Current / Economics

Release the Refineries!

Crude Conundrum

With third-quarter growth clocking in at 5%…

…might the fourth quarter see a boon due to this?
https://i1.wp.com/www.wtrg.com/daily/clspot.gif
West Texas Intermediate (WTI) might drop half in value in the last quarter of 2014.  Brent is also sliding down a cliff:
https://i1.wp.com/www.wtrg.com/daily/cbspot.gif
 Good for all around, no?  Well, everybody except Japan:

Japanese annual core consumer inflation slowed for a fourth straight month in November due largely to sliding oil prices, highlighting the challenges the central bank faces in achieving its 2 percent inflation target.

Factory output unexpectedly fell and real wages marked the steepest drop in five years, underscoring the fragility of the recovery and dealing a blow to premier Shinzo Abe’s stimulus policies aimed at pulling the economy out of stagnation.

The core consumer price index (CPI), which excludes volatile fresh food but includes oil products, rose 2.7 percent in November from a year earlier, matching a median market forecast, government data showed on Friday.

Stripping out the effects of a sales tax hike in April, core consumer inflation was 0.7 percent, slowing from 0.9 percent in October and far below the Bank of Japan’s 2 percent target.

“While the economy is recovering, falling oil prices and slowing inflation will force the BOJ to ease policy further at some point next year,” said Hiroshi Watanabe, senior economist at SMBC Nikko Securities.

Oh, so austerity-derived stagflation is less than optimal.  The fact of the matter is if you ignore the effects of the VAT increase…


…the BOJ hasn’t managed to hit the 2.0% target since the Great Recession commenced.  How reassuring.  Dean Baker takes up the Reuters-drubbing from here:

First, if we check the base paths, we see that Japan is almost 100 percent dependent on imported oil. This is different from the U.S. which has a substantial oil producing sector. That should make the story pretty unambiguous. In the U.S. we can say that areas like North Dakota and Texas might take a hit, even if other parts of the country will benefit from lower oil prices. Japan doesn’t have a North Dakota or Texas, which means that they are only looking at paying less for their energy.

So how is this bad? Well, the Reuters piece says it means lower inflation. This is true, but we have to think of why lower inflation could be a problem. Let’s imagine that if the price of oil were unchanged, then Japan’s central bank would be hitting its 2.0 percent inflation target. Now because of lower oil prices, the overall rate of inflation will come in substantially under 2.0 percent.

From the standpoint of firms that are looking to lower real wages due to a fall in demand, how does the drop in oil prices make the situation worse. If the price of their output is falling relative to other, non-oil prices, and wages are falling as well in relative terms, these firms will be just as able to bring about the necessary price and wage adjustments as if the price of oil had not changed.

In terms of eroding the real value of debt, the drop in oil prices actually helps. Homeowners and others who have fixed nominal debts, will now see their income go further, if they can pay less for their gas, heating, and electricity. In other words, the debt is less of a burden to them.

Similarly, the real interest rate story is not affected by the drop in oil prices. If firms expect the price of software, cars, and other items to rise 2.0 percent a year, they have every bit as much incentive to invest after the drop in oil prices as before. (Actually, they would probably have more incentive, since the increased consumer demand for non-oil products will make investments look more attractive.)

In short, there is no plausible story in which the economy of a country like Japan, with little domestic oil production, is not benefited by lower oil prices.

Almost.  Japan doesn’t have crude oil production (just look at the Second World War to dispel all doubt), but does have a significant number of oil refineries (29).  Lower oil prices are impacting Japanese production of refined fuels:

Japan’s oil product sales fell 2.5 percent in October from a year earlier to just over 3 million bpd, the lowest for the month since 1985.

It appears that for now the surplus refining capacity is preventing Asia’s refiners from rebuilding margins on the back of weaker crude prices.

This is the mark of a supremely broken oil market, which traces back to the collapse of the U.S. refining industry.

