As oil whipsaws its way toward the unheard-of-level of $150 a barrel (crude closed at $134.60 yesterday, extending a multi-day skid, but traded above $147 as recently as Friday), Americans are finally responding to the pressure of higher gasoline prices and have downshifted their consumption.

Indeed, according to a report last week, U.S. consumers used 3.3% less gasoline than at the same time last year and usage now stands at a five-year low.  Although the relative merits of slowing energy consumption is a subject upon which reasonable minds can disagree, the drop is nonetheless an extremely rare event in American economic history.

Many on Wall Street are cheering the possibility that further "demand destruction" due to soaring gasoline prices will ultimately lead to significantly lower oil prices.  After all, this is basic economics.  Prices are a function of supply and demand, and as demand drops, prices must follow. 

This is simple logic – but it’s wrongly applied.

The Global Gasoline Game

What is missing from this analysis is that oil is a global commodity, which means that its price is not simply a function of U.S. demand.  As demand is destroyed here, it is being created abroad.  The result of that swap will be an increase in oil and gasoline prices, despite the fact that Americans are using much less of both.

In countries where currencies have risen against the dollar, oil-price increases have been much milder.  Given the strengthening economies overseas, and the slower price increases in those markets, foreign demand continues to rise, just as higher U.S. dollar prices cause demand to fall here.  In addition, central banks in nations where currencies are pegged are continuing to print huge quantities of money.  This massive monetary stimulus is fueling oil demand, as foreign consumers use the new cash to buy gasoline.

And that’s not all. As economic-growth rates abroad far exceed what we’re seeing here at home, foreigners are using their newly increased wealth to buy more automobiles. So, while car sales are falling through the floor in America, they are zooming around the world.  Take a look at what is happening in Russia, where booming car sales have resulted in Russia surpassing Germany as Europe’s largest automobile market.  We are talking about the former Soviet Union, where not too long ago, many comrades still traveled in mule-drawn buggies.  So, as poor Americans drive fewer miles due to higher gasoline prices, wealthier Russians more than make up the difference.

The Ripple Effect of Reduced Demand

Here lies the source of our problems.  When the dollar was king, demand here in the U.S. market was strong. American consumers – armed with the mighty U.S. greenback – flexed their collective muscles and priced foreign consumers out of the market.

Now, however, that same greenback is little more than the proverbial "98-pound weakling," and foreign consumers are returning the favor by kicking sand in our faces.  The bottom line is this: As more goods and resources are consumed abroad, Americans will be forced to consume less. Demand creation abroad leads to demand destruction at home. There’s just no way around that fact.

But here’s what most folks fail to realize: The demand destruction in America will not be limited to gasoline, but will encompass a wide variety of resources and consumer goods, as strong demand abroad prices more Americans out of more markets.  In the end, America’s gargantuan trade deficit will return to surplus, not because of a highly over-hyped export boom, but because of an import bust.

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a regular contributor to Money Morning, and most recently wrote about why currency intervention can't help the greenback. To find out how to get a report on the once-in-a-lifetime profit plays that will emanate from the so-called "SuperCrash" - and a free copy of Schiff's New York Times bestseller "Crash Proof: How to Profit from the Coming Economic Collapse," please click here. Schiff is scheduled to be a guest on Charles Osgood's TV Show, "Sunday Morning," on CBS, this Sunday, at 9 a.m. EDT].
News and Related Story Links:

• Euro Pacific Capital Inc. Special Research Report:
  The Collapsing Dollar: The Powerful Case for Investing in Foreign Securities.

• Money Morning Special Investment Research Report:
  Special Energy Indicator Points Toward Higher Gas Prices – and a Potential 467% Profit Play.

• Money Morning Financial Analysis
  Currency Intervention Won’t Halt the U.S. Dollar’s Nosedive.

• Money Morning Financial Analysis:
  Pain at the Pump: It’s Time to Start Thinking About $7 a Gallon Gasoline. 

By Keith Fitz-Gerald
Investment Director
Money Morning/The Money Map Report

Here at Money Morning over the past six months, we’ve talked a great deal about oil and gasoline prices. We’ve offered our predictions about how high those prices were going, and have detailed a number of investment opportunities – chosen as much for their margins of safety as for their profit potential.

This time we’re going to detail three energy stocks with the potential for double-digit – or even triple-digit – profit gains. Admittedly, these are longer-shot, speculative plays. But we used a special energy indicator to help ferret out these energy plays.

This indicator is known as the “crack spread.”

In case you’ve never heard the term before, the crack spread is the difference between the price of crude oil and the value of the petroleum products that refiners can make from it. The crack spread can widen or narrow over time, depending upon various combinations of supply and demand.

If the spread is positive, that means the price of the products that result from the refining process – gasoline, diesel fuel, aviation fuel, heating oil, kerosene and asphalt, to name a few – is greater than the cost of the crude oil needed to make them. But if the spread is negative, it suggests that the cost of crude is higher than the end-game value of its derivatives.

Right now, the crack spread is narrowing. In fact, it has been for some time as governments around the world and gasoline companies actually try to hold down the pain motorists feel at the pump.

Granted, governments and major oil players make for strange bedfellows. But they have a common interest right now: Both are trying to prevent “demand destruction,” the plunge in oil demand that would result if millions of motorists – fed up with high oil and gasoline prices – just stopped driving. Governments want to prevent an economic collapse, while the integrated oil companies simply want to avoid being branded as the “bad boys” of the soaring-oil-price era – making it much easier for the incoming presidential administration to slap the entire sector with an “excess-profits tax” (something that’s already being discussed by Washington insiders).

