The recent spurt in US gasoline prices cannot be blamed solely on rising crude oil prices. The other culprit is the current state of the US refining and products distribution infrastructure. That situation was created by decades of ever more-stringent, government-imposed fuel formula specifications designed to improve the nation's air quality. And it will get worse before it gets better.
For refiners observing the latest emerging government mandates for changing fuel formulas-reduced sulfur limits, phase-outs and bans of methyl tertiary butyl ether, and a renewables (ethanol, really) quota-the view must, as Oscar Wilde said while watching the gallows being built, "concentrate the mind wonderfully."
Those survivors of an inadvertent regulatory pogrom are likely to see better margins than this traditionally low-margin business has seen in years. But their enjoyment of those improved margins will be tempered by consumer ire over higher prices and the inevitable politicians' kneejerk response to investigate.
Current status
For the moment, it's looking better for refiners. US refining margins have risen in recent weeks as inventories of gasoline and distillates were drawn down. Gasoline stocks in the first week of April were a paltry 0.2% over their 1997-2001 average and were down 6% since the year's peak at the end of February, notes Paul Cheng, Lehman Bros. analyst.
"This is mainly due to a combination of aggressive refinery run cuts, as well as planned turnarounds that have caused utilization rates to average a very low 86% over the past month," Cheng said in early April.
Underscoring the bullish outlook for refiners is the fact that runs have remained low despite relatively high margins.
"This is due in large part to the fact that the distillate crack spread remains depressed, and consequently, refiners are reluctant to boost utilization of their crude units, choosing instead to run other units with higher gasoline yields," Cheng said. "We think that this trend is likely to continue and should allow gasoline inventories to continue to decline through mid-April while distillate stocks could keep falling for several months."
So refining margins will be especially robust in the second quarter, especially with the onset of the driving season at the end of May.
"This will be particularly evident in the niche markets of the West Coast, Midwest, and Midcontinent, since these areas remain susceptible to gasoline supply disruptions due to continued regional logistical constraints," Cheng concluded.
Logistical constraints
The logistical constraints of which Cheng speaks have cropped up before and will again. There were especially sharp spikes in gasoline prices in 2000 and first half 2001-with California and the Chicago-Milwaukee area the hardest hit. They were brought down last year by unusually high refinery runs, a weakening economy, and a seasonal downturn in gasoline demand.
Pump prices at the start of this year were down about 60¢/gal from their spring 2001 peak, according to Petroleum Industry Research Foundation Inc. (Pirinc), vs. the 21¢/gal drop in crude prices for the same period.
"But structural problems remain and show signs of reemergence as strong economic recovery and rising demand, as well as rising crude prices, fuel upward movement in gasoline prices," the New York think tank said.
The price increases have been especially strong in-you guessed it-California and the Chicago-Milwaukee area, another reminder of their special vulnerability as "boutique fuel" havens. And the gasoline price increases have outpaced those of crude oil, bolstering refiner margins.
Here's a prediction: During the spring debate on US energy policy, to score points on gasoline price spikes, antioil polticians will again dredge up the tired claims about the effects of mergers and collusive price-fixing by Big Oil.
But Pirinc's analysis clearly shows that recent mergers have, in fact, helped boost competition in certain markets. The downside is that fewer refiner-marketers mean a reduced cushion of inventories against supply interruptions, with the threat greatest in the boutique fuel havens that cannot draw easily on supplies from elsewhere in case of a shortfall.
While there's been some progress in alleviating this threat, Pirinc warns that more is needed: "Misplaced concerns over industry concentration must not divert policy-makers from a serious discussion of this issue."
Refiners are sure to program their VCRs for C-SPAN for that eventuality, right?
(Online Apr. 12, 2002; author's e-mail: [email protected])
