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Demand weak, but gas prices heading to $4, anyway

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(Read caption) Chris King fills up his truck at a gas station displaying a price of $4.59 for a gallon of self-service regular gas last week. Gas prices have spiked between 57 and 59 cents over the past 30 days in California, although national prices remain below $4 a gallon.

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Motor gasoline appears headed to $4 a gallon at the pump. The main catalysts appear to be higher Brent crude prices and limited refining processing capacity on-line. 
 
It's not demand that's driving energy prices higher. Indeed, if it were, we would have a double tailwind, and energy prices would be more reminiscent of early 2008. No, demand remains weak. Keep in mind that nearly 50% of our overall energy consumption is driven by transportation fuels, and in turn, transportation fuels are nearly 100% crude-based. 

Motor gasoline demand, a major indicator for total energy demand and for economic growth, continues to be weak. Demand has fallen successively lower each year since April of 2007; even as the EIA reports that U.S. retail gasoline demand is higher by 2.0% on a four week average, 2012 compared to 2011. 

To offset weak refined product demand at home, U.S. refiners have nearly doubled product exports, particularly to Latin America - Brazil and Mexico in that order. 

While crude imports have dropped 16% from their recent high in June of 2012. Retail gasoline prices are moving higher propelled by a rise in crude prices.

Higher energy prices appear set to derail the fragile U.S. economy once again as they did in 2008 and 2011. 

Looking at data since 2011, gasoline prices headed toward $4.00 a gallon three times: May 2011, April 2012, and September 2012. However, each of those times, gasoline prices were not sustainable at that level and quickly moved lower. It would appear that demand destruction begins to set in as prices reach $4.00/gallon; as gasoline demand moves sharply lower, and the S&P 500 index also moved in tandem sharply lower. 

Right now, during the last three weeks in February, the S&P 500 index appears to have flattened out and looks set to roll over. Likewise, the energy sector's index, the XLE, appears to also have flattened out. 

Noteworthy, is that when gasoline prices move closer to $4.00, the WTI-Brent spread has been under the $20 per barrel (bbl) differential, and right now, the spread is hovering at $20/bbl. Should the WTI-Brent spread tighten under $20 this would crimp refining profits, and limit the upside to refiners' share prices. 

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Other immediate headwinds to energy equities are a stronger U.S. dollar and the "political" noise impacting markets regarding the impending Federal government "sequester" spending cuts. Right now, the investing bias should be to manage the downside risk, and let these headwinds play out and look for energy investment opportunities at lower price levels.

– This article originally appeared in Energy Trends Report, a free subscriber-only newsletter that identifies and analyzes financial trends in the energy sector. It's published by Energy Trends Insider.

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