It
is truly amazing how much can change in four years. Or, more accurately, how
little things change in terms of human behavior. Four years ago the US was
mired in the last spike in gasoline prices heading into the summer. Virtually
every media outlet was conducting daily interviews, polls, and newsbytes
about how Mr. and Mrs. Average were dealing with the high gas prices. Today,
we have a new norm, and the wires are rather silent on the high gas prices
other than quietly reporting the national averages. We as a country have come
to be comfortable with $3.50 gas. Gas is one of those strange commodities too
because, unlike so many other things, almost everyone has a pretty good idea
of the price they paid for their last tankful.
What
should be even more disconcerting are the misperceptions surrounding this
latest increase in prices. There have been many
factors blamed so far, such as America’s lack of energy independence,
speculation, more expensive summer blends, high gas taxes, and supply and
demand. Some groups focus on refining capacity, while others focus on more
energy efficient vehicles and higher EPA standards for efficiency. There are
also others that argue that there should be national standards for gasoline
instead of each state setting its own rules. This, they say, would make the
refiner’s job a lot easier.
In
a way, they’re all right – and wrong at the same time. The point
of this article, however, is not to assign blame, but to present some very
relevant information and let you draw your own conclusions. The list of
issues is by no means a complete one by any stretch and I’ll say in
advance that, in terms of analysis, the data relied upon is provided by the
US Energy Department. Aside from the reality of prices, there is really no
way to either back check or verify their data.
Analysis
– Supply and Demand or ‘Other Factors’?
The
chart below shows the number of barrels of finished motor gasoline supplied
per day in the United States. The data is by the week. Since reaching a peak
of 9.688 million barrels per day (mbpd) during the
week of 7/27/07, gasoline demand has dropped to 8.861 mbpd
during the most recent week for which there is data (4/6/12). Demand bottomed
at 8.018 mbpd during the week of 1/27/12. In
percentage terms, demand for finished gasoline has dropped 8.5% from the 2007
peak through the present, and 17.2% from the 2007 peak through the January
2012 bottom.
The
next chart is basically an overlay covering essentially the same period of
time. Prices were all over the place while demand slowly but steadily grew
into 2007, peaked at 9.688 mbpd during the week of
7/27/07, and has been trending downward ever since. This pretty much eliminates
increasing US demand as the culprit for rising prices. Unfortunately for us
the market for gasoline, like most commodities, is now global. This is where
the story becomes rather sad.
The
charts below show the ‘movement’ of gasoline products. Most
Americans do not realize that we actually export a good deal of finished
gasoline, while simultaneously importing the same. Certainly many of these
decisions are made at the corporate level, but as a national policy
‘theme’, it certainly seems silly to import something, use less
and less of it domestically, then have enough to export while at the same
time consumers are being crushed by near-record level prices.
Many
economists cited demand destruction as the reason prices fell after peaking
in 2008, and while this may be true, demand certainly didn’t pick up,
even when the average price was cut by more than half. Remember, not too long
ago, we were paying less than $2/gallon. So the price has more than doubled,
while demand continues to fall. Many folks might use this reality to make the
case that there is absolutely no sense to economics and that supply and
demand ‘laws’ aren’t really laws but theories and cannot be
taken seriously.
Rather
to the contrary, I believe it is more important to use this situation to
impress upon readers that there are numerous factors involved in setting
prices, many of which were previously mentioned in this piece. Unfortunately,
this is only part of the story; it gets even worse.
Refining
Capabilities
Many
individuals will be quick to point out that America hasn’t built a
refinery in several decades. When we built our last refinery really
doesn’t matter at this point. What is important is that the stage is
set for America to actually lose refining capacity – and
it is already happening.
Earlier
this week there was an excellent article in the Financial Times
that got some play in the US media, but not nearly enough. It asserted that
the East Coast of the US is set to lose roughly half of its refining
capacity. Here are some of the details:
-Sunoco
has already scuttled two refineries and indicated it will close a third by
July of this year if a buyer is not found.
-Sunoco
has lost $1 billion over the past three years at its East Coast refineries.
-Conoco-Phillips
is trying to sell a refinery in Philadelphia that has been sitting idle since
last year.
-More
than 3 mbpd of refining capacity has been lost in
Western nations since the financial crisis back in 2008.