But we can also see another scenario, one that’s very different. Peering into our crystal ball, we can see a situation in which the crack spread begins to widen, and gasoline prices run away anyway – eventually reaching $7 or even $9 a gallon.

For motorists, the pain would be excruciating. For investors, however, there’s a chance for double or even triple-digit profit gains.

Let me explain…

The Subsidy Gambit

It turns out that a number of Asian governments – most notably Taiwan, Malaysia and China, for instance – are actually reducing or eliminating fuel subsidies designed to shield their consumers from crude oil’s relentless march. Ostensibly, this is designed to control demand, but history suggests this will merely give those with the money access to increasingly large supplies that they’ll gobble up. In other words, we believe that demand may be growing fast enough to override the prices that governments around the world still believe to be inelastic.

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Combine that possible new reality with the fact that a developing Asia accounts for as much as 70% of the increase in global oil consumption, this end of subsidies would probably hammer worldwide markets, including our own.

Given that Asia represents a mere 20% of current global usage, Asia’s growth is critical to how the rest of the world uses and prices petroleum-related products – particularly gasoline. Incidentally, this stands in stark contrast to how Japan and much of Europe do things where high taxes on fuel and transportation are used to blunt demand.

The economic forces that will be unleashed when these subsidies are removed have the potential to make the Great Tunguska Blast that took place 100 years ago this month look like a wet firecracker.

Indonesia, for instance, spends nearly 20% of its budget to underwrite fuel costs and has telegraphed a 30% hike in fuel prices when those subsidies are removed. It’s much the same story in China, India and the Philippines, where separate figures for fuel subsidies are hard to come by, but where it’s safe to say that the net effect of these price controls have contributed to artificially low prices and artificially high levels of demand.

In China, where the government caps gasoline prices, for instance, motorists pay about half of what their U.S. counterparts pay. All in all, governments around the world will spend about $100 billion on oil subsidies this year – meaning about half the world’s population is benefiting from “cut-rate” petroleum prices. This year, those folks will account for all of the growth in global oil demand, equal to an additional 1 million barrels of oil per day, says Deutsche Bank AG (DB).

Now, pressure is escalating globally for countries to end the subsidies the world economy can ill-afford. The International Monetary Fund (IMF), for instance, is “calling on governments to let consumers face market prices in order to kick-start conservation and reduce official spending,” says The Christian Science Monitor.

As I hinted earlier, this change has the potential to jam a lot of consumers personally. But it would allow world markets to function as, well, markets. And that, in turn, would afford investors one of the biggest turnaround opportunities available in the energy sector today. The reason: As the subsidy removals, pricing changes and demand shifts work their way through the global economy, the crack spread would widen again… and fast.

And the biggest beneficiaries could well be the oil refiners, which have seen their profits get zapped along with crack spreads in the past year.

The Best Way to Play the Shift From Subsidies

If there is a sector turnaround, the upside could be huge. And the three firms in line to benefit are Western Refining Inc., Valero Energy Corp. and Holly Corp. Let’s take a closer look at each of the three:

• Western Refining Inc. (WNR): The El Paso, Tex.-based Western is an independent crude-oil refiner that owns and operates four refineries, and that also owns and runs 155 retail service stations and convenience stores in the Southwest. Although Western’s shares rose 77 cents each, or nearly 7.1%, to close at $11.66 yesterday (Thursday), the stock is down 82% from its 52-week high of $66.13. Independent researcher Soleil Securities Group Inc., this week initiated coverage of Western with a “Sell” rating and a target price of $8, contending that the company is highly leveraged and has seen its shares suffer in concert with its peers as part of a general sector downturn. That underscores the sentiment these companies face. But a return to its 52-week high would represent a 467% gain.

• Valero Energy Corp. (VLO): The San Antonio, Tex.-based Valero Energy owns and operates a total of 17 refineries spread across the United States, Canada and Aruba, and its products run the petrochemical gamut. At yesterday’s closing price of $44.42, Valero’s shares are down 44% from their 52-week high of $78.68. A return to that 12-month peak would represent a gain of 77%.

• Holly Corp. (HOC): The Dallas, Tex.-based Holly is another independent petroleum refiner that focuses on such “light” products as gasoline, diesel fuel and jet fuel. It operates several refineries, about 900 miles of crude-oil pipelines, and a number of other operations. At yesterday’s closing price of $40.44, Holly’s shares are down 50% from their 52-week high of $80.55. If the shares were to bounce back to that 12-month peak from yesterday’s close, investors would reap a return of 99%.

Clearly, these aren’t “slam-dunk” stock picks. But volumes are going up and many of the sector players have been beaten down to bargain-basement levels not seen in years.

Besides, for a shot – even a long shot – at a 467% gain, investors can afford to be somewhat patient.

News and Related Story Links:

• The Christian Science Monitor: Subsidies:
  A Big Culprit in High Gas Prices.

• Money Morning News Analysis:
  Pain at the Pump: It’s Time to Start Thinking About $7 a Gallon Gasoline.

• Wikipedia:
  The Crack Spread.

• Money Morning Investment Analysis:
  Two Ways to Profit as China and Japan Quietly Forge the Most Powerful Trading Alliance in the World.

• Wikipedia:
  Demand Destruction.

• Briefing.com:
  Short Stories (WNR).

• Wikipedia:
  Tunguska Event.

