2022 Theme: Expensive Energy - What Are The Knock On Consequences Of Record Gasoline Prices?!
Memorial Day marks the traditional start of the summer driving season in the US and this year, the holiday has come alongside a series of big headlines around the global energy industry:
The EU banning (most) Russian on one day, OPEC meeting and Saudi Arabia agreeing to increase production the next, windfall oil and gas taxes in the UK in between.
There has been one headline to rule them all, however - the price of gasoline.
Many of our readers have likely noticed that the price per gallon continues to make new records nearly every day.
It would be difficult not to take notice. Nothing keeps the gas price top of mind like the way it is advertised. Even if you take the bus or drive an electric vehicle (or ride a bike!) the price of gas is displayed prominently on large billboards along roadsides, large and small, coast to coast.
In case you have been living under a rock:
According to the AAA club, on Thursday the US nationwide average rose to $4.761 per gallon (that's up more than 57% from a year ago).
Wherever you live the prices are high and records are being set. By our count we went 4/5 on days for new all time highs last week.
This is a problem.
It is also leading to a few consequences. Some of them profound, some of them unexpected and some of them flat out weird.
The first, which we have written about before, is that the price of gas and diesel is focusing minds in Washington, DC. We have shared this brutal reality of American politics before. As goes the gas price, so, generally speaking, goes political fortunes in the White House and in Congress.
We will likely update our political analyses more completely as we come closer to the midterms in November but for now all you have to remember is:
Price of gasoline up, President Biden and Democratic approval down.
The second and a little less noticed impact is that the record US gasoline prices are having a profoundly distorting impact on the oil industry itself.
How so? Well, for one thing, the profits for oil refiners that refine gasoline from raw petroleum are exponentially large.
The crack spreads for refiners right now is above $60. That is an all time record.
This spread is obviously a bit technical but it measures the price between buying the purchase price of the raw commodity and selling the refined product.
The current spread chart is abnormal. See here:
The most important outcome from this is that the crack spread price is exceptionally incentivizing to the refining industry.
Specifically, the ravenous demand for oil and the heavy political pressure that goes with it is leading to those refiners working flat out trying to refine as much raw commodity into sellable product as possible.
This is great in some respects. The profit motive is keeping the US economy supplied with gasoline and other refined products but it also comes with real risks. In the summer heat and with machinery working around the clock (and possibly skipping maintenance) and the nature of very combustible molecules being what they are, there’s real and rising risk of an accident. And we simply don’t have the gas inventory to deal with an outage. None.
This is equally true for diesel (or jet fuel) and is especially true in the Northeast US.
Why is this happening?
Well, during the pandemic, global refining capacity fell for the first time in 30 years as the global energy industrial complex assumed that demand would be reduced for years.
They had no ability to predict the surging bounce in consumption or the fact that the war in Ukraine would, almost overnight, remove a significant chunk of global refining capacity (as much as 30% of Russia's).
And the Northeast is particularly poorly supplied by refiners. A nasty combination of NIMBYism and a belief that "oil is over" has led to a dearth of new refining regulatory approvals and a resulting lack of investment from the industry.
Here is a little known fact: Oil may be a global commodity but it is a regional business.
It is one thing to find or buy more oil on the other side of the world but it is a whole other affair to get it where it is needed and the second step is often to get it refined.
It is the geographic spread of the second step and lack of ready supply that is creating these crack spreads and therefore raising the danger of an accident and an extended outage in, say, New Jersey.
This regionality is also why gasoline or diesel prices can have very lumpy outcome. The price can be extremely different even if you control for taxation and regulatory outcomes. For an example of this, look no further than gasoline prices going over $10 a gallon in California this weekend.
We obviously have no ability or expertise to predict an accident but we are very confident that, if one would occur, there would be shortages very swiftly thereafter. So, beware! The idea of lining up for gas 1970s-style is not as far fetched as you might have believed.
Imagine those headlines.....
Third and last, what has been most impressive about the current situation has not been the lack of available supply but the lack of a reaction to that paucity.
This is the flat-out weird impact we mentioned above.
A lot of our previous writing on oil has centered around the very constrained supply situation.
That is still the case. Witness the fact that OPEC+ and in particular, Saudi Arabia, agreeing to increase production going forward had a negligible impact on oil prices.
By "negligible" we really mean: oil went up on the day!
But the striking thing about the lack of supply is that, in many cases, it is not leading to greater production. This isn't completely true, of course. Existing oil fields are working nonstop and nearly all oil and gas companies are printing record profits.
But one the reasons for that is those same companies are not investing in new production. They are keeping the money they make today but not investing significantly in the ability to make more tomorrow.
The best example of this is the US rig count or the number of drill rigs on US land. Incredibly, though the oil price continues to make records, the rig count actually fell (very slightly) last week.
In other words, record gasoline, sky high oil prices and yet the oil industry itself is not reacting to the clear incentive of more profit by increasing their investment.
This is stunning and difficult to explain. It isn't how markets are supposed to work.
In the past, we have been exceptionally critical of the Biden administration's direct discouragement and regulatory push against the US energy industry precisely because we feared we would end up in this situation. And we have been arguably even more critical of their hypocrisy
But it is difficult to make that case now.
The administration has re-opened drilling on federal lands. They have belatedly though strongly pivoted on their explicit regulatory approach and implicit discouragement of the oil and gas industry.
They have gone from gun shy to gung-ho in less than two quarters.
And yes, more could be done no doubt but the oil industry is reacting to the present set of conditions exactly counter to their swashbuckling, cowboy reputation.
It is as if probity and discipline have replaced good old American risk taking and profit motive.
Perhaps the ESG industry and the regulatory complex have done their job too well? Or perhaps the newly found sense of responsibility in the oil patch, firmly monitored by Wall Street, is difficult to shake. Executives and boards who have promised to be careful with shareholder capital are reluctant to risk losing their jobs just because the political winds have changed in Washington, DC.
Just because it's American to "drill, baby, drill" again doesn't mean that the industry necessarily agrees especially after years of the opposite.
There is a lesson there, for anyone willing to listen.
In any event, it is likely a bit of column (A) and a bit of column (B) but the end result is an industry that is reacting very sluggishly to high demand and low supply.
It leaves us with high prices, record low gasoline and diesel inventory and US refiners working full tilt with machinery they may not have serviced properly in years.
Cross those fingers!
*******
Have questions? Care to find out more? Feel free to reach out at contact@pebble.finance or join our Slack community to meet more like-minded individuals and see what we are talking about today. All are welcome.
