R-Squared Energy Blog

Pure Energy

Gasoline Prices Part II: Long-Term Factors

Introduction

In Part I, I discussed the short term factors that have resulted in the recent, rapid increase in the price of gasoline. But there are a number of underlying, long-term issues that have been major contributors. I will attempt to address them and answer a number of related questions, such as: Why have no new refineries been built in the past 30 years? Are U.S. refineries breaking down more than normal? Are oil companies purposely withholding supplies to keep prices high? Have environmental regulations played a role? Does the use of ethanol influence gasoline demand growth? The answers to some of these questions may surprise you.

Please note that my essays should not be confused with financial advice. Following Part I, I received a number of e-mails requesting financial advice. While there are often potential financial implications, I am not a financial planner. If you choose to make investment decisions based on what you read here, you are on your own.

Further note that it is not my contention that refiners are not benefiting from higher prices. They are. But my contention is that prices aren’t higher because they have increased margins. Margins have increased because prices are higher.

U.S. Refinery Capacity

The problem, I have read on many occasions, is that we aren’t building any new refineries, and that “limiting refinery capacity seems to make more money for oil companies than expanding it.” Claims like the following from the Foundation for Consumer and Taxpayer Rights – are quite common:

America’s big oil companies figured out long ago that they could make more money by making less gasoline. That’s why the industry hasn’t built a new refinery in 30 years. Since deregulation of the refinery business in 1982, oil consumption has increased 33% but oil companies have kept refining capacity near what it was 25 years ago. Why not? They know that the scarcer the product, the bigger the profit.

Even members of the Senate Committee on Energy and Natural Resources seem to believe this, with New Jersey Senator Robert Menendez recently commenting in a Senate hearing on gas prices:

Senator Menendez: Isn’t there a reality that we are paying for some industry decisions that actually reduced refining capacity in this country? I mean there was a time that we had greater refining capacity, and the industry reduced that refining capacity, and as a result of making that decision, consumers today find themselves with exactly the consequences that you have described in your testimony before.

There are elements of fact and elements of fiction in the preceding statements. So, what’s the scoop? Are oil companies cutting refinery capacity in order to boost profits?

In the past 10 years, refining capacity in the U.S. has increased by about 2 million barrels per day, which is equivalent to about 10 good-sized refineries. Capacity expansions equivalent to 8 more new refineries have been announced for the next 4 years (although some refiners have recently suggested that some expansions may be put on hold as a result of the stated goal of reducing gasoline consumption by 20% in 10 years – in order to avoid an oversupply situation). So while it is true that new refineries aren’t being built, it is certainly not true that capacity is stagnant. There are several reasons for expanding existing refineries as opposed to building new ones.

First, it is less expensive per barrel to expand an existing refinery than to build a new one. The estimates I have seen suggest that existing refineries can be expanded at 60% of the per barrel cost of building a new refinery. Second, the permitting process for building a new refinery is onerous. A group in Arizona has been trying to build a new refinery, and it took them 7 years just to get the permit. If they proceed and build the refinery, it will have taken 13 years from the time they started the process. (Even as I was working on this essay, they have announced a further 1 year delay). Finally, while everyone seems to want more refining capacity, nobody seems to want a refinery in their community. This makes building a new refinery next to impossible. As Investor’s Business Daily recently asked Senator Chuck Schumer: “Just where in New York state would you like a new refinery to be built…?

However, the critics are correct on one point. Starting in the early 80’s, U.S. refining capacity did drop significantly, before beginning to climb back up in the 90’s. The reason for this is quite simple: There was far more refining capacity than was warranted by the demand. The result was that gasoline was $1.00 a gallon, and many oil companies were losing money. Many refineries shut down. Some oil companies went out of business. Property values in “oil towns” like Houston plummeted. Yet many view oil companies as if they are public utilities. But the majority are owned by shareholders, who expect a return on their investment. Billions of dollars of capital are risked in this business, and if the rewards are poor (or negative), the risks won’t be taken.

No industry can be expected to maintain high production levels in the face of poor or even negative margins. If milk producers make too much milk, prices fall and some producers go out of business. When that happens, supply is reduced and prices go up. The same is true for any other business. Yet people don’t accept this very well in the case of oil companies, because many have come to view cheap gas as an entitlement.

U.S. Senator Ron Wyden has spent quite a bit of time investigating these issues, and his view is probably typical with respect to the evolution of refining capacity:

The Oil Industry, Gas Supply and Refinery Capacity: More Than Meets the Eye

In this report, Senator Wyden presents a number of “smoking guns”, such as this internal Texaco document from 1996:

“As observed over the last few years and as projected well into the future, the most critical factor facing the refining industry on the West Coast is the surplus refining capacity, and the surplus gasoline production capacity. The same situation exists for the entire U.S. refining industry. Supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline.”

Senator Wyden skipped right past the part about poor margins and poor financial results, and focused on the “smoking gun”, that either supplies needed to be reduced or demand for gasoline increased. He then gives a list of the refineries that have closed since the mid-90’s, apparently failing to connect these events with “poor refining margins.” Here are the refineries he lists that closed in 1995:

Indian Refining Lawrenceville, IL
Cyril Petrochemical Corp. Cyril, OK
Powerine Oil Co. Sante Fe Springs, CA
Sunland Refining Corp. Bakersfield, CA
Caribbean Petroleum Corp. San Juan, Puerto Rico

Do you recognize any of those names? Probably not, because most of the companies that shut down did so because they went out of business. Margins were too poor to remain in business for some. For others, it was failure to comply with environmental regulations (some of the closed refineries are now Superfund sites). Yet Senator Wyden presents a picture in which it was a systematic and cooperative effort between oil companies to reduce refining capacity – and that refinery capacity should have been maintained at any cost (as long as oil company shareholders are the ones to bear those costs). Somehow “the industry” is culpable for the closure of a number of marginal producers – many of whom went completely out of business. But it was years of poor returns in this cyclical business that drove down refining capacity.

Even in the past 10 years, refinery margins have turned negative on numerous occasions. The problem is that many people take a snapshot of the current view and believe this is normal. See the data that the IEA has accumulated (XLS download warning). Shall we expect that those who are calling for measures to be taken to address the current refinery margin situation will be calling for the government to extend a helping hand the next time margins go negative? Somehow, I doubt it. (Incidentally, for those who think oil companies have boosted their margins by raising prices, how do you explain the incredible variability from month to month? How do you explain negative margins?)

Paul Sankey, an analyst with Deutsche Bank, testified on May 15th before the Senate Committee on Energy and Natural Resources. He pointed out the long-term factors that have resulted in the refinery capacity we have today:

The reason for the massive recent run up in prices can be traced back to the last significant period of high prices, in the late 1970s, which forced lower gasoline demand, then more efficient cars, which led to excess refining capacity, which led to years of poor returns in refining (and cheap gasoline prices), which disincentivised investment in refining and encouraged demand, and which has ultimately led to today’s intense market tightness.

