Craig Eisele on …..

February 24, 2012

The Story Behind Rising Gasoline Prices

Filed under: Uncategorized — Mr. Craig @ 6:01 pm

Angry About High Gas Prices? Blame Shuttered Oil Refineries

It is MORE than the issues in the middle east that are causing oil prices and in particular gasoline prices to raise.

The U.S. has lost nearly 5 percent of its refining capacity in the past three months, as a handful of old refineries have shut down

The average price of gas is up more than 10 percent since the start of the year, a point repeatedly made during Wednesday’s Republican Presidential debate. Predictably, the four GOP candidates blamed President Barack Obama for the steep increase.

Actually, the President doesn’t have that kind of pricing power. The more likely reason behind the price increase, though certainly less compelling as a political argument, is the recent spate of refinery closures in the U.S. Over the past year, refineries have faced a classic margin squeeze. Prices for Brent crude have gone up, but demand for gasoline in the U.S. is at a 15-year low. That means refineries haven’t been able to pass on the higher prices to their customers.

As a result, companies have chosen to shut down a handful of large refineries rather than continue to lose money on them. Since December, the U.S. has lost about 4 percent of its refining capacity, says Fadel Gheit, a senior oil and gas analyst for Oppenheimer. That month, two large refineries outside Philadelphia shut down: Sunoco’s plant in Marcus Hook, Pa., and a ConocoPhillips plant in nearby Trainer, Pa. Together they accounted for about 20 percent of all gasoline produced in the Northeast.

This week, Hovensa finished shutting down its refinery in St. Croix. The plant processed 350,000 barrels of crude a day, and yet lost about $1.3 billion over the past three years, or roughly $1 million a day. The St. Croix plant got hit with a double whammy of pricing pressure. Not only did it face higher prices for Brent crude, but it also lacked access to cheap natural gas, a crucial raw material for refineries. Without the advantage of low natural gas prices, which are down 50 percent since June 2011, it’s likely that more refineries would have had to shut down.

The U.S. refining industry is being split in two. On one hand are the older refineries, mostly on the East and Gulf Coasts, that are set up to handle only the higher quality Brent “sweet” crude—the stuff that comes from the Middle East and the North Sea. Brent is easier to refine, though it’s gotten considerably more expensive recently. (Certainly another reason for higher gas prices.)

Then there are the plants able to refine the heavier, dirtier West Texas Intermediate (WTI)—the stuff that comes from Canadian tar sands, the deep water of the Gulf of Mexico, and the newer outposts in North Dakota, which just passed Ecuador in oil production. These refineries tend to be clustered in the Midwest—places such as Oklahoma, Kansas, and outside Chicago. While the price of Brent crude has closed at over $120 a barrel in recent days, WTI is trading at closer to $106. That simple differential is the reason older refineries that can handle only Brent are hemorrhaging cash and shutting down, while refineries that can handle WTI are flourishing.

“The U.S. refining industry is undergoing a huge, regional transformation,” says Ben Brockwell, a director at Oil Price Information Services. “If you look at refinery utilization rates in the Midwest and Great Lakes areas, they’re running at close to 95 percent capacity, and on the East Coast it’s more like 60 percent,” he says.

This is primarily why the cheapest gas prices in the country are found in such states as Colorado, Utah, Montana, and New Mexico, while New York, Connecticut, and Washington, D.C., have some of the highest prices.

Gas prices are off to a fast start in 2012. The national average for a gallon of regular gasoline is up more than 8 percent since the end of 2011, rising from $3.25 per gallon to $3.52, according to new data released by the U.S. Energy Information Administration.

While gas prices tend to rise through the first half of the year, this is the earliest the average price per gallon has breached the $3.50 mark. If this pace continues, the national average should hit $4 a gallon by May, if not sooner. The last time the average price did so in the U.S. was summer 2008, when the price of oil hit $140 a barrel. Last year gas prices approached $4, hitting an average of $3.98 in April, before falling.