Cracking Crude

The Energy Information Administration only began collecting data on American oil refineries in 1982, after the 80s oil glut was in full swing.  Monthly (as opposed to annual) dates back to 1985.  We are definitively not in a glut situation currently:

U.S. Percent Utilization of Refinery Operable Capacity (Percent)
 
Year Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
  1985 74.0 73.8 73.7 76.5 78.4 79.3 80.8 77.7 76.9 78.6 80.3 81.2
  1986 81.4 77.9 75.9 81.5 86.0 86.3 84.1 86.8 85.5 82.6 83.7 83.6
  1987 81.8 79.9 78.6 81.2 82.5 85.4 86.7 86.7 85.5 82.7 82.3 83.9
  1988 82.8 80.9 83.3 84.0 85.7 86.0 86.5 87.4 83.7 83.4 83.9 85.1
  1989 86.2 82.8 83.8 83.7 86.5 89.6 88.9 89.3 88.4 86.1 86.1 84.0
 
  1990 87.8 87.9 83.9 85.0 87.1 89.1 92.4 90.7 91.1 83.5 84.2 82.8
  1991 82.5 84.4 83.2 84.6 87.5 89.8 88.8 89.1 88.3 83.4 83.7 86.6
  1992 83.4 81.3 85.1 85.5 89.4 92.4 91.9 89.1 90.7 89.3 90.1 87.5
  1993 86.8 86.6 89.3 91.3 92.8 95.1 95.1 92.7 92.8 91.8 91.9 91.2
  1994 89.8 88.7 87.6 92.4 95.4 95.8 95.5 96.4 94.4 89.8 92.7 92.6
 
  1995 89.6 87.9 86.7 90.5 94.0 95.6 94.0 94.0 95.6 90.5 92.1 93.3
  1996 90.6 90.2 91.8 95.0 95.8 96.4 94.9 95.0 95.9 94.6 94.2 94.3
  1997 89.1 88.0 90.6 92.6 97.5 97.8 97.1 98.9 99.6 97.0 95.8 97.2
  1998 93.3 90.7 94.7 97.5 98.4 99.1 99.2 99.9 95.0 89.6 94.8 95.1
  1999 90.4 90.0 90.9 94.6 93.9 93.5 94.9 95.5 94.1 91.1 92.0 90.4
 
  2000 85.7 86.4 89.7 92.6 94.7 96.2 96.8 95.8 94.2 92.2 92.6 93.9
  2001 90.2 90.5 89.4 94.9 96.4 95.6 93.9 93.3 92.2 92.0 92.2 90.2
  2002 87.7 86.6 87.9 93.0 91.5 93.1 93.5 92.9 90.4 87.5 92.6 91.1
  2003 87.2 87.4 90.5 94.1 95.8 94.7 94.0 95.0 93.1 92.4 93.6 93.0
  2004 89.1 88.8 88.5 92.5 95.6 97.5 96.8 97.1 90.1 90.2 94.4 95.0
 
  2005 91.3 90.6 90.8 92.8 94.2 97.1 94.2 92.7 83.6 81.3 89.3 89.4
  2006 87.0 86.5 85.8 88.0 91.2 93.0 92.5 93.2 93.0 87.9 88.0 90.6
  2007 88.2 84.7 87.1 88.1 89.7 88.5 91.2 90.8 88.9 87.4 88.9 88.7
  2008 85.8 85.0 83.2 86.2 88.8 89.5 88.8 87.1 74.6 85.3 85.8 83.9
  2009 82.3 81.5 81.5 82.7 84.0 86.0 84.2 84.1 84.9 81.5 81.1 81.3
 
  2010 79.9 81.1 83.2 88.7 88.2 90.7 91.2 89.1 86.5 82.5 86.5 88.4
  2011 84.8 80.0 84.4 82.9 85.3 89.0 90.2 90.3 88.7 84.9 87.0 86.5
  2012 85.6 86.5 85.6 86.6 90.6 92.5 92.5 91.1 87.6 87.1 88.6 90.4
  2013 83.8 81.6 83.7 85.8 88.2 91.6 92.5 91.4 90.7 86.8 90.6 91.9
  2014 87.2 86.6 85.8 90.7 90.2 90.3 94.6 93.7 91.8  