The bottom line on the refinery capacity issue is that yes, refining capacity has been reduced at times. And there were perfectly valid reasons that this happened. It is also true that capacity is short at the moment – if the objective is to maintain sub-$3 gasoline prices. But, reduced investment in refining capacity is indeed a key factor behind the current gasoline price spike. If some want to level the charge that refiners failed to accurately anticipate demand growth, then that charge is accurate. But like the rest of us, refiners don’t have crystal balls.

Are Oil Companies Purposely Withholding Supplies?

This charge has been repeated quite a bit lately. Oil companies are either accused of withholding supplies ala OPEC, or they are accused of stretching out their maintenance in order to keep supplies low. Let’s address that.

In a very tight market, events that take supply off of the market are likely to drive prices higher. In light of that, would it be a wise business practice if BP, for instance, purposely slowed down the maintenance at their Whiting, Indiana refinery that is partially closed due to a fire? Not a chance. When BP has supply off the market, it benefits everyone BUT BP. They are foregoing money every day they have that capacity offline. The refinery manager at Whiting will have part of his performance graded based on the financial returns of his refinery. The longer the supply is offline, the worse that grade will be.

Consider a couple of examples. Say that you operate a 200,000 barrel a day refinery. Margins are quite good right now – let’s say in your area they are $20 a barrel. So, when the refinery is running normally, you are grossing $4 million a day. Would it make good business sense to cut your capacity in half – to 100,000 barrels a day? While such action would probably cause the overall price of gasoline to rise, it is going to have a disproportionate effect on your refinery. If margins go up to $30 a barrel (although there is no way taking 100,000 barrels off the market would impact margins to that degree), you are still $1 million a day worse of than you were. You have given up $365 million a year in order to reduce your capacity. You would have made an incredibly stupid business decision. In fact, you would be much better off if you could boost capacity by 100,000 barrels a day. Sure, prices might slightly drop, but your overall profits will be higher, especially in such a tight market.

Furthermore, you don’t know if Shell down the street might be able to make up the production shortfall, pocketing the money that would have been made by your refinery. (Contrary to popular opinion, oil companies do not consult each other on such issues). You also don’t know if exporters from Europe will respond. If they respond by boosting exports to the U.S., now they are pocketing the money that your refinery is losing. In summary, this is not a rational way to conduct business – unless your margins are negative. You would be making a decision that will certainly cut the returns at your refinery, while not knowing how your competitors will respond to the supply shortfall.

For another example that many can relate to, consider that you wish to put your house on the market. Housing prices in your area have been outstanding, and you want to capitalize. However, you are afraid that by putting your house on the market, you may boost the supply in your area and cause prices to fall. So, you decide to be a charitable neighbor and keep your house off of the market in order to maintain prices for everyone else. You will sell some other time, even though the market may not be as good. If your primary objective is to capitalize on the good housing market, have you made a rational business decision? Of course not. The same is true regarding the charge that oil companies are deliberately prolonging maintenance. It just wouldn’t make good business sense in this market.

Are Refineries Breaking Down More Than Normal?

It certainly seems each week brings several new refinery outages. While refineries still have not reached pre-Hurricane Katrina production levels, most of the outages that you read about are the kinds of things that happen every year. Practically all refineries have one or more unplanned outages each year. Most years, when the market is amply supplied, these sorts of events don’t make the news. But this year, as we have seen, is very different.

As the afore-mentioned Paul Sankey testified:

The poor returns of the 1980s and 1990s have indirectly caused some additional external events that have played into the problems. The years of losing money caused companies to neglect refining investment, culminating in BP’s Texas City disaster. Texas City has now rightly caused other refiners to operate more cautiously – and so less capacity is available.

A second impact of years of reduced investment has been a lack of qualified engineering, procurement and construction staff. One vital issue here is that the tightness of US refining capacity at this time is not because companies are unwilling to invest in more capacity, it is that they are unable.

Refineries are complex. Heat is being added to flammable materials, and the entire chain of events depends on a steady supply of raw materials, equipment, and qualified people to keep things running smoothly. Equipment is going to break down. A refinery is much more complex than your car. Yet you would not be surprised if your 30-year old car had annual maintenance problems.

While this year’s outages may be somewhat above average, similar outages happen every year. The only difference is that most years there is enough spare capacity that the outages go unnoticed by the media.

The Impact of Environmental Regulations

Let me make it clear that I am in favor of the environmental regulations we have in place. They have made our air and water cleaner. But there is a price to be paid for those regulations, and consumers should understand that, as they are the ones who will ultimately bear those costs.

There are several things that can happen when a new regulation is implemented. First, new regulations may redirect capital that might have gone into expanding refining facilities. Second, they may increase the costs of producing the fuel. Third, additional processing, as in the case of ultra-low sulfur diesel (ULSD) and gasoline – can reduce the overall product yield. Fourth, and perhaps of greatest importance, additional equipment will increase the complexity of the refinery.

Those are the consequences. The more complex the refineries are, the more unreliable they are going to be. With each additional complexity that is added, there are more ways for them to break down. There is more danger as the inventory of hazardous materials increases. Politicians who are quick to point fingers should understand that they make their own contribution to supply shortages. If they are going to hold hearings on gas prices, they needn’t ponder “Gosh, I wonder why prices are going up?” Stricter environmental regulations – necessary as they may be – are one more piece of the puzzle. They have helped crimp supplies and add to costs.

Investor’s Business Daily recently touched on this:

Our refineries are doing more than ever, but their numbers are dwindling and no new ones are being built. The reason is not greed, but cost and regulations. From 1994 to 2003, the refining industry spent $47.4 billion, not to build new refineries, but to bring existing ones into compliance with ever new and stringent environmental rules. That’s where those allegedly excessive profits go.

I think most people are willing to pay higher prices for a cleaner environment, but it is important that they understand that this is a component of fuel prices.

The Ethanol Factor

It is a fact that ethanol only contains about 65% of the energy content of gasoline on a volumetric basis. Therefore, to displace the gross energy content of 1 gallon of gasoline requires 1/0.65, or 1.5 gallons of ethanol. What this means is that as ethanol is put into the gasoline pool, demand will go up simply because the pool now contains less energy. Is this enough to explain why motor gasoline demand (which includes blended ethanol) is at a record high?

In March of 2007, ethanol contributed 539 million gallons to the gasoline pool, according to the Renewable Fuels Association (RFA). This is almost 50% greater than the 365 million gallon ethanol demand in March of 2006. Gasoline demand in March, according to the Energy Information Administration, averaged 9.266 million barrels per day (up from 9.076 a year earlier). Total gasoline demand in March was then 9.266 million * 31 days * 42 gallons/bbl, or 12.06 billion gallons. The breakdown would have then been 11.52 billion gallons of gasoline and 0.54 billion gallons of ethanol. (Ethanol imports have been omitted as their impact would have been pretty small).

The energy content, however, of the 12.1 billion gallons would have been equivalent to 11.52 gallons of gasoline plus 0.54 billion gallons of ethanol * 0.65 (factoring the lower energy content), or 11.87 billion gallons of gasoline equivalent fuel. Therefore, our perceived gasoline demand is 1.9% (12.06/11.87) higher than it would be without ethanol in the pool.

