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Why Mid-West Drought Will Drive Up Gasoline Prices
I pulled into the gas station the other day ready to take my weekly hit to the wallet. At around $3.70 a gallon out here, I’m used to hearing people grumble about how high the price of gas has risen.
I agree that it’s bad. But there is something most people don’t realize: it’s about to get worse … and not for the reasons you might think.
You’ve probably never taken much notice of the sticker on almost every gas pump in the country that reads “Contains Ethanol Blend.” In most cases, all it means is that the gas will burn a little cleaner, and that we used a little less foreign oil in making it.
. 
What it means today, though, is that the drought that has wrecked crops across the country will soon take its toll on our gas prices, and most people have no idea it’s about to happen.
Though there isn’t much we can do to keep gas prices down on our end, we can use our knowledge of what’s about to happen to set ourselves up to profit when they do rise.
A Homegrown Solution to an Energy Problem
In the U.S., the ethanol-blended gasoline with which we fuel our cars is a processed product of corn.
If you are as old as I am, you probably remember the long gasoline lines back in the late 1970s. Corn-based ethanol has been around since then. It made a lot of sense to use corn – ethanol is cleaner energy, and the U.S. is the world’s largest producer of the commodity. Adding ethanol helped extend our fuel supplies and reduce our dependence on foreign oil … slightly. And, for a long time, corn-based ethanol was available and cheap.
The average price of corn from the late 1970s until 2007 was below $3 per bushel. The corn solution was so good that the U.S. government put into place a series of mandates, tariffs and tax breaks for U.S. producers of ethanol and farmers that grow corn.
Even with more farmers planting corn to take advantage of government incentives, increasing global demand for food, combined with its use as fuel, has kept corn prices rising. This, in turn, has led to even more planting. At the beginning of this season, farmers planted the largest corn crop in the U.S. since 1944, when the U.S. fed a war-torn Europe. All hopes were pinned on a huge crop to satisfy steadily rising global demand. A larger corn crop this year would mean healthy profits for farmers!
What the farmers did not count on was the devastating drought that has wreaked havoc on the U.S.
Mother Nature Strikes Again
This year’s drought has badly damaged the corn crop. The abundant plantings in the spring have wilted under the dry heat and turned into one of the worst crops on record. The total amount of corn harvested will be way below expectations and not enough to satisfy demand. Corn prices are already over $8 a bushel and rising.
The crop is so bad, it’s not unreasonable to expect prices to hit $9 or $10 a bushel. But the real issue is not so much the price of corn; it’s availability.
The U.S. Department of Agriculture’s latest crop report on August 10 cut the estimated size of the corn crop drastically. Instead of 166 bushels of corn per acre, there will be 123.7 bushels – a 17-year low.
The total corn crop in 2011 was 13 billion bushels. Ethanol production accounted for five billion bushels last year. Already, there is pressure on Washington to cut the ethanol mandate to satisfy corn demand and control runaway prices. Whether they do or not, the simple fact is there is less corn available.
And that is exactly where we find our investment opportunity.
Cashing in On Higher Gas Prices
This year, Mother Nature has thrown a monkey wrench into the supply-and-demand equation for corn and fuel.
Less corn available for the production of ethanol means we need more crude to replace it, and that means we will wind up paying more to fill up at the pump. In 2011, a study by researchers at the University of Wisconsin and Iowa State University concluded that ethanol blending of gasoline at 10% actually lowered wholesale prices of gasoline by a whopping $1.09 a gallon!
So let’s take a look at what less ethanol in gasoline means for prices at the pump at the current price of $3.70 a gallon:
These prices assume no increase in the price of crude oil or gasoline, just a decrease in the amount of ethanol blended. Without ethanol, the price you would be paying at the pump today would be $4.79 a gallon!
Make no mistake about it, less ethanol in gasoline equals more crude oil demand. Add to that sanctions on Iran, a highly volatile Middle East and increasing demand for fuel and energy, and you have the perfect prescription for higher crude oil prices.
I expect the price of crude oil and gasoline to continue to rise over the coming months. This is going to hit consumers right in the pocketbook. However, oil refiners will be the beneficiaries of consumer woes.
Oil Refiners Will Be the Winners
This is the perfect time to buy a cheap oil-refining stock that pays a healthy dividend. Marathon Petroleum Corp. (MPC) is a refiner, transporter and marketer of petroleum products in the U.S. MPC is currently $49.50 a share. MPC is trading at seven times earnings, which is cheap! On top of that, it pays a hefty 2.8% dividend.
I would buy MPC up to $50 a share. I believe all oil-sector stocks are going to soar in the coming months. I particularly like MPC because it is trading at a significant discount based on trailing P/E and forward P/E when compared to many of its industry peers in the refining space, and it continues to pay an attractive dividend. MPC has a market cap of under $17 billion which has room to grow.
Sometimes you have to look through the forest to see the trees … or in this case, through the corn fields to see the gas pump. Unfortunately, the corn fields are sparse, and higher prices at the pump are staring us right in the face! This year’s smaller corn crop will increase demand for oil, resulting in surging gasoline prices. We will look back at the drought of 2012 as the catalyst for $5 prices at the pump.
Your eyes and ears in the commodity markets,
Andy Hecht
P.S. Oil is headed higher in the long-term no matter what happens with the corn crop, and that means good things for oil-based currencies around the world. That’s just one of the trends we’ll be talking about at next spring’s Global Currency Expo. With the future of the dollar looking grim, we’ll show you how to get your money into other currencies and investments that will provide real growth in the years ahead. To learn more about how you can reserve a spot, click here.
2012-08-20 14:03:36
Source: http://sovereign-investor.com/2012/08/20/crude-oil-prices-are-set-to-skyrocke/
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