• Money Morning Special Investment Report:
  Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

U.S. consumers barely had time to get used to the idea of $4 a gallon gasoline before prognosticators started talking about $5 a gallon fuel.

And unfortunately for the U.S. economy, the worst is yet to come.

The average price of gasoline in the United States broke $4 a gallon for the first time Sunday, following a double-digit surge in oil prices last week. And despite an economy that appears to be in an increasingly fragile state, experts are already debating the potential for gasoline to hit $5 this summer.

But here’s what most economists aren’t saying yet: U.S. motorists could easily be looking at $7 a gallon gasoline within two years. And that could have a disastrous impact on the U.S. economy.

“The bottom line is that the effect on the economy is going to be a lot worse than anyone’s talking about right now,” said Money Morning Investment Director Keith Fitz-Gerald, a longtime energy bull who recently boosted his oil-price projection to $225 a barrel. “The bottom line is this: Until someone develops a truly [interchangeable] alternative for oil and gasoline – something that works the same, costs the same and is just as effective – Americans are just going to have to face the fact that over time they’re going to pay more.”

First Stop: $4

According to a new survey by the national automotive group AAA, unleaded regular gasoline reached a national average of $4.005 a gallon on Sunday, up from $3.67 a month ago and $3.10 a year ago.

The Lundberg Survey, a systematic review of prices at 7,000 gas stations nationwide, last week indicated that the retail price of a gallon of gasoline had reached $3.9985, an increase of 20.5 cents a gallon since the middle part of May.

Gas prices are up 89 cents a gallon from a year ago.

The main culprit for the price increase has been the meteoric rise in oil prices, which have soared 110% in the past year. According to the U.S. Energy Department, the cost of crude accounts for 73% of the price of gasoline. For this reason, many experts anticipate that the price of gasoline will continue to rise in near lockstep with the price of oil.

“We can expect some further increases at the pump,” Trilby Lundberg, editor of the Lundberg Survey, told Reuters. “If crude oil prices stay at nearly $139 a barrel, a 30-cent rise [for a gallon of gas] over the next few weeks is possible.”

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Gas prices are already nearing $4.50 a gallon in many parts of California. Motorists in San Francisco are currently paying an average of $4.42 a gallon. In Oakland they’re paying $4.39 and in San Jose $4.40, the San Francisco Chroniclereported yesterday (Monday).

Over the weekend, several cable TV news broadcasts even showed sections of California where gasoline prices were approaching $5 a gallon. In Southern California, some motorists are actually driving down to Tijuana, where gasoline is $2.75 a gallon – compared to the $4 a gallon or more they pay near home.

For truckers who use diesel fuel, the difference is even more dramatic: In California, diesel is averaging $4.71 a gallon. In Mexico: It’s $2.10.

Why the disparity? In Mexico, gasoline stations operated by the state-run Petróleos Mexicanos – better-known as Pemex – everywhere are selling regular gasoline for more than $1 a gallon less than in the United States.

So far, analysts are divided on whether the average U.S. gasoline price will hit the $5 mark this year. There’s a case to be made either way.

The Case for $5 Gas

Analysts estimate that for every $1 increase in the price of oil, gasoline prices rise 2.5 cents. And while crude futures retreated from their record high levels yesterday, the long-term outlook is for higher gas-and-oil prices.

Since 2005, global oil production has remained stagnant, but demand has increased exponentially. Even if American consumers are unwilling to pay $4 a gallon for gasoline, and U.S. demand plummets, global demand will continue to escalate.

Eduardo Lopez, an analyst with the International Energy Agency, told The Independent that America’s role as the global arbiter of oil prices – the United States consumes one out of every four barrels of oil used worldwide – is ebbing.

“Demand is coming from emerging markets. As long as the [United States] doesn’t collapse, it doesn’t really matter if the mature economies are slowing,” Lopez said.

While the International Energy Agency expects demand in industrialized countries to decline by 0.7% (about 300,000 barrels of oil per day) this year, the Paris-based group says oil consumption in the rest of the world will grow by 3.7% (1.4 million barrels a day).

China’s net oil imports totaled 44.95 million metric tons in the first quarter, up 15%, and net imports of oil products rose by 32% from a year ago, according to the Asian nation’s General Administration of Customs.

Meanwhile, India is expected to overtake the United States, Japan and China as the world’s leading net importer of oil by 2025. Since 1997-98, alone, India’s petroleum imports have almost tripled.

In 1970-71, India was importing 11.66 million metric tons of crude oil. By 2005-06, however, the imports had increased to 99.40 million metric tons, the Economic Times reported.

Together, China and India will account for 45% of the increase in global primary energy demand through 2030. The two countries’ net oil imports are expected to jump from 5.4 million barrels a day in 2006 to 20 million barrels a day in 2030, which could create a “supply crunch” as early as 2015 according to the IEA.

Many other developing nations throughout the Middle East and Latin America are also consuming more oil.

“This a world oil market,” Severin Borenstein, a business and public policy professor at the University of California-Berkeley, told the San Jose Mercury News. “A lot of smaller countries want oil more oil, so it’s hard to point to [China and India] as the boogeyman.”

Like Money Morning’s Fitz-Gerald, Borenstein expects gas to cost between $6 and $7 a gallon by summer 2010.

The Case Against $5 Gas

Other analysts point to declining demand throughout the United States, arguing that cash-strapped consumers will opt to leave their car in park.