In other words, part of the record high gasoline demand we are currently experiencing is due to the fact that ethanol is scaling up rapidly, and it is being counted in the finished motor gasoline pool. Even if demand was constant on a BTU basis, increasing the fraction of ethanol in the pool will increase the volume demand.

Conclusions

While the immediate cause of skyrocketing gas prices is a combination of record demand and low gasoline inventories in the U.S., several longer-term factors have contributed. Following years of poor returns and expensive new environmental regulations, investments into expanding existing refineries dried up. Many refineries closed their doors permanently, as a number of smaller producers went completely out of business in the 80’s and 90’s. The cumulative effect was that refining capacity fell starting in the early 80’s, but has recently been climbing back as margins have improved. Just as we were in an oversupply situation in the 80’s, we are now in an undersupply situation if the goal is to keep gasoline below $3.00/gallon. However, refining capacity has increased significantly in the past 10 years, and looks to continue this trend in the foreseeable future. But demand growth has remained robust in the face of higher prices, so an oversupply situation in which gasoline returns to $2/gal does not appear likely in the foreseeable future.

June 10, 2007 Posted by | energy policy, gas prices, oil refineries, price gouging, price manipulation, profit margins, refining | 14 Comments

Gasoline Prices Part II: Long-Term Factors

Introduction

In Part I, I discussed the short term factors that have resulted in the recent, rapid increase in the price of gasoline. But there are a number of underlying, long-term issues that have been major contributors. I will attempt to address them and answer a number of related questions, such as: Why have no new refineries been built in the past 30 years? Are U.S. refineries breaking down more than normal? Are oil companies purposely withholding supplies to keep prices high? Have environmental regulations played a role? Does the use of ethanol influence gasoline demand growth? The answers to some of these questions may surprise you.

Please note that my essays should not be confused with financial advice. Following Part I, I received a number of e-mails requesting financial advice. While there are often potential financial implications, I am not a financial planner. If you choose to make investment decisions based on what you read here, you are on your own.

Further note that it is not my contention that refiners are not benefiting from higher prices. They are. But my contention is that prices aren’t higher because they have increased margins. Margins have increased because prices are higher.

U.S. Refinery Capacity

The problem, I have read on many occasions, is that we aren’t building any new refineries, and that “limiting refinery capacity seems to make more money for oil companies than expanding it.” Claims like the following from the Foundation for Consumer and Taxpayer Rights – are quite common:

America’s big oil companies figured out long ago that they could make more money by making less gasoline. That’s why the industry hasn’t built a new refinery in 30 years. Since deregulation of the refinery business in 1982, oil consumption has increased 33% but oil companies have kept refining capacity near what it was 25 years ago. Why not? They know that the scarcer the product, the bigger the profit.

Even members of the Senate Committee on Energy and Natural Resources seem to believe this, with New Jersey Senator Robert Menendez recently commenting in a Senate hearing on gas prices:

Senator Menendez: Isn’t there a reality that we are paying for some industry decisions that actually reduced refining capacity in this country? I mean there was a time that we had greater refining capacity, and the industry reduced that refining capacity, and as a result of making that decision, consumers today find themselves with exactly the consequences that you have described in your testimony before.

There are elements of fact and elements of fiction in the preceding statements. So, what’s the scoop? Are oil companies cutting refinery capacity in order to boost profits?

In the past 10 years, refining capacity in the U.S. has increased by about 2 million barrels per day, which is equivalent to about 10 good-sized refineries. Capacity expansions equivalent to 8 more new refineries have been announced for the next 4 years (although some refiners have recently suggested that some expansions may be put on hold as a result of the stated goal of reducing gasoline consumption by 20% in 10 years – in order to avoid an oversupply situation). So while it is true that new refineries aren’t being built, it is certainly not true that capacity is stagnant. There are several reasons for expanding existing refineries as opposed to building new ones.

First, it is less expensive per barrel to expand an existing refinery than to build a new one. The estimates I have seen suggest that existing refineries can be expanded at 60% of the per barrel cost of building a new refinery. Second, the permitting process for building a new refinery is onerous. A group in Arizona has been trying to build a new refinery, and it took them 7 years just to get the permit. If they proceed and build the refinery, it will have taken 13 years from the time they started the process. (Even as I was working on this essay, they have announced a further 1 year delay). Finally, while everyone seems to want more refining capacity, nobody seems to want a refinery in their community. This makes building a new refinery next to impossible. As Investor’s Business Daily recently asked Senator Chuck Schumer: “Just where in New York state would you like a new refinery to be built…?

However, the critics are correct on one point. Starting in the early 80’s, U.S. refining capacity did drop significantly, before beginning to climb back up in the 90’s. The reason for this is quite simple: There was far more refining capacity than was warranted by the demand. The result was that gasoline was $1.00 a gallon, and many oil companies were losing money. Many refineries shut down. Some oil companies went out of business. Property values in “oil towns” like Houston plummeted. Yet many view oil companies as if they are public utilities. But the majority are owned by shareholders, who expect a return on their investment. Billions of dollars of capital are risked in this business, and if the rewards are poor (or negative), the risks won’t be taken.

No industry can be expected to maintain high production levels in the face of poor or even negative margins. If milk producers make too much milk, prices fall and some producers go out of business. When that happens, supply is reduced and prices go up. The same is true for any other business. Yet people don’t accept this very well in the case of oil companies, because many have come to view cheap gas as an entitlement.

U.S. Senator Ron Wyden has spent quite a bit of time investigating these issues, and his view is probably typical with respect to the evolution of refining capacity:

The Oil Industry, Gas Supply and Refinery Capacity: More Than Meets the Eye

In this report, Senator Wyden presents a number of “smoking guns”, such as this internal Texaco document from 1996:

“As observed over the last few years and as projected well into the future, the most critical factor facing the refining industry on the West Coast is the surplus refining capacity, and the surplus gasoline production capacity. The same situation exists for the entire U.S. refining industry. Supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline.”

Senator Wyden skipped right past the part about poor margins and poor financial results, and focused on the “smoking gun”, that either supplies needed to be reduced or demand for gasoline increased. He then gives a list of the refineries that have closed since the mid-90’s, apparently failing to connect these events with “poor refining margins.” Here are the refineries he lists that closed in 1995:

Indian Refining Lawrenceville, IL
Cyril Petrochemical Corp. Cyril, OK
Powerine Oil Co. Sante Fe Springs, CA
Sunland Refining Corp. Bakersfield, CA
Caribbean Petroleum Corp. San Juan, Puerto Rico

Do you recognize any of those names? Probably not, because most of the companies that shut down did so because they went out of business. Margins were too poor to remain in business for some. For others, it was failure to comply with environmental regulations (some of the closed refineries are now Superfund sites). Yet Senator Wyden presents a picture in which it was a systematic and cooperative effort between oil companies to reduce refining capacity – and that refinery capacity should have been maintained at any cost (as long as oil company shareholders are the ones to bear those costs). Somehow “the industry” is culpable for the closure of a number of marginal producers – many of whom went completely out of business. But it was years of poor returns in this cyclical business that drove down refining capacity.

