The Gazette (Montreal, Canada)
As many motorists have learned, if there’s news that the price of oil has shot up, it can be smart to pull over and fill up right now, maybe beating the inevitable shock at the gas pump.
But what we’re seeing this week is that oil prices, largely controlled by OPEC, are only half the problem. Crude oil supply is only one of the two squeeze points affecting the cost of gasoline.
The other is our own refiners’ ability (or willingness) to turn the gooey black stuff into gasoline. And today, it’s inadequate refinery output that’s causing sticker shock at gas pumps across North America this week.
As the American Automobile Association pointed out yesterday, there’s little pressure now from oil, with the price of crude at least $10 less per barrel than the last time gasoline cost about this much, in August of 2006.
So is it a conspiracy? Not in the crude fashion that many critics of the oil
business imagine.
It’s more like a tacit agreement. After all, there’s no need to break the law by conspiring to fix prices if all that’s really necessary is to sit back, do little to increase the supply of gasoline, and let growing demand slowly squeeze prices higher.
There’s plenty of evidence that this is exactly what major oil companies have done over the last couple of decades in the U.S, whose huge petroleum market sets the tone for prices all over North America.
In most businesses, this wouldn’t be possible. If one company failed to serve the market, its many competitors would rush in, taking away customers. But when there are very few companies serving the market, and it’s a long, costly process to build a new refinery, oil companies can be pretty sure that no competitor will rush in.
And why would they even bother? Gasoline is one of those products for which demand is quite inflexible, which makes it different from candy bars or TV sets. With gasoline, more supply would just mean lower prices, not more demand.
When the price goes down, people don’t buy much more gas, since they still have the same commute and the same errands to run. And when the price goes up, people don’t buy much less. At least they don’t at any price we’ve seen so far.
So with a small number of producers and with no fear that demand will slump if prices rise, we have a perfect prescription for an industry to enjoy the rising profits without any need to build costly new refineries.
In fact, the industry hastened this process a little, as was perfectly legal in the absence of some action by competition regulators. Refinery closings and company mergers have cut in half the number of refineries in the U.S. over the past 25 years.
A California consumer group, the Foundation for Taxpayer and Consumer Rights, has dug up a number of old memos from major oil companies discussing quite frankly the need to cut refining capacity in order to boost profit margins.
But with refinery capacity not growing, the U.S. depends increasingly on imports of refined products from Canada and offshore suppliers. These imports can’t always keep up with rising demand, even at very high prices.
In the meantime, existing refineries in North America are getting older, which might explain the increasing number of unexpected shutdowns, like those caused by fires at two different Imperial Oil refineries in Ontario this winter.
Likewise in the U.S, where the last new refinery was built 31 years ago, surviving refineries need to operate flat out in order to come close to meeting demand, but seem less and less able to do so.
Ten years ago, refineries in the U.S. typically operated at about 95 per cent of capacity, but in recent years, this number has fallen steadily, to average just over 89 per cent last year, notes Bart Melek, a commodities specialist with BMO Capital Markets.
Amid a string of breakdowns over the past several weeks, refinery output fell to 87.8 per cent of capacity last week, then edged up to 88.3 per cent this week, according to U.S. government figures, leaving gasoline inventories badly depleted just as motorists begin the highest-demand period of the year.
As refinery output has fallen farther behind demand, one rough indication of refinery profitability has moved steadily higher. A measure of the spread between the price of crude and the price of refined products has nearly tripled, from an average of just $3.56 in 1999 to $10.94 last year.
Amid the recent shortages, this so-called “crack spread” shot as high as $24.80, Melek says. He predicts in a recent report that “we look for sky high crack spreads throughout the summer.”
————-
Contact the author at: [email protected]