Higher gas prices could pose a serious threat to the fledgling economic recovery, which has shown signs of strength recently. Typically, $4 a gallon tends to be the point at which the price of gas starts to eat into economic growth.

“Anytime the economy spends 4 to 5 percent of GDP on oil, then you’re getting close to stall speed,” says Jason Stevens, an equity analyst at Morningstar. “We saw this last year when Libya and Japan blew up, and prices went through the roof. Demand pulled back a bit, but growth certainly slowed.”

Strangely, the current run-up in prices comes despite sinking demand in the U.S. “Petrol demand is as low as it’s been since April 1997,” says Tom Kloza, chief oil analyst for the Oil Price Information Service. “People are properly puzzled by the fact that we’re using less gas than we have in years, yet we’re paying more.”

Kloza believes much of the increase is due to speculative money that’s flowed into gasoline futures contracts since the beginning of the year, mostly from hedge funds and large money managers. “We’ve seen about $11 billion of speculative money come in on the long side of gas futures,” he says. “Each of the last three weeks we’ve seen a record net long position being taken.”

Refineries have also been getting squeezed by higher crude prices over the past several months, forcing some of them to shut down rather than operate at a loss, says Stevens. “The price that refineries have been paying for crude was roughly flat, while the price they were getting for gasoline was lower than what they needed to make their crack spread,” he says. A crack spread refers to oil refineries’ profit margins and is roughly the difference between what they pay for crude oil, and what they make by “cracking” crude into petroleum products such as refined gasoline. As the U.S. refining capacity has decreased, prices have begun to rise.

But prices aren’t high everywhere. For example, the average price of gas in Wyoming is $2.90 right now, nearly a dollar cheaper than the average price in California. That’s largely due to the relatively cheap amount of crude that’s coming into the upper Midwest from Canada. “There is more diversity between crude prices now than I’ve ever seen in my career,” says Kloza. “It’s extraordinary.”

So How to deal with this issues in a political manner?

Lets’s look at that the White House is doing to at least diffuse the issue and lay blame where it may be better put….. 

The White House’s economic achievement checklist looks better each day. Unemployment rate back in the low 8 percent range? Check. The Dow Jones Industrial Average back above 12,000? Check. Payroll-tax cut extended for the rest of this year, giving an extra boost to the economy? Check.

Yet a worrisome item casts a shadow over the good news. The political risk of rising gasoline prices is the emerging hot topic inWashington. The question is: Are gas prices and their impact on middle-class families like the weather, a phenomenon everyone complains about but no one can change? Or can President Barack Obama and his team defuse this danger before it grows harder to manage?

According to AAA, gas prices have climbed an average of 14 cents a gallon in the past month and about 30 cents a gallon since late November. In states such as Pennsylvania and Florida, prices are an additional 10 cents to 15 cents a gallon higher, and seem to go up each week.

The political pinch that this can cause is often underappreciated. For some people, a few extra dollars at the pump each week is little more than an annoyance. But for hard- pressed middle-class families, and working families living paycheck to paycheck, the soaring numbers at the corner gas station are far more meaningful than the indexes at the New York Stock Exchange. (SPX)

Bigger Impact

Consider this: The president just won a victory over congressional Republicans who couldn’t withstand the political consequences of a payroll-tax increase of $40 a month for the average working person. But for an average couple living in suburbia, driving about 1,500 miles per person each month, in two cars that get average gas mileage, a 50-cents-a-gallon increase will cost them about 20 percent more than the payroll- tax cut saves them. In their case, what the president and Congress gives, the gas man takes away.

The potential economic impact of such a hit to the middle class is obvious. Mass-market retailers have long correlated even modest increases in gas prices with falling sales, which, in turn, could damp the recovery. But even this understates the political effect of rising gas prices, which is magnified for three reasons.