Even in the past 10 years, refinery margins have turned negative on numerous occasions. The problem is that many people take a snapshot of the current view and believe this is normal. See the data that the IEA has accumulated (XLS download warning). Shall we expect that those who are calling for measures to be taken to address the current refinery margin situation will be calling for the government to extend a helping hand the next time margins go negative? Somehow, I doubt it. (Incidentally, for those who think oil companies have boosted their margins by raising prices, how do you explain the incredible variability from month to month? How do you explain negative margins?)

Paul Sankey, an analyst with Deutsche Bank, testified on May 15th before the Senate Committee on Energy and Natural Resources. He pointed out the long-term factors that have resulted in the refinery capacity we have today:

The reason for the massive recent run up in prices can be traced back to the last significant period of high prices, in the late 1970s, which forced lower gasoline demand, then more efficient cars, which led to excess refining capacity, which led to years of poor returns in refining (and cheap gasoline prices), which disincentivised investment in refining and encouraged demand, and which has ultimately led to today’s intense market tightness.

The bottom line on the refinery capacity issue is that yes, refining capacity has been reduced at times. And there were perfectly valid reasons that this happened. It is also true that capacity is short at the moment – if the objective is to maintain sub-$3 gasoline prices. But, reduced investment in refining capacity is indeed a key factor behind the current gasoline price spike. If some want to level the charge that refiners failed to accurately anticipate demand growth, then that charge is accurate. But like the rest of us, refiners don’t have crystal balls.

Are Oil Companies Purposely Withholding Supplies?

This charge has been repeated quite a bit lately. Oil companies are either accused of withholding supplies ala OPEC, or they are accused of stretching out their maintenance in order to keep supplies low. Let’s address that.

In a very tight market, events that take supply off of the market are likely to drive prices higher. In light of that, would it be a wise business practice if BP, for instance, purposely slowed down the maintenance at their Whiting, Indiana refinery that is partially closed due to a fire? Not a chance. When BP has supply off the market, it benefits everyone BUT BP. They are foregoing money every day they have that capacity offline. The refinery manager at Whiting will have part of his performance graded based on the financial returns of his refinery. The longer the supply is offline, the worse that grade will be.

Consider a couple of examples. Say that you operate a 200,000 barrel a day refinery. Margins are quite good right now – let’s say in your area they are $20 a barrel. So, when the refinery is running normally, you are grossing $4 million a day. Would it make good business sense to cut your capacity in half – to 100,000 barrels a day? While such action would probably cause the overall price of gasoline to rise, it is going to have a disproportionate effect on your refinery. If margins go up to $30 a barrel (although there is no way taking 100,000 barrels off the market would impact margins to that degree), you are still $1 million a day worse of than you were. You have given up $365 million a year in order to reduce your capacity. You would have made an incredibly stupid business decision. In fact, you would be much better off if you could boost capacity by 100,000 barrels a day. Sure, prices might slightly drop, but your overall profits will be higher, especially in such a tight market.

Furthermore, you don’t know if Shell down the street might be able to make up the production shortfall, pocketing the money that would have been made by your refinery. (Contrary to popular opinion, oil companies do not consult each other on such issues). You also don’t know if exporters from Europe will respond. If they respond by boosting exports to the U.S., now they are pocketing the money that your refinery is losing. In summary, this is not a rational way to conduct business – unless your margins are negative. You would be making a decision that will certainly cut the returns at your refinery, while not knowing how your competitors will respond to the supply shortfall.

For another example that many can relate to, consider that you wish to put your house on the market. Housing prices in your area have been outstanding, and you want to capitalize. However, you are afraid that by putting your house on the market, you may boost the supply in your area and cause prices to fall. So, you decide to be a charitable neighbor and keep your house off of the market in order to maintain prices for everyone else. You will sell some other time, even though the market may not be as good. If your primary objective is to capitalize on the good housing market, have you made a rational business decision? Of course not. The same is true regarding the charge that oil companies are deliberately prolonging maintenance. It just wouldn’t make good business sense in this market.

Are Refineries Breaking Down More Than Normal?

It certainly seems each week brings several new refinery outages. While refineries still have not reached pre-Hurricane Katrina production levels, most of the outages that you read about are the kinds of things that happen every year. Practically all refineries have one or more unplanned outages each year. Most years, when the market is amply supplied, these sorts of events don’t make the news. But this year, as we have seen, is very different.

As the afore-mentioned Paul Sankey testified:

The poor returns of the 1980s and 1990s have indirectly caused some additional external events that have played into the problems. The years of losing money caused companies to neglect refining investment, culminating in BP’s Texas City disaster. Texas City has now rightly caused other refiners to operate more cautiously – and so less capacity is available.

A second impact of years of reduced investment has been a lack of qualified engineering, procurement and construction staff. One vital issue here is that the tightness of US refining capacity at this time is not because companies are unwilling to invest in more capacity, it is that they are unable.

Refineries are complex. Heat is being added to flammable materials, and the entire chain of events depends on a steady supply of raw materials, equipment, and qualified people to keep things running smoothly. Equipment is going to break down. A refinery is much more complex than your car. Yet you would not be surprised if your 30-year old car had annual maintenance problems.

While this year’s outages may be somewhat above average, similar outages happen every year. The only difference is that most years there is enough spare capacity that the outages go unnoticed by the media.

The Impact of Environmental Regulations

Let me make it clear that I am in favor of the environmental regulations we have in place. They have made our air and water cleaner. But there is a price to be paid for those regulations, and consumers should understand that, as they are the ones who will ultimately bear those costs.

There are several things that can happen when a new regulation is implemented. First, new regulations may redirect capital that might have gone into expanding refining facilities. Second, they may increase the costs of producing the fuel. Third, additional processing, as in the case of ultra-low sulfur diesel (ULSD) and gasoline – can reduce the overall product yield. Fourth, and perhaps of greatest importance, additional equipment will increase the complexity of the refinery.

Those are the consequences. The more complex the refineries are, the more unreliable they are going to be. With each additional complexity that is added, there are more ways for them to break down. There is more danger as the inventory of hazardous materials increases. Politicians who are quick to point fingers should understand that they make their own contribution to supply shortages. If they are going to hold hearings on gas prices, they needn’t ponder “Gosh, I wonder why prices are going up?” Stricter environmental regulations – necessary as they may be – are one more piece of the puzzle. They have helped crimp supplies and add to costs.

Investor’s Business Daily recently touched on this:

Our refineries are doing more than ever, but their numbers are dwindling and no new ones are being built. The reason is not greed, but cost and regulations. From 1994 to 2003, the refining industry spent $47.4 billion, not to build new refineries, but to bring existing ones into compliance with ever new and stringent environmental rules. That’s where those allegedly excessive profits go.

I think most people are willing to pay higher prices for a cleaner environment, but it is important that they understand that this is a component of fuel prices.

