Why Abundant Oil Hasn't Cut Gasoline Prices
For the first time since 1995, the U.S. will likely produce more oil than it imports. That’s great for the country’s trade balance, but the benefits of all that cheap domestic crude still haven’t shown up at the one place it matters most: the gas station. Even as fuel consumption has fallen to 16 percent below its 2007 peak, gasoline remains about a dollar higher than the average price over the past decade. So far this year, gasoline prices have risen 11 percent nationwide, to $3.65 a gallon.
Simple economics suggest that higher supplies and lower demand should translate into cheaper prices. That presumes today’s petroleum markets are simple. Over the last year, the oil boom has upended the long-held belief that U.S. production would inexorably decline while America’s appetite for gasoline continued to rise, leaving the country hopelessy hooked on foreign crude. As the opposite has occurred, regulatory and transportation systems that grew out of those old assumptions have become increasingly outdated, preventing the forces of supply and demand from working efficiently.
Most of the surge in oil production has happened in places such as North Dakota, Wyoming, Colorado, and Oklahoma, far from refining hubs and big population centers. With competition fierce for limited pipeline capacity, producers have begun moving crude on barges and trains, adding as much as $17 a barrel to the price of domestic oil. That extra cost eventually makes its way to the price at the pump. Ethanol requirements have backfired. The idea was to stretch a limited oil supply, cut reliance on imported crude, and make use of abundant corn harvests. But today the ethanol program is raising costs for refiners even as the price of oil has fallen 10 percent over the last year.
Complicating the equation is a 1920 law called the Jones Act, which requires any cargo shipped between U.S. ports to be carried by vessels that are based in the U.S., made in the U.S., and crewed mostly by U.S. citizens. The law was intended to protect U.S. shipping interests but has made it more costly to move fuel between U.S. ports. This in particular hurts the Northeast, which is struggling to meet its fuel needs after several refineries closed in the last two years. According to Ed Morse, chief commodity analyst at Citigroup (C), those constraints add between $6 and $8 a barrel to transport costs. As a result, it’s often cheaper for a Gulf Coast refiner to send gasoline to Brazil than to New York.
In late 2011 the U.S. quietly surpassed Russia as the largest exporter of such refined products as gasoline and diesel. Canada’s fuel imports from the U.S. jumped 15 percent in 2012. Brazil’s demand for U.S.-made fuel rose 6 percent. China’s leapt 17 percent. Exports to Venezuela and India more than doubled. Without realizing it, U.S. drivers are competing for American-made gasoline with consumers in Latin America and Asia, where demand is rising. “Americans don’t think about their prices being impacted by a global market,” says Morse. “The American public just thinks about the rising price at the pump.”
Exports have continued to rise in 2013. In March the U.S. shipped out a record 3.2 million barrels a day of refined fuel. “The tools are in place for the U.S. to become an even bigger exporter of gasoline and diesel,” says Stephen Schork, president of the Pennsylvania energy consulting firm Schork Group. “The U.S. has the most sophisticated network and the most technologically advanced refining system in the world, and it has access to a tremendous amount of domestically produced crude oil in a country where demand is stagnant at best.”
Despite the added costs of transport, U.S. refiners retain a price advantage over their foreign competitors in Europe and Latin America, since U.S. crude is still cheaper than most foreign benchmark blends. This has led to healthy profits for some of the nation’s largest refiners. Shares of Marathon Petroleum (MPC) and Phillips 66 (PSX) hit records in January after earnings beat estimates. Now those lucrative margins have come under pressure as fuel makers run headlong into a biofuel mandate that has become tougher and more expensive to meet.
This year, the law requires U.S. refiners to blend 13.8 billion gallons of ethanol into the fuel they sell to domestic customers. In their calculations when crafting the bill in 2007, lawmakers assumed gasoline demand would continue to rise and that refiners would need all that ethanol to make up 10 percent of the fuel sold to motorists. The problem is that U.S. drivers are consuming less, not more, gasoline because they’re driving fewer miles in increasingly fuel-efficient vehicles. As a result, refiners don’t need all the ethanol the government forces them to buy. To make up the roughly 400 million gallon difference between the ethanol the industry needs and the amount the government mandates, refiners must buy credits called Renewable Identification Numbers, or RINs.
The drop in gasoline use has been so dramatic that demand for RINs has spiked, as has the price: from 7¢ a gallon at the beginning of the year to more than $1 on March 8. The price has recently come down to 66¢. If sustained, the increase may add as much as 10¢ to the retail price of a gallon of gasoline, says Bill Klesse, chief executive officer of Valero Energy (VLO), the world’s largest independent refiner. “It’s going to get passed on,” Klesse told an audience of oil industry executives at a March 18 conference. The end result is that refiners have an even greater incentive to sell their fuel abroad, where it isn’t subject to U.S. ethanol requirements.
All of this means that while U.S. oil production is forecast to rise this year, much of it will be refined into gasoline or diesel for the new drivers of Brazil, India, and China. “You have demand growth in every market around the world,” says Schork. “We’d be paying considerably more than we are if we hadn’t had the runup in prices and the incentive to bring more oil to the market.”
To bring U.S. gasoline prices way down requires improvements in the pipeline, barge, and truck network that connects the fields of North Dakota with refineries on the Gulf and East Coasts. Progress is being made; already more barrels of North Dakota crude are being carried by train from the Bakken Shale thanks to several newly completed rail terminals near East Coast refineries. Two refineries are also being built in North Dakota. Some analysts are betting that gasoline prices will be lower by summertime. Yet even with improvements in oil-field logistics, as long as U.S. refiners export their fuel, U.S. drivers will be competing for gasoline with their counterparts elsewhere in the world.
The bottom line: U.S. refiners of gasoline and other fuel are increasingly going after global market share rather than selling to the home market.
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