High Gasoline Prices Put Focus on Refiners, No Easy Solutions Ahead
On June 14, President Biden sent letters to several U.S. refining companies addressing the issue of rising fuel prices and urging the industry to alleviate the consumer pain at the pump, which has become both an economic and political sore point for the administration. In response, the industry has cited market forces, the Russian invasion of Ukraine, financing, economic and supply chain considerations, and policy and regulatory concerns focused on the role for and longevity of oil and gas in a decarbonized world.
Some people have taken offense at either the language of the outgoing letter or the tone of the incoming responses, but at least the parties are now talking, a marked change from the early days of the administration. On June 23, Energy Secretary Jennifer Granholm met with a group of refining executives, and additional meetings are now scheduled with industry groups over the next several weeks.
After months of focusing on global crude oil and natural gas supply, including ratcheting up domestic production, urging the Organization of the Petroleum Exporting Countries (OPEC) to put additional oil on the market, and releasing millions of barrels of strategic (mostly crude oil) stocks, the discourse has now shifted to examine the pivotal role of refining, delivery infrastructure, and potential demand remedies. Depending on one’s view of continued economic and energy growth and the timing, logistics, and cost of delivering sanctioned and unsanctioned barrels to market, a modest global crude oil surplus by the end of this quarter is possible. The same may not be true, however, for the range of refined and intermediate petroleum products the world continues to demand.
And unfortunately, absent a recession or mandated demand reduction, there is little that can be done short term to alleviate continued tight product markets—and geographic, seasonal, geopolitical, and weather events are positioned to only add to upside risk.
Even before the pandemic, growing concerns about climate change, the rise of environmental, social, and governance (ESG) forces and increased regulation, restraints on capital, and market dynamics were crimping oil and gas finances. For the upstream, such underinvestment meant companies and nations were unable to bring on new long-lived projects to offset and replace depletion rates as well as accommodate new demand growth. For the midstream and downstream sectors, this meant deferring or scrapping needed equipment upgrades and connections to better service supply chains and consumer requirements.
The Covid-19 pandemic had a devastating impact on personal wellbeing, which in turn tanked economic and energy growth, caused prices to plummet, and created havoc for suppliers and logistics everywhere. On the oil side, OPEC-plus took action to restrict supply in order to support prices and reduce the overhang of global inventories. Not unlike local restaurants or manufacturing entities, energy companies similarly reduced workforces and cancelled projects. Turning complex processes on and off is not a simple or immediate act and shuttering refineries and shutting in production requires significant capital outlays and long lead times to restore, if at all. Climate considerations and regulatory proposals limiting fossil fuel use undermined investor confidence that such an outlay will be worth the expense. In uncertain times, valuations of complex investments are particularly susceptible to being deferred.
Coming out of the pandemic, economic and energy demand growth took off faster than anticipated and supply chain issues impacted the delivery of a wide variety of goods, raising prices and spurring inflation.
There were already signs of impending shortages in early 2022, but some of the concerns were tamped down by Covid-19 lockdowns in Asia and more general economic slowdowns. In addition, even as crude volumes increased (e.g., from OPEC, U.S. production, SPR releases, etc.) refining constraints along with higher crude, transport, and general inflation costs, contributed to keeping product prices high.
The International Energy Agency (IEA) estimates that between 2019 and April of this year, the world’s operable refining capacity was reduced by over 3 million barrels per day. While U.S. capacity utilization is approaching 95 percent, total output has been materially reduced due to closures and conversions. China’s policy took additional capacity offline this spring, and Russian-owned facilities physically located in Europe but relying on Russian oil inputs have been stymied in their efforts to lock in alternative supply sources.
In addition, the range of intermediate products formerly supplied by Russia, which are sourced as inputs to U.S. Gulf Coast and other refining operations, are severely limited by sanctions. Russian oil that has continued to ship to China and India (under heavy discounts) has been impacted by longer shipping times.
As with most vexing policy issues, trade-off considerations, near and longer-term impacts, and political calculations, only add to the complex operational, logistical, engineering, and cost calculations. Some proposed “remedies” that have been advanced fail to move the dial on correcting the underlying problem. Refining processes are expensive and complex. There are over 150 different crude oil types and 700 refineries worldwide. The equipment in each facility is designed to optimize the conversion and processing of a range of crudes (and other inputs) to make a profitable and needed slate of refined product outputs. Replacing crude or altering output specs and product arrays is challenging.
Many proposals have been advanced to address the gas price surge as peak driving season approaches in July. Some ideas, like waiving state and federal gas taxes, may provide limited, short-term relief to consumers, but in the process, do nothing to materially curb demand. Others, like banning domestic crude or refined product exports, are actually counterproductive and could raise global prices. Because of the composition of the U.S. auto fleet, the United States typically exports diesel to Europe and imports gasoline. Consequently, an export ban could end up reducing gasoline availability to U.S. consumers while serving to further increase prices.
Other suggestions, like temporary Reid vapor pressure (RVP) or Jones Act waivers may prove helpful on the margin in terms of increasing gasoline supply and reducing prices, but are likely to be met with significant political resistance.
In a market economy, price is the final allocator of product. And in fact, persistently high prices may already be showing early signs of demand erosion as gasoline consumption has been slowing declining along the East Coast for the past few weeks. Crude prices have also presently retreated from recent highs, in reaction to both the Federal Reserve’s recent action to hike interest rates and renewed concerns over a global economic slowdown. At the end of last week, the price for West Texas Intermediate crude oil (WTI) was some $15 per barrel lower than a week and a half ago. But as mentioned earlier, events and sentiment have a way of quickly reversing near-term trajectories. Hurricane season has arrived, and almost half of the U.S. refining capacity operates along the Gulf Coast. Russia’s invasion of Ukraine continues and production upheavals in Nigeria, Libya, and elsewhere remain ongoing. Yesterday’s proposal by the G7 to cap oil prices actually drove prices higher as concerns of supply limitations resurfaced.
And while markets may be efficient, they are also unfeeling and lack empathy for less fortunate players. Inflation at 40-year highs and persistently high energy prices are damaging economies and forcing consumers to make suboptimal choices, including the substitution of coal for natural gas or choosing to pay for fuel rather than food, rent, or medical care. This is where thoughtful policy can play a purposeful and helpful role.
Getting government and industry, financiers, engineers, and policymakers together for a constructive dialogue and “same page” understanding of the scale, timeline, and range of possible actions may not be an immediate panacea for today’s gas prices, but is certainly overdue and welcomed first step.
Frank Verrastro is a senior adviser (non-resident) with the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Albert Helmig is a non-resident senior associate with the CSIS Energy Security and Climate Change Program.
Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).
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