Editorial: The funnel shrank

In a June 14, 2022, letter to oil companies with US refining interests, President Joe Biden expressed the belief that they had “an opportunity to take immediate actions to increase the supply of gasoline, diesel, and other refined product[s].” Attempting to address the current high retail cost of fuels at the refining level is more sensible than suggestions it could be solved by issuing more drilling permits. Even so, the nature of this “opportunity” is unclear.

Gasoline and diesel prices and production margins are well above historical averages due to several factors. Foremost among these are low inventories—both globally and in the US—and demand having increased to near pre-pandemic levels.

At the same time, US refinery capacity has fallen by more than 1 million b/d since early 2020 as several refineries closed or converted. The biggest of the refineries shuttered was Shell PLC’s 260,000-b/d plant in Convent, St. James Parish, La. The company couldn’t operate it profitably during the pandemic and couldn’t find a buyer for it. Phillips 66 Co. never reopened its 255,000-b/d Alliance refinery in Belle Chasse, La., after it suffered severe damage during 2021’s Hurricane Ida. Marathon Petroleum Corp. is converting its 161,000-b/d Martinez, Calif., refinery to renewable diesel production after initially idling it in response to COVID-19.

This capacity, and that of other plants that have closed, is gone, not just unavailable. But the elimination of these supply sources wasn’t the result of a nefarious plot by either the industry or the Biden administration. Each of the refiners involved made the best business decision it could, given the circumstances at hand. The result was an overall reduction in capacity.

The US Energy Information Administration (EIA) expects what capacity remains to be running at as much as 96% rates this summer, close to the maximum maintainable level. Much as President Biden—and for that matter, the oil companies—might wish it were so, there is no switch that can be flipped to just start producing more refined products.

No more cushion

In any commodity market, prices are set by the marginal transaction. If buyers are worried that the next barrel they need will cost more, they’ll buy now instead. If not, they’ll stay on the sideline and buy when prices, to their estimation, will be lower. Sellers have a similar (but inversed) metric on their side of the equation. Price-reporting services recognize this with their end-of-day pricing-window methodologies.

President Biden noted that gasoline prices are substantially higher than the last time crude spiked to current levels in early March 2022. At the end of the first week of that month, US refinery utilization was just 89.3% according to the EIA. There was room to increase domestic fuels production and Russian barrels had yet to be removed from the market. The pressure on the incremental barrel then was not what it is now, particularly given the current need for European consumers to replace supplies sourced from Russia.

In a response to President Biden’s letter, the American Petroleum Institute and American Fuel & Petroleum Manufacturers noted that the current situation “did not materialize overnight and will not be quickly solved.” It went on to cite supply-demand imbalance, logistics reshuffling due to both the pandemic and the war, and “policy decisions made at the federal and state level over many years and by successive administrations” as causing the high crude prices which remain the single biggest factor in high gasoline prices.

In the meantime, US crude exports are on course to hit a record 3.3 million b/d in second-quarter 2022 as, with domestic processing options constrained, producers seek the highest price possible for their goods on the global market. To expect or, worse still, attempt to compel them to do otherwise would be both short-sighted and counterproductive.