Refinery utilization in the U.S. hasn’t been at these levels since 2004-2006, not accounting for the fact that U.S. refineries have more than one million more bpd throughput than during the middle of the last decade:

U.S. Refinery Operable Atmospheric Crude Oil Distillation Capacity as of January 1 (Barrels per Stream Day)
 
Decade Year-0 Year-1 Year-2 Year-3 Year-4 Year-5 Year-6 Year-7 Year-8 Year-9
  1980’s     19,018,024 17,870,694 17,059,205 16,504,465 16,345,502 16,459,979 16,824,558 16,567,983
  1990’s 16,506,614 16,556,514 16,633,464 15,935,049 15,904,282 16,326,231 NA 16,286,961 NA 17,155,221
  2000’s 17,393,070 17,511,261 17,675,551 17,675,090 17,815,034 18,030,887 18,307,502 18,425,322 18,558,022 18,681,308
  2010’s 18,581,089 18,953,189 18,560,350 18,971,643 19,064,210  

   
Yet somehow there are 142 operable refineries in the U.S. currently, versus 150 in 2008 (not to mention 301 in 1982).  Stranger is the fact that only in the past year refining capacity has finally risen above the baseline that existed 32 years earlier, despite crude oil prices having reached $147 a barrel in the interim.  This is due to an odd quirk in the refining business:

As many may know, the oil refining business is mostly a low-margin operation, despite the all-familiar headline news on higher gasoline prices at times, supposedly something favorable to refiners. Refining profitability can be roughly measured by something called crack spread, a margin that refiners can add on top of their crude costs. Current crack spread for gasoline is under $19 a barrel when compared to West Texas Intermediate. Since one barrel equals 42 gallons, a crack spread of $19 translates to about 45 cents per gallon of gasoline in potential refining profits. Actual earnings, however, will be less after deducting all refining costs.

Rising crude prices benefit oil producers but often cost refiners more for the same gallons of gasoline produced. The extra cost may or may not be fully absorbed by changes in the price of gasoline, potentially further lowering refining margins. Assuming $100 a barrel for crude, it would be $2.38 in base crude cost for a gallon of gasoline. After adding all refining costs including expenses on transporting crude and other logistics, plus allowing certain pricing room for retail markup, there seems to be little margin of profits left for refiners.

The above statement is 100% true, but completely wrong at the same time.  Crack spreads are bullshit.

Fifty Years of Failure

Three crude indexes (Brent Crude, Dubai Crude and WTI) serve as benchmarks for overall fuel demand worldwide.  It is a serious oversight.  Burning unrefined oil produces numerous waste gases, which are naturally explosive.  Crude oil has but a single customer–oil refineries.

Mathematically, oil refineries add no value to their product.  Refiners purchase crude (priced in Brent, Dubai, WTI, WCS, or what have you), remove impurities, and sell refined fuels…at the same crude oil prices!  The crack spread was invented in acknowledgement than running massive refining complexes at no margin whatsoever is a nonstarter.  Back here on the ground, in reality, refineries are the bottleneck.

American refineries are running close to maximum capacity, and oil prices are crashing.  Any benefit refiners derive from lower input prices is destroyed by being forced to sell using the same benchmark prices.  The solution is very simple–split the benchmarks.  

Refineries should buy crude with one index price, and sell with another tied to actual fuel demand.  Brent, Dubai, WTI (and every oil index while we’re at it) could easily be split into a crude listing and a refined listing on mercantile exchanges.  The price on the refined side would skyrocket in most cases (refinery constraints) while crude would continue to plummet (glut of crude production such as WTI), signalling a need for more refineries.  Unless the market signal is corrected, there will never be enough refined energy to meet rising worldwide demand.

(Yes, this would have adverse effects on global warming–but only in the sense that internal-combustion fuel demands would be fulfilled without throwing economies into wild oscillations due to crude prices spiking and crashing due to erratic and improper market signals.  Fixing refinery economics solves a supply issue; climate change is predominately a demand issue.  To truly address environmental effects, a fuel substitute needs to be rolled out on a planetary scale).

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One thought on “Release the Refineries!

  1. Pingback: The Wrong Turn | In The Corner, Mumbling and Drooling

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