The Ethanol Factor

It is a fact that ethanol only contains about 65% of the energy content of gasoline on a volumetric basis. Therefore, to displace the gross energy content of 1 gallon of gasoline requires 1/0.65, or 1.5 gallons of ethanol. What this means is that as ethanol is put into the gasoline pool, demand will go up simply because the pool now contains less energy. Is this enough to explain why motor gasoline demand (which includes blended ethanol) is at a record high?

In March of 2007, ethanol contributed 539 million gallons to the gasoline pool, according to the Renewable Fuels Association (RFA). This is almost 50% greater than the 365 million gallon ethanol demand in March of 2006. Gasoline demand in March, according to the Energy Information Administration, averaged 9.266 million barrels per day (up from 9.076 a year earlier). Total gasoline demand in March was then 9.266 million * 31 days * 42 gallons/bbl, or 12.06 billion gallons. The breakdown would have then been 11.52 billion gallons of gasoline and 0.54 billion gallons of ethanol. (Ethanol imports have been omitted as their impact would have been pretty small).

The energy content, however, of the 12.1 billion gallons would have been equivalent to 11.52 gallons of gasoline plus 0.54 billion gallons of ethanol * 0.65 (factoring the lower energy content), or 11.87 billion gallons of gasoline equivalent fuel. Therefore, our perceived gasoline demand is 1.9% (12.06/11.87) higher than it would be without ethanol in the pool.

In other words, part of the record high gasoline demand we are currently experiencing is due to the fact that ethanol is scaling up rapidly, and it is being counted in the finished motor gasoline pool. Even if demand was constant on a BTU basis, increasing the fraction of ethanol in the pool will increase the volume demand.

Conclusions

While the immediate cause of skyrocketing gas prices is a combination of record demand and low gasoline inventories in the U.S., several longer-term factors have contributed. Following years of poor returns and expensive new environmental regulations, investments into expanding existing refineries dried up. Many refineries closed their doors permanently, as a number of smaller producers went completely out of business in the 80’s and 90’s. The cumulative effect was that refining capacity fell starting in the early 80’s, but has recently been climbing back as margins have improved. Just as we were in an oversupply situation in the 80’s, we are now in an undersupply situation if the goal is to keep gasoline below $3.00/gallon. However, refining capacity has increased significantly in the past 10 years, and looks to continue this trend in the foreseeable future. But demand growth has remained robust in the face of higher prices, so an oversupply situation in which gasoline returns to $2/gal does not appear likely in the foreseeable future.

June 10, 2007 Posted by | energy policy, gas prices, oil refineries, price gouging, price manipulation, profit margins, refining | 6 Comments

The FTCR Slander Continues

I have written previously about the Foundation for Taxpayer and Consumer Rights (FTCR). You can see a list of these essays here. Their web site states:

FTCR is a non-profit, non-partisan consumer watchdog group. We fight corrupt corporations and crooked politicians every day.

Now that sounds like a noble goal. That is, until you start to dig a little deeper, and find out that “corrupt corporations” too often means “we are paying too much for gasoline, and it must be because of corrupt corporations.” In fact, they have stated that they think gasoline should be under $2.00/gallon for everyone. They seem to feel that this is some sort of a birthright for Americans. Given my often-repeated mantra that we need to conserve, and that I think that a higher gasoline price is the most effective conservation mechanism we have, the kind of logic employed by the FTCR is anathema to me. Just think of how much “cleaner” that California air would be if you lowered the gasoline price to $2.00/gallon.

Well, they are at it again. The FTCR just released another report:

California’s Call to Arms: Gasoline Spikes 45 Cents a Gallon Higher Than U.S. Average

Yes, a “call to arms”, because they aren’t happy about gasoline prices. Some choice pieces from the report:

The Foundation for Taxpayer and Consumer Rights, saying there is no credible reason for the large and widening disparity, called for immediate action by Congress and California lawmakers to regulate gasoline supplies and curb price-gouging by oil companies and refiners.

Now, I want to emphasize that the FTCR is constantly complaining of price-gouging and calling for an investigation. Well, they got one last year by the California Energy Commission. Here were the findings:

The report, by the California Energy Commission, puts down refinery outages leading to a supply squeeze, coupled with a surge in exports, as the key factors behind record high prices in the state this year.

The lengthy report cites a stunning number of planned outage days at California refineries in the first six months of 2006 compared with same period last year – 175 vs. 58. Most of the unplanned outages, comparing the same periods, lasted twice as long this year.

Also, it found port congestion a factor, as well as high additives costs and the introduction of the new ultra-low-sulfur diesel fuel (ULSD).

It dismisses the notion held by some that pump prices dashed to $3.33/gal because refiners practiced price gouging (dubbed goug-onomics by some consumer groups).

As you might imagine, this was a slap in the face to the FTCR, as it was a direct repudiation of their constant complaints about price-gouging. Instead of retracting their charges, they responded by simply making more unsupported claims:

“Oil companies are ripping off Californians in exactly the same way electricity profiteers did by artificially shorting the market,” snapped FTCR President Jamie Court.

Continuing with their most recent report, the FTCR is demanding that more taxpayer money be spent to once again investigate, despite their most recent slap-down:

“California’s price spike in February, nearly the lowest consumption period of the year, is setting up the state to smash last year’s $3.38 a gallon record,” said Judy Dugan, research director of the nonprofit, nonpartisan FTCR. “Lawmakers will be guilty of political malpractice if they ignore this blatant profiteering at the expense of the nation’s most populous state and largest gasoline market.”

Really, what would be the purpose? The FTCR has already concluded that price-gouging is going on. When an investigation found that it isn’t, they rejected the findings. Their minds are made up, so no investigation is going to suit them unless it has their desired conclusions. Perhaps they could fund an investigation themselves, and then if the finding turns out to be that price has risen and fallen due to supply and demand, perhaps they should pay a penalty for all of their slander. Continuing on:

FTCR pointed to the oil industry’s manipulation of gasoline supplies on hand to keep prices higher in California than in the rest of the country.

Once more, careless and unsubstantiated charges, which they have shown that they will not retract when their charges are shown to be without merit. Let’s see what the Energy Information Administration recently had to say about this issue in This Week in Petroleum:

One way to assess current conditions is to look at the inventory situation. If inventories are relatively plentiful, an immediate source of supply is available should market conditions tighten, thus lessening upward price pressure. However, if inventories are relatively scarce, prices would likely need to rise more than they would otherwise to attract more supply should market conditions tighten. At first glance, Figure 4 in the Weekly Petroleum Status Report (WPSR), it appears that gasoline inventories are more than comfortable when looking at the absolute level.

However, as the chart below illustrates, when the level of demand is taken into consideration and the number of days of supply is compared to the last two years, gasoline inventories are actually lower this year, at this point in the calendar. Partly as a result of the inventory situation, the gasoline crack spread (the difference between the average spot price for gasoline and the spot price of West Texas Intermediate crude oil) will likely be a record for the month of February. This February, the spread will be about 19 cents per gallon higher than last February (28 cents per gallon this year vs. 9 cents per gallon last year). This reflects both weak refining margins last year (the 5-year average for February is about 15 cents), and record strength this year.