“Five dollars? I don’t see it happening,” Denton Cinquegrana, who tracks West Coast gasoline markets for the Oil Price Information Service, told the San Francisco Chronicle.  “Demand is just so [lousy] right now.”

For the Memorial Day holiday week – the official start of the summer driving season — U.S. gasoline demand fell 4.7% from a year earlier, according to the Energy Department. And in the past four weeks, the country has used 1.6% less gasoline than a year ago, the Energy Information Administration reported.

A survey of 43,000 people nationwide was recently conducted by the market researcher, The NPD Group, which found that high gasoline prices had induced 12% of respondents to cancel planned vacations. And about the same amount have tried carpooling as a means of coping with those higher fuel costs.

Also, 6% of those surveyed tried telecommuting, 5% started working closer to home, and 8% started using public transportation.

Another 6% of respondents already had purchased vehicles that were more fuel-efficient.

Indeed, year-over-year sales of hybrid cars surged 25% during the first four months of 2008. And the trend only grew stronger in May, when sales jumped 58% – outpacing a gain of 18% in April, the Los Angeles Times reported.

Meanwhile sales of pickups dropped 16.8% in the first four months of the year, Autodata Corp. reported. Sales of SUVs dropped 9.9% and luxury vehicle sales fell 12.9%. Sales of small cars, on the other hand, rose 7.5%

Additionally, U.S. gasoline supplies may increase over the next month as profit margins for refiners increase. For several months, the price of gasoline lagged behind the price of oil, so refiners were paying more for oil. But those higher costs were not yet being passed on to the consumer. As a result, turning oil into gas became far less profitable, forcing refiners to cut back on capacity.

Last month, U.S. refineries cut their utilization back to 85%  – down from 89% a year ago. And that’s during a part of the year when utilization is typically 95%. Why the drop? Refineries wanted to draw down gasoline inventories to drive up the price of gasoline.

Gasoline supplies are expected to increase over the next month as refiners boost production to take advantage of the fatter profit margins they’re earning. The margin for turning one barrel of oil into one barrel of gasoline has increased 22% since May 1 to $10.467 a barrel, according to Bloomberg.

Consequences for the U.S. Economy

While there may be room for debate about whether gas will hit $5 a gallon, there is a relatively strong consensus that higher gas prices are threatening the U.S. economy.

The Reuters/University of Michigan consumer confidence index fell again in May, down to 59.8 from April’s reading of 62.6. The index is at its lowest level since June 1980.

“Consumers are painfully aware that their living standards are shrinking under the weight of higher food and fuel prices and see little hope for improvement anytime soon,” Richard Curtin, the director of the Reuters/University of Michigan survey, said in a May 30 statement.

Unemployment added to those concerns after the Labor Department late last week reported that the economy lost 49,000 jobs in May, taking the unemployment rate up to 5.5%.

“The fact that confidence has gone down as inflation expectations are going up indicates gasoline has been an important driver because it’s one of the reasons expectations are rising,” Nigel Gault, chief U.S. economist at Global Insight Inc., told Bloomberg News.

Gault estimates that every 20-cent increase in the cost of gasoline shaves 0.3% off consumer spending growth.

This is all bad news for an economy that was already flirting with recession. If food and energy prices don’t subside and consumer spending continues on its downward trajectory, analysts may not be just be talking about inflation anymore, but rather stagflation [For an in-depth look at stagflation in today's issue of Money Morning, please click here].

“What we’re seeing here is a lot of additional pressure on a consumer sector that was soft to begin with,” Joseph Careson, an economist with AllianceBernstein Holding LP (AB), told The Wall Street Journal. “Is it a tipping point by itself? It’s close.”

The “Worst” Case

By fixating on near-term prices, and near-term fallout, Money Morning’s Fitz-Gerald says that investors and economists alike are missing the bigger point: Long-term – or at least until a true replacement for oil is found – the U.S. economy is going to be badly stung, and U.S. consumers who don’t take steps to protect themselves are looking at a markedly reduced standard of living.

As the post-Memorial Day hangover lingers, and $4 per gallon gasoline becomes a national reality, expect more and more daily energy prognostications.

Goldman Sachs Group Inc. (GS) already is on record for $200-a-barrel oil. As you all know, our own Keith Fitz-Gerald – Money Morning’s investment director – has projected a crude-oil price of $225 a barrel. Do I hear $250?  What about $5 a gallon gasoline by July 4th?

Sometimes, these daily price gyrations take on lives of their own, but at the end of the day, the basic laws of supply and demand always work themselves out.

The upcoming week’s hectic economic calendar could go a long way to clarifying the "Are we in a recession, yet?" discussion.  Crucial news from manufacturing and labor highlight the week and any renewed strength in these sectors could put an end to the "R" talk for the time being (or until next week). In fact, the National Association of Business Economic forecast 0.4% economic growth for the 2nd quarter and a much stronger 2.2% gross domestic product (GDP) pickup in the 3rd quarter as the U.S. Federal Reserve and those tax rebates begin to work their ways through the system.  Suddenly, economists are projecting a rebound and cries of recession have become somewhat muted (and replaced by cries of inflation). 

Market Matters

Now that Memorial day has come and gone, investors seem to be monitoring the daily energy trades even more closely than usual (if that is possible) for signs that prices have peaked and Americans will be able to afford summer travel again.  Well, in the aftermath of the holiday, gas prices actually continued their trek toward that dreaded $4/gallon level and hit a new national average of $3.96 late in the week.  In fact, 11 states and the District of Columbia already are reporting average prices at the pump in excess of that psychological barrier. 

