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By Robert Rapier on May 18, 2007 with no responses

Gouging is an Idiotic Explanation

Not my words, but I have expressed similar sentiments. Paul Sankey, an analyst with Deutsche Bank, testified on May 15th before the Senate Committee on Energy and Natural Resources. I would guess some jaws dropped during his testimony, as some of the Senators on the committee have certainly suggested that gouging is going on. Below are some extended excerpts from Mr. Sankey’s testimony. While I have some minor quibbles here and there, for the most part he told it like it is.

Update: Here is the full online version: Gouging is an Idiotic Explanation; there are some very good graphs in there. Thanks to KingofKaty for that link.

Gouging is an idiotic explanation – Senate Testimony of Paul Sankey

Anybody who blames record high US gasoline prices on “gouging” at the pump simply reveals their total ignorance of global oil supply and demand fundamentals. The real reason for high pump prices is the lack of global gasoline supply relative to demand. Just in the US, overall US refining capacity, at 17 million barrels per day (mb/d), is far below demand at 22 mb/d. In turn, pump prices are effectively set by import prices. With strong demand outside the US on the back of global economic growth and a weak dollar, the era of abundant US oil supply augmented by willing international sellers is dead.

The investment cycle drives the story – but it is 30 years long

High gasoline prices will cure high gasoline prices. 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. It is fair to say that as we enter driving season in 2007, we are one major incident away from a 1970s-style gasoline crisis. There is now US gasoline inventory, at record lows, for just twenty days of consumption.

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.

Nevertheless, because the industry is so stretched, there have been subsequent accidents, for example, a further BP issue at the company’s Whiting, Indiana plant. These two BP refineries alone are two of the five biggest US refineries, now running at half capacity, with some 400 kb/d shut down, and the remaining operating sub-optimally, running rare light sweet crude when they should be using more abundant heavy sour grades. Not all problems are with BP, for example a fire at Valero’s McKee refinery has tightened the Mid-Continental refining balance.

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. There is competition from non-refining investment to exacerbate the problem, notably in Canadian heavy oil sands.

Then, just when imports are needed more than ever, European and Asian demand strength has combined with a weak dollar to leave margins higher elsewhere, crimping import levels. In this tight context the government has mandated tougher-to-make fuels, requiring more refining and plant maintenance. The law of unintended consequences results in government mandated ultra-low sulfur diesel (ULSD) being so hard to transport around the country that it excludes higher sulfur off-road diesel from the pipeline system, forcing farmers to use higher quality, more expensive, more difficult to make diesel than they would legally have to, and encouraging the export of off-road diesel to competing global markets.

US policy makers must stop attempting to re-create a 20th century of abundant and cheap US gasoline, it is as dead as the geology that leaves no more cheap US oil. Avoid additional mandates and allow the market to direct capital towards the areas of tightness. Returns are now high, so US refining capacity IS being added, as fast as reasonably possible, and demand IS slowing. It is vital to allow US gasoline prices to reflect the true cost of supply, which even now they arguably do not do (awful geopolitics, the suffering environment). For this summer, be prepared to take emergency measures (lifting environmental restrictions, emergency IEA gasoline inventory drawdown) should an emergency develop. We are not there yet, but we are close.

Refinery utilization is very low

US refinery utilization (essentially supply) has been particularly low this year.

There are several possible reasons for this. We believe it is some combination of the following:

Extended maintenance – Refiners have universally pointed to longer maintenance periods (turnarounds) due to (1) tighter fuel specifications that require more frequent plant maintenance (2) the difficulty in finding and retaining skilled contract labor and (3) the considerable damage to machinery that has been pushed to the limits by strong product demand over the past few years.

Product specifications – Tightened product specifications for transportation fuels (i.e. Tier II gasoline, ultra-low sulfur diesel) have made it more difficult to produce fuels. Problems which used to cause a refiner to alter operations now cause one to shut down until necessary repairs are made.

Safety concerns – In the wake of the deadly explosion at BP’s Texas City refinery in 2005, refiners are more concerned about safety than ever. As such, they are much quicker to halt operations than in the past.