I have consistently said that if you want to understand what’s going on with prices, look to the inventories. Falling inventories mean that prices must rise, and vice-versa. (Another key issue is that gasoline demand is at an all-time record for this time of year). The inventory picture also explains why oil prices have fallen since last summer. Inventories have been high. This is a concept that the FTCR took a long time to understand, but once they did they started charging that refineries were keeping inventories low on purpose. Their evidence? Well, I am still waiting for that. But lack of evidence has never stopped them from making these charges in the past.

The FTCR can’t even seem to do the most basic of fact-checking:

“If oil companies won’t increase their refinery capacity and gasoline storage in the state, government must do it. Otherwise California drivers will remain the oil industry’s pick-pocketing victims.”

Refinery capacity has increased by a very large amount over the past 20 years, and continues to increase year after year. These expansions take many billions of dollars, and are made possible by the profits that the FTCR would like to see disappear.

Also, it might be a good time to repost the following graphic:

Oil Industry “Windfall”
Source: Facts on Fuel

For reference, the 4th quarter of 2005 was the quarter after Hurricane Katrina when oil companies made multi-billion dollar profits and were universally accused of price-gouging. I know it’s tough for organizations like the FTCR to understand, but a look at the graph should show you that you aren’t being gouged. Oil company profits are huge because the companies themselves are huge. Imagine that if you formed a company from all the small farmers in the U.S., and pooled their profits. The overall profit number would be huge, because the organization would be huge. But their profit margins aren’t going to be all that impressive.

People who think that big profits alone equate to gouging don’t understand the difference between a profit and a profit margin. And the FTCR has demonstrated on numerous occasions that they are ignorant of this basic distinction, as well as the most rudimentary economic principles.

March 1, 2007 Posted by | FTCR, gas inventories, gas prices, price gouging, price manipulation | 10 Comments

The FTCR Slander Continues

I have written previously about the Foundation for Taxpayer and Consumer Rights (FTCR). You can see a list of these essays here. Their web site states:

FTCR is a non-profit, non-partisan consumer watchdog group. We fight corrupt corporations and crooked politicians every day.

Now that sounds like a noble goal. That is, until you start to dig a little deeper, and find out that “corrupt corporations” too often means “we are paying too much for gasoline, and it must be because of corrupt corporations.” In fact, they have stated that they think gasoline should be under $2.00/gallon for everyone. They seem to feel that this is some sort of a birthright for Americans. Given my often-repeated mantra that we need to conserve, and that I think that a higher gasoline price is the most effective conservation mechanism we have, the kind of logic employed by the FTCR is anathema to me. Just think of how much “cleaner” that California air would be if you lowered the gasoline price to $2.00/gallon.

Well, they are at it again. The FTCR just released another report:

California’s Call to Arms: Gasoline Spikes 45 Cents a Gallon Higher Than U.S. Average

Yes, a “call to arms”, because they aren’t happy about gasoline prices. Some choice pieces from the report:

The Foundation for Taxpayer and Consumer Rights, saying there is no credible reason for the large and widening disparity, called for immediate action by Congress and California lawmakers to regulate gasoline supplies and curb price-gouging by oil companies and refiners.

Now, I want to emphasize that the FTCR is constantly complaining of price-gouging and calling for an investigation. Well, they got one last year by the California Energy Commission. Here were the findings:

The report, by the California Energy Commission, puts down refinery outages leading to a supply squeeze, coupled with a surge in exports, as the key factors behind record high prices in the state this year.

The lengthy report cites a stunning number of planned outage days at California refineries in the first six months of 2006 compared with same period last year – 175 vs. 58. Most of the unplanned outages, comparing the same periods, lasted twice as long this year.

Also, it found port congestion a factor, as well as high additives costs and the introduction of the new ultra-low-sulfur diesel fuel (ULSD).

It dismisses the notion held by some that pump prices dashed to $3.33/gal because refiners practiced price gouging (dubbed goug-onomics by some consumer groups).

As you might imagine, this was a slap in the face to the FTCR, as it was a direct repudiation of their constant complaints about price-gouging. Instead of retracting their charges, they responded by simply making more unsupported claims:

“Oil companies are ripping off Californians in exactly the same way electricity profiteers did by artificially shorting the market,” snapped FTCR President Jamie Court.

Continuing with their most recent report, the FTCR is demanding that more taxpayer money be spent to once again investigate, despite their most recent slap-down:

“California’s price spike in February, nearly the lowest consumption period of the year, is setting up the state to smash last year’s $3.38 a gallon record,” said Judy Dugan, research director of the nonprofit, nonpartisan FTCR. “Lawmakers will be guilty of political malpractice if they ignore this blatant profiteering at the expense of the nation’s most populous state and largest gasoline market.”

Really, what would be the purpose? The FTCR has already concluded that price-gouging is going on. When an investigation found that it isn’t, they rejected the findings. Their minds are made up, so no investigation is going to suit them unless it has their desired conclusions. Perhaps they could fund an investigation themselves, and then if the finding turns out to be that price has risen and fallen due to supply and demand, perhaps they should pay a penalty for all of their slander. Continuing on:

FTCR pointed to the oil industry’s manipulation of gasoline supplies on hand to keep prices higher in California than in the rest of the country.

Once more, careless and unsubstantiated charges, which they have shown that they will not retract when their charges are shown to be without merit. Let’s see what the Energy Information Administration recently had to say about this issue in This Week in Petroleum:

One way to assess current conditions is to look at the inventory situation. If inventories are relatively plentiful, an immediate source of supply is available should market conditions tighten, thus lessening upward price pressure. However, if inventories are relatively scarce, prices would likely need to rise more than they would otherwise to attract more supply should market conditions tighten. At first glance, Figure 4 in the Weekly Petroleum Status Report (WPSR), it appears that gasoline inventories are more than comfortable when looking at the absolute level.

However, as the chart below illustrates, when the level of demand is taken into consideration and the number of days of supply is compared to the last two years, gasoline inventories are actually lower this year, at this point in the calendar. Partly as a result of the inventory situation, the gasoline crack spread (the difference between the average spot price for gasoline and the spot price of West Texas Intermediate crude oil) will likely be a record for the month of February. This February, the spread will be about 19 cents per gallon higher than last February (28 cents per gallon this year vs. 9 cents per gallon last year). This reflects both weak refining margins last year (the 5-year average for February is about 15 cents), and record strength this year.

I have consistently said that if you want to understand what’s going on with prices, look to the inventories. Falling inventories mean that prices must rise, and vice-versa. (Another key issue is that gasoline demand is at an all-time record for this time of year). The inventory picture also explains why oil prices have fallen since last summer. Inventories have been high. This is a concept that the FTCR took a long time to understand, but once they did they started charging that refineries were keeping inventories low on purpose. Their evidence? Well, I am still waiting for that. But lack of evidence has never stopped them from making these charges in the past.

The FTCR can’t even seem to do the most basic of fact-checking:

“If oil companies won’t increase their refinery capacity and gasoline storage in the state, government must do it. Otherwise California drivers will remain the oil industry’s pick-pocketing victims.”