While crude prices fell from last week’s record highs of $135/barrel, the ongoing "supply/demand vs. speculation" debate rages on.  In one corner…The Department of Energy said that exports from the top oil producers dropped by 2.5% in 2007 and are on pace for a similar showing this year.  While much of the increased demand focus has been on China, oil consumption throughout the Middle East (and Saudi Arabia, in particular) has skyrocketed in recent years, thus, leaving less to export and meet the growing demand abroad.  On the flipside, conspiracy theorists cry wolf that prices have been running without any regard to true supply/demand issues.  They point to escalating trades in commodity (petro) futures indexes and make Internet bubble comparisons (remember those fun days?) as explanations for the wild price swings.  This week, the regulators got involved (typically a day late and a dollar short) as the Commodity Futures Trading Commission initiated a probe into potential market manipulations by energy insiders. 

And suddenly those increased water cooler discussions about the dreaded "I" word are starting to move from speculation to reality.  Dow Chemical announced a 20% across the board price increase to "mitigate the effects of raw material costs." German-based DHL soon will be "outsourcing" its North American delivery biz to competitor UPS as its seeks to reduce costs.  Discounter airline JetBlue will not be adding to its fleet as expected because it too suffered the ill-effects of rising fuel prices that have prompted major changes throughout its industry (can you say consolidation?).  Likewise, automakers continued to struggle from consumer activity (rather inactivity) as both Ford Motor Co. (F) and General Motors announced major reductions to their respective workforces.  Apparently, the "rich and famous" have been impacted far less than others as Polo Ralph Lauren and Tiffany both reported better than expected quarterly earnings.  Even Dell Inc. (DELL) surprised many analysts with a solid quarter on strong sales in Asia.  Turning to financials, shareholders finally approved the JP Morgan Chase & Co. (JPM) acquisition of The Bear Stearns Cos. (BSC) (like they had much of a choice), though $10 a share is a far cry from the $170 the stock traded at in early 2007. 

Investors took their clues from declining crude prices this week and again looked for value in the equity markets.  The major indexes traded higher (often at the expense of fixed income).   In fact, the yield of the benchmark 10-year drifted back above 4.0% for the first time in about five months as talks of inflation seemed to overshadow prior recessionary fears (see below).  Still investor sentiment can change on a dime these days and next week brings significant economic releases that are sure to be over-analyzed.  Until then, happy motoring (at $4/gallon). 

Economically Speaking

If the consumer truly accounts for 2/3 of the growth of the economy, the latest confidence readings cannot be good news.  The Conference Board reported that its confidence index fell for the 5th consecutive month to its lowest level in almost 16 years.  Meanwhile, the competing U. of Michigan sentiment survey plummeted to a 28-year low. (So, whatever your index of choice…the consumer appears to be in hibernation.)  Then again, what consumers SAY and what consumers DO are often two very different things.  Of note, orders for durable goods dropped by 0.5% in April; HOWEVER, once aircrafts and autos were factored out of the equation, sales of these high ticket items actually rose by 2.5% last month.  In fact, orders for appliances and electrical equipment surged by over 25%, the best reading ever reported.  Overall consumer spending also increased in April, though the naysayers quickly point out that much of the gains were reflective of higher prices as opposed to increased sales.  (Bear in mind, any over-analysis of the data can lead to a variety of diverse and confusing conclusions about consumer activity…so pick your poison, but don’t read too much into any one number). 

This past week also found the revision of the 1st quarter GDP which had initially been reported as growth of 0.6% during the January through March months.  Again, the pessimists in the bunch claimed that recession already was in our midst, and (by true definition) two consecutive quarters of negative activity were closing in.  Instead, the revised GDP reflected a 0.9% gain in the 1st quarter, a weak showing by any measure, but still positive and far from recessionary. 

News and Related Story Links:

• Money Morning Special Investment Research Report:
  Money Morning Boosts Oil Target Price to $225 a Barrel, Thanks to Continued Scarcity, Burgeoning Demand in China.

By Jennifer Yousfi
Managing Editor

Back when it was Esso, the Exxon Mobil Corp. (XOM) predecessor urged motorists to “put a tiger in your tank.”

These days, consumers probably feel more like they’ve got a tiger by the tail.

And they should, for their family budget is certainly getting mauled.

Retail gas hit its 22nd consecutive daily high yesterday (Thursday), according to AAA’s Daily Fuel Gauge Report.

The average nationwide cost for a gallon of regular unleaded was $3.952, while the average cost for a gallon of diesel was $4.787.

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According to the AAA survey, gas prices have increased nearly 10% from a month ago and are up almost 24% from one year ago, CNNMoney.com reported.

Connecticut has the highest average by state at $4.223 for a gallon of regular, while Missouri has the lowest at $3.761.

The average cost of gas has crossed the $4 threshold in 11 states and Washington, D.C.

The cost of gas has climbed steadily higher, following in the wake of soaring oil prices. Oil reached a record high of just above $135 per barrel on May 22, but since then the price has dropped.

Crude oil for July delivery fell $4.31, or 3.3%, to $126.72 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange, according to Bloomberg data, as the high cost of gas is finally acting to curb consumer demand.

“There’s a lot of demand destruction taking place,” Nauman Barakat, senior vice president of global energy futures at Macquarie Futures USA Inc. in New York, told Bloomberg News. “We are probably headed for $120 in the near term.”