First, working-class residents of suburbs and exurbs are hit hardest — and these are the families (and the areas) that disproportionately account for swing voters in presidential contests. Second, gas prices tend to surge sharply in states that happen to be critical electoral battlegrounds — especially in the industrial heartland and the upper Midwest. And third, big price increases almost always occur in the summer — after the primaries end and before the conventions — when little else is stirring the political conversation.

In each of the last three presidential elections, rising gas prices have posed a particular problem, especially for the Democratic presidential candidate. In 2008, the faltering campaign of the Republican nominee, Senator John McCain, was revived in the late summer — not just by Sarah Palin’s star appeal, but also by the power of her “drill, baby, drill” message as a purported response to rising gas prices.

This is a particularly difficult political problem for Democrats, because the two most popular responses — a cut in gas taxes or an expansion of oil drilling — are anathema to critical party constituencies. Lower gas-tax revenue dries up the funding source for building roads, bridges and transit projects. This affects the working-class voters who derive their livelihood from such projects. And expanding oil drilling — beyond the aggressive plans that the administration has already put forward — would alienate conservation-minded voters who are also important Obama supporters. Moreover, some environmentally oriented voters believe that higher gas prices are a good thing, as they provide an incentive for more conservation, less driving and the purchase of more fuel-efficient vehicles.

Bad Choices

This dynamic creates three bad choices for Democratic presidential candidates: abandon principled positions on conservation and the environment, watch as working-class voters critical to the candidacy rally behind ill-advised Republican plans for gas-tax cuts and recklessly expanded oil production, or suffer the political consequences of taking no action at all.

In 2008, the political fallout from the gas-tax issue faded in the fall, as the price receded and the financial collapse in September dwarfed all other concerns. But waiting for fall to come, or hoping that other events will distract voters, isn’t a strategy for coping with the economic and political challenge of rising prices in 2012.

Instead, the White House should act boldly, and move immediately to cope with the problem before it becomes politically red hot.

One idea might be a “pocketbook protection” plan, which would work as follows: If the average price of gas exceeds $4 a gallon, an additional, automatic payroll tax cut of 1 percent would kick in, as much as $50 per month, per person. The cut would stay in place for at least 90 days; it would disappear when the price fell below $4.00 per gallon.

There are three advantages to this approach. First, because the plan is of limited duration and is capped at $50 a month, its cost is relatively modest — about $5 billion a month, or $20 billion total, assuming the usual four-month gas-price surge. Second, because it isn’t a reduction in gas taxes, it doesn’t weaken any incentives for fuel conservation or efficiency: All workers get $50 to soften the blow of higher gas prices, but the less fuel they use, the more money they save. And third, the relief provides the greatest relative help to lower-income workers who need gas to commute and feel the price pinch the hardest.

Ripple Effect

Admittedly, by decoupling the tax relief from gas-tax collections, the pocketbook protection plan does give some benefit to workers who don’t drive. But any such windfall is modest, and even these non-drivers will need help dealing with the ripple effect of rising gas prices on the costs of other goods and services that are transportation-dependent.

The plan could be almost entirely paid for with a modest, no-loopholes surcharge on corporate taxes on profit derived from the higher gas prices. The administration would be able to avoid pejorative terms such as “windfall” or “excess” profit tax, because the tax is neither confiscatory nor punitive. With higher gas prices, oil companies will make record profit — and a partial surcharge will still leave that profit at record high levels. In other words, the plan isn’t vulnerable to suggestions of creeping, soak-the-rich redistribution. It would leave in place all incentives for oil companies to increase production, do more research and development, and explore alternative fuels. But a modest surcharge would help fund at least a partial pocketbook protection program to make sure the cost of the oil companies’ gain isn’t excessive pain for the rest of us.

With gas prices now rising in the winter (when they are traditionally low), and increased anxiety about stability in the Middle East, all signs point to a surge this summer. By developing and announcing a plan now, the administration can avoid being unarmed when facing the horrible choice between enduring the anger from voters hurt by gas prices or backing Republican policies that are bad for conservation and the environment.

The administration should take this chance to fill its tank with political capital before the gauge says “E” — for economic peril.

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