Refinery capacity has increased by a very large amount over the past 20 years, and continues to increase year after year. These expansions take many billions of dollars, and are made possible by the profits that the FTCR would like to see disappear.

Also, it might be a good time to repost the following graphic:

Oil Industry “Windfall”
Source: Facts on Fuel

For reference, the 4th quarter of 2005 was the quarter after Hurricane Katrina when oil companies made multi-billion dollar profits and were universally accused of price-gouging. I know it’s tough for organizations like the FTCR to understand, but a look at the graph should show you that you aren’t being gouged. Oil company profits are huge because the companies themselves are huge. Imagine that if you formed a company from all the small farmers in the U.S., and pooled their profits. The overall profit number would be huge, because the organization would be huge. But their profit margins aren’t going to be all that impressive.

People who think that big profits alone equate to gouging don’t understand the difference between a profit and a profit margin. And the FTCR has demonstrated on numerous occasions that they are ignorant of this basic distinction, as well as the most rudimentary economic principles.

March 1, 2007 Posted by | FTCR, gas inventories, gas prices, price gouging, price manipulation | Comments Off on The FTCR Slander Continues

The FTCR Slander Continues

I have written previously about the Foundation for Taxpayer and Consumer Rights (FTCR). You can see a list of these essays here. Their web site states:

FTCR is a non-profit, non-partisan consumer watchdog group. We fight corrupt corporations and crooked politicians every day.

Now that sounds like a noble goal. That is, until you start to dig a little deeper, and find out that “corrupt corporations” too often means “we are paying too much for gasoline, and it must be because of corrupt corporations.” In fact, they have stated that they think gasoline should be under $2.00/gallon for everyone. They seem to feel that this is some sort of a birthright for Americans. Given my often-repeated mantra that we need to conserve, and that I think that a higher gasoline price is the most effective conservation mechanism we have, the kind of logic employed by the FTCR is anathema to me. Just think of how much “cleaner” that California air would be if you lowered the gasoline price to $2.00/gallon.

Well, they are at it again. The FTCR just released another report:

California’s Call to Arms: Gasoline Spikes 45 Cents a Gallon Higher Than U.S. Average

Yes, a “call to arms”, because they aren’t happy about gasoline prices. Some choice pieces from the report:

The Foundation for Taxpayer and Consumer Rights, saying there is no credible reason for the large and widening disparity, called for immediate action by Congress and California lawmakers to regulate gasoline supplies and curb price-gouging by oil companies and refiners.

Now, I want to emphasize that the FTCR is constantly complaining of price-gouging and calling for an investigation. Well, they got one last year by the California Energy Commission. Here were the findings:

The report, by the California Energy Commission, puts down refinery outages leading to a supply squeeze, coupled with a surge in exports, as the key factors behind record high prices in the state this year.

The lengthy report cites a stunning number of planned outage days at California refineries in the first six months of 2006 compared with same period last year – 175 vs. 58. Most of the unplanned outages, comparing the same periods, lasted twice as long this year.

Also, it found port congestion a factor, as well as high additives costs and the introduction of the new ultra-low-sulfur diesel fuel (ULSD).

It dismisses the notion held by some that pump prices dashed to $3.33/gal because refiners practiced price gouging (dubbed goug-onomics by some consumer groups).

As you might imagine, this was a slap in the face to the FTCR, as it was a direct repudiation of their constant complaints about price-gouging. Instead of retracting their charges, they responded by simply making more unsupported claims:

“Oil companies are ripping off Californians in exactly the same way electricity profiteers did by artificially shorting the market,” snapped FTCR President Jamie Court.

Continuing with their most recent report, the FTCR is demanding that more taxpayer money be spent to once again investigate, despite their most recent slap-down:

“California’s price spike in February, nearly the lowest consumption period of the year, is setting up the state to smash last year’s $3.38 a gallon record,” said Judy Dugan, research director of the nonprofit, nonpartisan FTCR. “Lawmakers will be guilty of political malpractice if they ignore this blatant profiteering at the expense of the nation’s most populous state and largest gasoline market.”

Really, what would be the purpose? The FTCR has already concluded that price-gouging is going on. When an investigation found that it isn’t, they rejected the findings. Their minds are made up, so no investigation is going to suit them unless it has their desired conclusions. Perhaps they could fund an investigation themselves, and then if the finding turns out to be that price has risen and fallen due to supply and demand, perhaps they should pay a penalty for all of their slander. Continuing on:

FTCR pointed to the oil industry’s manipulation of gasoline supplies on hand to keep prices higher in California than in the rest of the country.

Once more, careless and unsubstantiated charges, which they have shown that they will not retract when their charges are shown to be without merit. Let’s see what the Energy Information Administration recently had to say about this issue in This Week in Petroleum:

One way to assess current conditions is to look at the inventory situation. If inventories are relatively plentiful, an immediate source of supply is available should market conditions tighten, thus lessening upward price pressure. However, if inventories are relatively scarce, prices would likely need to rise more than they would otherwise to attract more supply should market conditions tighten. At first glance, Figure 4 in the Weekly Petroleum Status Report (WPSR), it appears that gasoline inventories are more than comfortable when looking at the absolute level.

However, as the chart below illustrates, when the level of demand is taken into consideration and the number of days of supply is compared to the last two years, gasoline inventories are actually lower this year, at this point in the calendar. Partly as a result of the inventory situation, the gasoline crack spread (the difference between the average spot price for gasoline and the spot price of West Texas Intermediate crude oil) will likely be a record for the month of February. This February, the spread will be about 19 cents per gallon higher than last February (28 cents per gallon this year vs. 9 cents per gallon last year). This reflects both weak refining margins last year (the 5-year average for February is about 15 cents), and record strength this year.

I have consistently said that if you want to understand what’s going on with prices, look to the inventories. Falling inventories mean that prices must rise, and vice-versa. (Another key issue is that gasoline demand is at an all-time record for this time of year). The inventory picture also explains why oil prices have fallen since last summer. Inventories have been high. This is a concept that the FTCR took a long time to understand, but once they did they started charging that refineries were keeping inventories low on purpose. Their evidence? Well, I am still waiting for that. But lack of evidence has never stopped them from making these charges in the past.

The FTCR can’t even seem to do the most basic of fact-checking:

“If oil companies won’t increase their refinery capacity and gasoline storage in the state, government must do it. Otherwise California drivers will remain the oil industry’s pick-pocketing victims.”

Refinery capacity has increased by a very large amount over the past 20 years, and continues to increase year after year. These expansions take many billions of dollars, and are made possible by the profits that the FTCR would like to see disappear.

Also, it might be a good time to repost the following graphic:

Oil Industry “Windfall”
Source: Facts on Fuel

For reference, the 4th quarter of 2005 was the quarter after Hurricane Katrina when oil companies made multi-billion dollar profits and were universally accused of price-gouging. I know it’s tough for organizations like the FTCR to understand, but a look at the graph should show you that you aren’t being gouged. Oil company profits are huge because the companies themselves are huge. Imagine that if you formed a company from all the small farmers in the U.S., and pooled their profits. The overall profit number would be huge, because the organization would be huge. But their profit margins aren’t going to be all that impressive.