But the slight reprieve we’re currently experiencing is likely to reverse itself just as quickly as we head into the summer driving season and speculators continue to push up the price of “black gold.”

Both Goldman Sachs Group Inc. (GS) and JPMorgan Chase & Co. (JPM) recently released reports that have oil soaring over $200 a barrel within the next two years.

Money Morning Investment Director Keith Fitz-Gerald – one of the first investment gurus to predict triple-digit oil prices – has boosted his own target, suggesting that oil could go as high as $225 a barrel.

“The math is really simple here,” Fitz-Gerald said in a recent e-mail interview from China. “We are burning through supplies at a rate that’s four times to five times faster than we’re discovering new reserves. Throw in a few [surprises]… perhaps a terrorist event… and add in the accelerating use of oil and gasoline in Third World countries, and we have the recipe for far higher prices.”

News and Related Story Links:

• CNNMoney.com:
  Record gas prices: 22 straight days

• AAA’s Media Site for Retail Gasoline Prices:
  Daily Fuel Gauge Report

• Bloomberg News:
  Oil Falls More Than $4 as Fuel Demand Drops, Dollar Rallies

• Exxon Mobil Corp:
  Corporate History

• Wikipedia:
  Esso

The price of gasoline across the country hit a record high yesterday (Tuesday), and some analysts believe motorists could be paying upwards of $3.75 a gallon in the near future.

Prices at the pump rose to a record national average of $3.2272 a gallon yesterday, topping the previous record of $3.2265 set last May, the Oil Price Information Service and AAA reported. The price of gas has risen 26 cents in the last month, tracking the meteoric rise of oil prices, which have stormed to record highs as well.

Several regions of the country are already seeing gas prices over $4.00 a gallon, leading many analysts to predict the national average will peak between $3.50 and $3.75.

The price of gas usually rises this time of year as refineries reduce output for routine maintenance and switch from winter to summer blends just in time for the busier driving seasons. However, experts say the spike will be more pronounced this year because of oil’s soaring price tag and attempts by refiners to increase profit margins.

Crude delivery for April rose as high as $1.82 (1.7%) to $109.72 a barrel in electronic trading on the New York Mercantile Exchange yesterday, the fifth record high hit in as many trading days. Oil, which accounts for 80% of the price of gasoline, is up 13% this year. Oil has surged 80% in the past year, significantly outperforming all three major U.S. stock indices.

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While oil prices erupted over the past year, gas prices remained relatively stagnant, sharply reducing refiners’ profit margins. John Kilduff, an energy analyst at MF Global Ltd. (MF), told CNN that refiners are making about $6 off of every barrel of oil they turn into gasoline, as opposed to $38 a barrel last spring. Kilduff attributed a 5% drop in refining capacity to the unimpressive profits many refiners are seeing for gasoline.

"There’s no market incentive to rush your unit back into production," he said, "[Gas prices] can’t go any lower in relation to crude."

While Kilduff and others see gas building on its record, they also see the price peaking relatively quickly in April or May, and adjusting for underlying fundamentals that don’t support such high prices.

A report from the International Energy Agency due at 2:30 pm ET today (Wednesday) is expected to show an increase of about 1.9 million barrels in the week to March 7, Thomson Financial News reported.

The IEA announced a reduction in its forecast for 2008 global oil demand for a second straight month yesterday. The IEA cut its 2008 forecast by 80,000 barrels a day to 87.54 million barrels
.
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Despite recession fears and a temporary pullback in the price of oil, gasoline prices will likely tease record highs even before the summer driving season kicks back into gear.

The price of crude oil accounts for more than 55% of the retail price of gasoline, according to the federal Energy Information Administration. So it came as no surprise that – as oil breached the $100 a barrel mark earlier this month – gas prices soared up over the $3.00 a gallon level.

However, fears of a recession and slumping demand slowly weighed on oil prices, and gasoline followed suit. The Lundberg Survey, which tabulates the prices at about 5,000 gas stations across the country, found that average retail gas prices have fallen 9.43 cents a gallon in the past two weeks. The price of gas had risen in each of the three prior weeks.

Survey Publisher Trilby Lundberg attributed the decline to sagging oil prices and shrinking profit margins among refiners and retailers. But Lundberg doesn’t think that prices will fall much further.

"Retail gasoline prices will probably hover around this level – just under $3 per gallon – for perhaps up to a month," she predicted. And even if oil prices don’t rise during that time, "there will be big pressure on gasoline prices to go up because our spring demand will pull it up."

Even though supplies are sufficient to meet demand, "When consumers soak up that extra supply, prices will stop falling and be on the rise, possibly to a dramatic degree," Lundberg added.

While slumping consumer spending and rising unemployment will threaten demand for both oil and gasoline, it’s likely that the Organization of Petroleum Exporting Countries will scale back its production over the next few months as evidence of an economic slowdown continues to emerge. For that reason, few analysts believe gasoline will drop much further than $2.50 a gallon, from its current price around $3.00.

In the short term, fears of a slowing economy, or even an outright recession, could cause gas prices to fall and range between $2.50 and $2.80 over the next few weeks, Tom Kloza, chief oil analyst at Oil Price Information Service, told CNNMoney.

But after that, Kloza expects gas prices to surge again to reach a new record of more than  $3.22 a gallon in the Spring, whether there is a recession or not.

"The same things that make the rally every spring are still there," he said.

