs. "

Refinery capacity is still limited, Goldstein explains, as are gasoline inventories. What's more, with refineries coming out of a long period of repairs and overhauls, the likelihood of an unscheduled shutdown or accident is much higher. "It's a tenuous balance," he says. "There's still an asymmetric bias to the upside" - in other words, it's easier for prices to go up than down.

Higher prices do seem to have cooled demand a bit - it's flat vs. a year ago, a shift from the historical 1.7 percent annual growth rate over the past decade. But given that the economy grew at a robust 4.8 percent in the first quarter, it's unlikely that $3 gas will lower demand enough to push gasoline prices back to $2.50 anytime soon.

"There's no major relief in sight," adds Jamal Qureshi, an analyst with PFC Energy in Washington. "The market isn't going to shift fundamentally this summer, and then we get hurricane season."

The pain isn't spread evenly. Retail gas prices averaged $3.33 a gallon in California and $3.13 in Washington state, according the latest federal survey, vs. $2.85 in Texas and $2.87 in Florida. Refining capacity is tighter on the West Coast, especially in California, which uses a different gasoline blend than the rest of the United States.

For drivers, one of the most frustrating aspects of the situation is that while price increases on the wholesale level translate into higher prices almost immediately when you fill up, drops like the recent move downward take more time to be reflected at your local gas station. University of California Energy Institute director Severin Borenstein calls this the "rockets and feathers effect," describing how prices rocket upward but only gently decline like feathers.

This economic phenomenon, says Borenstein, doesn't stem from any nefarious plot in the boardrooms of Big Oil to control prices. The vast majority of gas stations are independently owned even if they're branded Exxon or Shell or Chevron - and local owners want to hold onto higher retail prices as long as they can.

And drivers don't necessarily go out of their way to stations that might be offering gasoline for a few cents less. "It's not a perfect market," he says. "People shop around gradually, not instantaneously."

Continued high prices mean bad news for President Bush - and investors. Along with the war in Iraq, gas prices have been repeatedly cited for the president's low-approval ratings, and members of Congress are worried about how the issue will affect them in November's mid-term elections.

What's more, the news Wednesday that consumer prices rose at a slightly faster than anticipated rate helped push the Dow Jones average down by more than 200 points. That's a sign that high energy prices are finally beginning to be felt in the broader economy, and it increases the likelihood the Federal Reserve will raise rates when they meet next month. Public transportation anyone?

Find out how hedge funds, traders and Big Oil are really driving gas prices. Top of page

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