-Emerging
economies have added 4.2 mbpd of refining capacity
since the crisis with another 1.8 mbpd coming
online this year. This factoid would help to make the argument that we are
likely to be importing more gasoline in the years to come instead of becoming
more independent.
-Europe’s largest refiner, PetroPlus, has
filed for bankruptcy and is currently seeking buyers for five of its plants.
Sunoco’s
dilemma with its Marcus Hook refinery in the southeastern corner of
Pennsylvania is representative of some of the logistical issues facing
domestic refiners. The Marcus Hook refinery relied largely on oil from
Nigeria, Norway, and Azerbaijan. Nigerian crude is some of the finest quality
in the world and for nearly all of 2011, the price of a barrel of Nigerian
Crude (called Qua Iboe) averaged around
$114/barrel, more than a barrel of refined gasoline, making the refining of
this product a loser. Meanwhile, West Texas Intermediate Crude averaged $95/bbl during 2011, but Sunoco had no cost-effective way to
get the oil to PA, since there is no pipeline. And it is a real shame too
since Texas’ oil production has actually increased by 25% over the past
several years and topped a half billion barrels for the first time since
1998.
The
battle over the Keystone XL pipeline would do nothing to help Marcus Hook
either since it would connect the Alberta tar sands with Texas. And even if
there was a second pipeline shuttled to the East Coast, Marcus Hook and many
other refineries in that area are not designed or suitable for refining
heavy, sour crude, but rather depend on the higher quality grades such as Qua
Iboe for their refining activities.
Many
are quick to blame conspiracies amongst the oil companies to fix prices, and
while this may be true in some instances, Sunoco’s conundrum is
certainly a legitimate one. The only options really would be for Sunoco to
eat the loss and keep refining, essentially taking one for the team, or for
the government to subsidize continued refining by making up for the loss.
Unfortunately, this would have to be done by borrowing even more money from
foreigners and/or the federal reserve.
The
further loss of refining capacity (for whatever reason) is going to have
serious ramifications on prices – unless demand continues to fall,
which seems to be the consensus of the IMF among others. And even in the case
of falling demand, we’ve already demonstrated that prices can still
rise thanks to the complex factors already described.
The
economic landscape is changing right before our eyes. The lack of pickup in
demand for gasoline and oil in general in the United States is proof positive
that the ‘recovery’ so eloquently talked about in the press and
by politicians and central bankers is an absolute joke. Higher fuel
efficiency and ethanol have been credited with the decrease in overall gas
demand by the media, but high unemployment and stagnant consumer spending on
a unit basis have certainly taken their toll as well. It is a well-known fact
that vibrant, growing, and healthy economies use more oil unless
they’ve been set up to use alternatives, which we, by and large, have
not.
For
several years now, corn-based ethanol has been touted as the magic bullet
that will solve the gasoline crisis in America. Unfortunately, that too was a
poorly thought out, half-baked solution and as a result, the country is
littered with multi-million dollar ethanol plants, many of which have never
been used. There is one 20 miles from where I sit and it has never produced a
single gallon of ethanol.
The
bottom line is that America has been talking for decades about energy
independence, but there has never been a coherent plan for achieving it and
sadly, that is still the case today. To make matters even worse, paper
futures markets make it ridiculously easy for banks and hedge funds to get in
on the action too and rake in billions off the backs of consumers the world
over. We’ve always been told we should be happy because the Europeans
pay twice as much for gas as we do. Even a cursory glance at that continent
today should indicate we don’t want any part of the path they’ve
taken, with regards to energy or anything else for that matter.
Several
years ago, I pointed out that it would be unlikely that a serious economic
recovery would occur here in the US due to the issues of peak oil (as well as
poor policy decisions), and unfortunately, so far that thesis is intact. Yet
that still hasn’t stopped gas prices from hitting $4/gallon and it
would be my guess that before too long, Americans will be comfortable with it
and anything less will be considered ‘cheap’. Regrettably, other
than restructuring our lives to reflect this new reality, there is little we as consumers can do about this one.
Until Next Time,
Andrew W. Sutton, MBA
Chief Market Strategist
Sutton &
Associates, LLC
Interested in what is going on in the markets and
the economy? Read Andy Sutton's weekly market and economic commentary 'My Two
Cents' - go to www.my2centsonline.com