That includes a drop in inventories as refiners switch to summer blends, and increased demand heading into the heavier summer driving season.  Also, a lack of refining capacity is beginning to take its toll, as there hasn’t been a refinery built in the United States in roughly 30 years.

Nor is it likely that OPEC will come riding to the rescue, either. Crude oil hit $100 a barrel earlier this month, but the price has slipped significantly since, as the strength of the U.S. economy begins to wane.

And as U.S. Federal Reserve Chairman Ben S. Bernanke and central bank policymakers issued an emergency three-quarter-point rate cut a week ago (Jan. 22) and the stock markets sputtered, the price of oil dropped to a low of $86.11, before settling at $89.85 a barrel on the New York Mercantile Exchange.

OPEC doesn’t want prices to rise so high that it weighs down global growth and further erodes demand, but if it increases its output – and the world economy stalls anyway – oil prices could collapse.

The bottom line: OPEC will continue to maintain that bottlenecks in refining, a falling dollar, and speculative investing are the reason for high oil prices, not a lack of crude. An Energy Department report released today shows that U.S. crude inventories rose in the week ended Jan. 25 rose 1.8 million barrels.

Additionally, the average price OPEC charges for oil has dropped in each of the past three weeks. After hitting a record high of $93.78 a barrel Jan. 3, the price has dropped to $85.07 per barrel, according to Xinhua, the state-run China news agency.

Given that global growth is going to slow anyway – and the cartel’s profits already are destined to shrink – it’s unlikely that OPEC will open up its spigots. And given that OPEC provides the world with 40% of its oil, that will affect crude oil prices.

The leaders of OPEC-member nations are set to next meet in Vienna on Friday.

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Russia, Turkmenistan and Kazakhstan signed an agreement yesterday (Thursday) to begin construction on a natural gas pipeline along the Caspian Sea.

The move is a huge blow to the United States and Europe, who were encouraging the former Soviet republics to build a pipeline under the Caspian Sea and bypass Russia.

The project had stalled because of a dispute involving the price of gas, but Russia’s state-owned energy giant OAO Gazprom finally gave in to Turkmen demands, agreeing to pay $130 per 1,000 cubic meters of natural gas in the first half of 2008, and $150 in the second half.

"We have just signed an extremely important agreement between Russia, Kazakhstan, and Turkmenistan, on building the Caspian pipeline," Russia’s President Vladimir Putin announced. "It will become a new, important contribution of our nations into strengthening the European energy security."

What he really seems to mean is that the deal will strengthen his grip on European energy security. Gazprom already supplies 25% of Europe’s gas. It also hikes prices and threatens to cut supplies on a fairly routine basis.

In August, Gazprom threatened to cut off gas supplies to Belarus in an attempt to extort payment on a $456 million debt. Belarus eventually acquiesced with a $190 million payment. Two months later, Gazprom threatened to cut supplies to the Ukraine over a $1.3 billion debt.

Prospects for a pipeline under the Caspian Sea, which would act as an alternative, were made bleak by environmental concerns, high costs and territorial and resource disputes among countries in the region. 

Russia, Iran, Kazakhstan, Turkmenistan and Azerbaijan failed to agree on a fair allocation of the sea’s resources at a summit in Tehran several months ago.  In the meantime, Russia and Iran have made it clear that outside powers (i.e. the United States) should not be tempted to intervene in the conflict.

Putin has stressed the point that that all pipeline projects should require approval from all five nations. He has also registered his opposition to U.S.-backed efforts to build pipelines that would avert Russia while delivering Central Asian hydrocarbons to the West.

Turkmenistan has the second largest natural gas reserves in the former Soviet Union. It currently ships gas to Russia through a pipeline that has an annual capacity of 50 billion cubic meters. The new pipeline would have an initial annual capacity of at least 20 billion cubic meters. Completion of the pipeline is expected by 2010.

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MGM Mirage (MGM) will partner with the Mubadala Development Co. to develop the MGM Grand Abu Dhabi resort.

This latest MGM-headed project is projected to cost $3 billion and will be owned by Mubadala, which is wholly owned by the government of Abu Dhabi. MGM Mirage will develop and manage the project for a fee. The property, aimed at the high-end market, will have "unparalleled views of the city skyline" and "stunning panoramic views of the waterfront," the companies said in a joint statement.

The project should open in 2012.

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The 50-acre development on a waterfront site on Abu Dhabi Island will hold a non-gambling MGM Grand hotel, as well as two additional luxury hotels – giving it 1,200 luxury rooms. The MGM Grand Abu Dhabi also will feature an arena with up to 12,000 seats, restaurants and retail locations, high-dollar waterfront residences, private-yacht slips, and other entertainment-related facilities.

That 50-acre project is actually the first of three phases, and could create a project that ultimately covers 150 acres.

"We are thrilled that our first project with Mubadala will create a destination and icon for Abu Dhabi," MGM Chief Executive Officer Terry Lanni said when the project was announced.

The deal comes after Dubai World, a holding company for the Persian Gulf state, recently acquired a nearly 5% stake in MGM, and agreed to pony up $2.7 billion for a 50% stake in CityCenter, a 76-acre development in Las Vegas slated to open by 2009. Dubai World’s private-equity arm, Istithmar, is also involved in a joint venture with MGM and Kerzner International Holdings Ltd. to develop a multibillion-dollar Las Vegas resort that also is slated to open in 2012.

The arena at the MGM Grand Abu Dhabi will likely host well-known performers from the Middle East region, as well as well-known Western acts that often appear at MGM Mirage’s casino properties in Las Vegas – such as headline pop-music stars, and such as headline acts as Cirque du Soleil.

