Want to know why gas prices are so high? Look at the oil refineries

ADVERTISEMENT

The real reason gas is so damn expensive: Don’t just blame oil prices, blame refineries too

Gasoline prices are up. That is not a big surprise. People are no longer staying home, and the summer driving season is kicking off. Meanwhile, Russia, a major oil producer, has been cut off from the American market.

Gas prices sit at $4.59, according to the Energy Information Administration, surpassing the immediate post-Russian-invasion high of $4.32 and well up from $3 a year ago.

But whatever pressures — political or otherwise — there are on bringing down gas prices, there are big structural reasons that cheap gas isn’t in the United States’ future. Even if more oil was flowing freely out of American wells and tankers full of Russian crude were welcome in the U.S., it would still have to get refined into gasoline (or diesel, or jet fuel).

And that’s where the problem is.

ADVERTISEMENT

“We were seeing gasoline demand at or slightly above pre-pandemic levels. We are seeing distillate demand above pre-pandemic levels. And that demand is being met with significantly less refinery capacity as we had rationalization that occurred during the pandemic,” said Gary Simmons, chief commercial officer of Valero, which operates more than a dozen refineries in the United States and Canada, said in a call with analysts.

“Has the oil market run out of refining capacity? Given how the system is behaving, we think the answer may well be ‘yes,’” Morgan Stanley Equity Analyst Martijn Rats wrote in a note earlier this month.

In other words, demand for gasoline has returned, but the ability to meet it has been reduced — or rationalized — away during the pandemic. And looking ahead, it doesn’t seem like there are many options to improve refinery capacity. It takes years to expand existing facilities, and the trend in the industry hasn’t been to add more capacity but to shut down or convert them to produce renewable diesel.

“There isn’t enough capacity to meet higher-than-expected demand,” said Gregory Brew, an oil historian at Yale University.

U.S. refinery capacity was precarious before the pandemic

During the pandemic, refineries simply did less, while others closed down completely — including a refinery in Newfoundland shutting down. And before the pandemic, a refinery complex in Philadelphia was beset by a series of fires and explosions, which led to its complete shutdown. By late 2020, some industry figures were predicting that because of structurally lower demand for fuel due to covid, idle refineries would convert to being storage facilities as opposed to actually refining petroleum products.

ADVERTISEMENT

In the first quarter of its fiscal year, the operation income for Valero, the second-largest U.S. refiner by capacity, from refining was $1.45 billion, compared with a $592 million loss in the first quarter of 2021; in the fourth quarter of 2021, operating income from refining was $1.3 billion.

It’s not hard to understand why refiners are reluctant to build new facilities — and why the public and regulators would rather they not. “Every U.S. refinery site is more or less a Superfund site in waiting,” said Rory Johnston, founder of Commodity Context, noting that no completely new refineries had been built since 1977.

The industry has dealt with the problem by expanding existing facilities, which means more oil can be refined, but if something goes wrong — like an explosion — it means a bigger hit to the industry’s ability to produce gasoline and diesel. It creates fragility in the system that wouldn’t exist if you had the exact same refinery capacity in different places.

“No one is going to build a new refinery on the East Coast of the United States this year, next year or the year after,” Johnston said.

The most recent Energy Information Administration data put refining capacity at about 18 million barrels per day in February, while in the months before the pandemic shut down vast swathes of the economy, it was around 19 million barrels per day. And less oil is going into U.S. refineries daily: According to the most recent EIA data, it stands at almost 16 million barrels per day, which is well above the pandemic low of just under 13 million barrels, but a decline from the almost 16.5 million barrels per day in February 2020.

The global supply chain has its own hang-ups

Refining capacity has expanded in the Middle East and China. There have been limited exports, along with Russian exports drying up following its invasion of Ukraine.

“Outside the Middle East and China, atmospheric distillation capacity has contracted by ~1.9 mb/d since 4Q19, the largest decline in at least 30 years. New capacity has been added in China and the Middle East, but this has not translated into additional exports of oil products,” Rats wrote.

With this crunch, some refiners in the U.S. are actually exporting, especially to Latin America, according to S&P Global Commodity Insights.

The climate connection

That this year is forecast to be a major hurricane season means that refineries on the Gulf Coast are at risk, which could mean that more refining capacity is taken offline just as gasoline demand may start to cool in the late summer and fall.

The turnaround in the profitability of the refining business was not necessarily expected. Even before the covid pandemic tanked oil demand, analysts were predicting that demand for oil for cars and trucks would peak by the middle of this decade and overall by the beginning of the next one.


ADVERTISEMENT

Refiners got caught between the energy transition that was being predicted and the one that actually happened: an economy thirsty for oil and fuel and not getting it from the usual places.

For now, that means profits, but it could also mean fragility going forward.

“This is not a problem that is going to go away; hurricanes will make it worse potentially,” said Patrick De Haan, a petroleum analyst at GasBuddy.

Thanks to Lillian Barkley for copy editing this article.

  • Matthew Zeitlin
    Matthew Zeitlin

    Domestic Economics Reporter

    Matthew Zeitlin is an economics reporter at Grid focused on the domestic impact of major stories such as coronavirus, the supply chain and economic volatility.