People who think that big profits alone equate to gouging don’t understand the difference between a profit and a profit margin. And the FTCR has demonstrated on numerous occasions that they are ignorant of this basic distinction, as well as the most rudimentary economic principles.

March 1, 2007 Posted by | FTCR, gas inventories, gas prices, price gouging, price manipulation | 5 Comments

No Price Manipulation

I have lost track lately of the number of people who think oil companies are deliberately dropping prices in order to influence the election. I have close ties to the product pricing group, and I can tell you that these assertions are ludicrous. In fact, I mentioned these conspiracy theories this morning in a meeting, and everyone had a good laugh. But one person asked “Don’t people understand how oil and gas are priced?” The answer is, “No, they do not”, so we have this disconnect.

I have intended to write a post to address those who insist that gas prices are tied to the election, but I know that there are people who distrust me merely because I work for an oil company. That’s fine. So, I will give you the explanation from someone that you might trust. Jerome a Paris at Daily Kos has written an excellent essay explaining why gas prices are going down at the moment:

There is NO manipulation of gas prices. An explanation

He goes through and explains why gas prices are dropping. He mentions the transition to winter blends that I documented in my previous essay. But this is a seasonal issue, and is only one factor in the recent price changes. Anyway, if you really believe that the price drop is deliberate, read his essay and you will probably change your mind. A couple of highlights I wanted to bring up:

A first point to note is that gas prices rose in 2004 right up to the election, and dropped just afterwards (look at this graph, upside down if you don’t believe it), so there was no manipulation of that kind in 2004.

Basically, a lot of people bet that this summer would see the same problems as last year (which was not a completely stupid bet). That sustained demand (from speculators) and prices.

But the underlying market was less favorable (a bit more production from refiners, a bit less demand than expected), and the hurricanes speculators were betting on to give value to their virtual gasoline did not materialise, thus forcing them to sell their gasoline buying rights (in order not to have to take actual delivery, which involves a whole other kind of infrastructure and cost if you’re not a physical player in the market)

Financial speculators panicked, sold out, and drove price down massively.

Also, a couple of the comments following Jerome’s essay:

Look at the NYMEX, it does what it does. Can you believe exxon had a huge supply of hidden gasoline sitting in storage to dump the market with?

Also note primary stock levels are normal to high and still growing. So if they did dump the market, they did it with mystery bbls that they are not reporting to the DOE.

Care to offer an explanation why Nat gas dumped from $15 last winter to $6 by spring? No election then.

As for prices going up this fast, remember Katrina?? Now that was an obvious fundamental shortage due to refinery problems. Down moves are usually less severe, but can be this sharp. I’ve seen similar collapses for similar reasons. Just too much supply and finally the speculative length lets go.

And:

The tin hat thesis you see here daily is that “Big oil is driving prices down to elect republicans.”

2004 says the opposite and most if not all of this dump is explainable without resorting to hidden forces.

Does big oil support Republicans? 100%. Do they have the stroke to make gas jump up and down like a yo-yo to play with electoral politics, nope.

Gas Tax

Finally, I wrote a short essay for The Oil Drum this morning on raising the gas tax:

Let’s Talk Gas Tax

I am looking for dialogue on raising the gasoline tax in the U.S., which I think we need to do in order to spur conservation and stretch our oil supplies. Revenues would be given back to consumers in the form of tax credits, with some portion going to support mass transit and perhaps rebates for fuel efficient cars. Feel free to comment here or at The Oil Drum on what you think of this issue. I will say that this is probably an issue on which my opinions will sharply diverge from the stance of most oil companies.

September 18, 2006 Posted by | gas tax, oil companies, politics, price manipulation | 19 Comments

No Price Manipulation

I have lost track lately of the number of people who think oil companies are deliberately dropping prices in order to influence the election. I have close ties to the product pricing group, and I can tell you that these assertions are ludicrous. In fact, I mentioned these conspiracy theories this morning in a meeting, and everyone had a good laugh. But one person asked “Don’t people understand how oil and gas are priced?” The answer is, “No, they do not”, so we have this disconnect.

I have intended to write a post to address those who insist that gas prices are tied to the election, but I know that there are people who distrust me merely because I work for an oil company. That’s fine. So, I will give you the explanation from someone that you might trust. Jerome a Paris at Daily Kos has written an excellent essay explaining why gas prices are going down at the moment:

There is NO manipulation of gas prices. An explanation

He goes through and explains why gas prices are dropping. He mentions the transition to winter blends that I documented in my previous essay. But this is a seasonal issue, and is only one factor in the recent price changes. Anyway, if you really believe that the price drop is deliberate, read his essay and you will probably change your mind. A couple of highlights I wanted to bring up:

A first point to note is that gas prices rose in 2004 right up to the election, and dropped just afterwards (look at this graph, upside down if you don’t believe it), so there was no manipulation of that kind in 2004.

Basically, a lot of people bet that this summer would see the same problems as last year (which was not a completely stupid bet). That sustained demand (from speculators) and prices.

But the underlying market was less favorable (a bit more production from refiners, a bit less demand than expected), and the hurricanes speculators were betting on to give value to their virtual gasoline did not materialise, thus forcing them to sell their gasoline buying rights (in order not to have to take actual delivery, which involves a whole other kind of infrastructure and cost if you’re not a physical player in the market)

Financial speculators panicked, sold out, and drove price down massively.

Also, a couple of the comments following Jerome’s essay:

Look at the NYMEX, it does what it does. Can you believe exxon had a huge supply of hidden gasoline sitting in storage to dump the market with?

Also note primary stock levels are normal to high and still growing. So if they did dump the market, they did it with mystery bbls that they are not reporting to the DOE.

Care to offer an explanation why Nat gas dumped from $15 last winter to $6 by spring? No election then.

As for prices going up this fast, remember Katrina?? Now that was an obvious fundamental shortage due to refinery problems. Down moves are usually less severe, but can be this sharp. I’ve seen similar collapses for similar reasons. Just too much supply and finally the speculative length lets go.

And:

The tin hat thesis you see here daily is that “Big oil is driving prices down to elect republicans.”

2004 says the opposite and most if not all of this dump is explainable without resorting to hidden forces.

Does big oil support Republicans? 100%. Do they have the stroke to make gas jump up and down like a yo-yo to play with electoral politics, nope.

Gas Tax

Finally, I wrote a short essay for The Oil Drum this morning on raising the gas tax:

Let’s Talk Gas Tax

I am looking for dialogue on raising the gasoline tax in the U.S., which I think we need to do in order to spur conservation and stretch our oil supplies. Revenues would be given back to consumers in the form of tax credits, with some portion going to support mass transit and perhaps rebates for fuel efficient cars. Feel free to comment here or at The Oil Drum on what you think of this issue. I will say that this is probably an issue on which my opinions will sharply diverge from the stance of most oil companies.

September 18, 2006 Posted by | gas tax, oil companies, politics, price manipulation | 10 Comments