Sales of the luxury residential sites – apartments and villas – will help offset construction costs. That’s just what’s happening with the CityCenter project, where $3 billion of the $7.8 billion in construction costs are being offset by residential-property sales.

Abu Dhabi, the richest of the oil-laden United Arab Emirates, has a large expatriate population, and is aiming to transform itself into a global tourist destination.

Alcohol will be served throughout the complex, but some Las Vegas offerings, such as the Crazy Horse Paris topless revue at MGM Grand, will not be part of the plan.

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Shares of PetroChina Co. Ltd. (PTR) soared during its Shanghai initial public offering yesterday (Monday), making the state-owned oil and gas giant the largest company in the world by market capitalization. The Beijing-based company raised $8.94 billion, driving its total market value north of $1 trillion.

PetroChina is now twice the size of Exxon Mobil Corp. (XOM), which was worth $480 billion at the close of trading Monday.

With such an exorbitant valuation, market-watchers are growing more fearful of a China-based asset bubble that’s posing a threat to that nation’s continued economic advancement.

For decades, savings accounts with low interest rates were the only savings vehicles China’s consumers had available. Suddenly, the stock market is open to them – and at a time when share prices are soaring. The net effect has been to create a speculative culture not unlike the one that fueled the dot-com boom here in the United States in 1998 to 2001 – an investment mania whose implosion tipped the U.S. economy into a fairly rough recession. A booming stock market in China has fueled that speculative fervor.

China’s state-run media has reported that the number of share trading accounts now exceeds 100 million. According to the state-run Legal Daily, investing has become so popular in Wenzhou, one of China’s richest cities that the government had to ban public officials from trading at work or from leaving work to conduct trades.

All of the excitement has resulted in a massive run-up in stock shares, and fueled some highly successful IPOs, some of which are increasingly overvalued. China’s CSI 300 stock index has nearly quadrupled in the past year, and is currently trading at 42 times projected earnings, according to the International Herald Tribune.

"There is an accumulated desire to invest," Li Hongtao, an analyst with the Zhejiang Yongan Futures Company, told the International Herald Tribune. "People are heavily influenced by their families, friends, and colleagues at work. A lot of them don’t have any knowledge of the market or any idea of the risk."

It is that level of investor enthusiasm – perhaps even euphoria – that has flooded the Chinese market with excess wealth and liquidity. The value of mainland China’s public offerings this year has hit a record $61 billion. By comparison, listings in the United States and the United Kingdom have generated $51 billion and $43 billion respectively. 

As a result China is now home to five of the world’s ten largest companies. By market capitalization, it has the biggest bank, insurance company, telecommunications carrier, airline, and now energy company. Unfortunately, bigger doesn’t necessarily mean better…

Thanks to PetroChina’s wildly successful IPO, its mainland shares are trading at a 150% premium to its Hong Kong shares. And while the company may be worth twice as much as Exxon Mobil, it is half as profitable. In the first six months of 2007, PetroChina’s net income was $10.9 billion, while Exxon Mobil raked in $19.5 billion. 

"They are not of the strength of Exxon Mobil," John Vautrain, senior vice president of Purvin & Gertz, an energy economics consultancy based in Singapore, told IHT. "They are very strong in China and that is good if you make money, but China is not a good place to be a refiner at the moment. They are deeply underwater, losing a lot of money in refining."

Gains in PetroChina’s shares in Shanghai have more to do with China’s investors chasing returns than it does the outlook for the company’s exploration and production operations, or its refining business, Larry Grace, an oil analyst at Kim Eng Securities Co. in Hong Kong, told Bloomberg News.

"Production is static with limited upside for the next three to four years. As for the downstream, the price controls and overall regulatory trend limit the company’s earnings," Grace said.

China controls fuel prices to shield consumers in the world’s most-populous nation from accelerating inflation. The policy limits the ability of PetroChina and other state-owned energy companies to pass on the burden of higher crude oil costs. The losses are even more devastating now that oil is trading above $96 a barrel.

Warren Buffett, chairman of Berkshire Hathaway Inc. (BRK.A, BRK.B), didn’t hesitate to dump his 2.34 billion shares earlier this year.

"It’s easy to be carried away in the stock market when things are going very well," he said during an interview in the northern Chinese city of Dalian, during a recent visit to China. "We at Berkshire never buy stocks when we see prices soaring."

Buffett just announced that he’s taken positions in some-20 companies in Korea, a market with much lower valuations.

Other investors have followed Buffett’s lead and sold off their China holdings. Indeed, shares of PetroChina fell the most ever in U.S. trading Monday, after Bear Stearns Cos. Inc. (BSC) recommended investors sell the shares because they were too expensive compared with rivals such as Exxon Mobil.

"We see little fundamental reason why PetroChina should outperform other Chinese oil companies or even the China market," Bear Stearns analyst Adam Clarke wrote, citing record oil prices and the company’s completion of the biggest share sale this year.

PetroChina’s New York shares slid almost 13% Monday, dropping $32.96 each to close at $222.10. In Hong Kong, the stock dropped 8.2% to HK$18.

The iShares FTSE/Xinhua China 25 Index exchange-traded fund (FXI) – an ETF viewed as a proxy for the broader China stock market – fell 8.78%, or $18.28 a share, to close at $189.81 yesterday. The FXI ETF is down 14%, or $29.75 a share, from its 52-week high of $219.56.

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