Guest Post: The Story Behind US Gas Price Pain

Tyler Durden's picture

Submitted by Martin Karusa of Casey Research

The Story Behind US Gas Price Pain

Gasoline consumption in the United States has been dropping for years. In the last decade, vehicle fuel efficiency has improved by 20%, and the combination of that shift and a weak economy of late has pushed gasoline demand to its lowest level in a decade.

At the same time, US oil production is at its highest level in a decade. Deepwater wells in the Gulf of Mexico and horizontal fracs in the Bakken shale have turned America's domestic oil production scene around. After 20 years of declining production, US crude output rates started to climb in 2008 and have increased every year since.

With production up and demand down, the basics of supply and demand indicate that oil prices should be falling. Americans should be paying less at the pump.

Instead, the average US price at the pump reached US$3.80 per gallon on March 5, after 27 consecutive days of gains. That's 26.7¢ above the old record for March 5, set last year. The price of gasoline has climbed 32¢ or 9.3% since February 1; analysts expect prices to continue rising, reaching a national average of something like US$4.25 per gallon.

What gives? Is it all about Iran? Are speculators manipulating the market? Do any politicians have good ideas on how to "fix" the high cost of gasoline? And is there relief on the horizon?

What gives is a combination of forces. Rising tensions in the Middle East are part of the problem, but so are deficiencies in North America's oil infrastructure that are causing price discrepancies across the nation. Some of the refineries being forced to pay premium prices for oil are shutting down, and that limits gasoline supplies in parts of the country. Speculation is also a factor, as it is an ingrained part of the market, but it is not the driving force behind America's fuel-price problems.

If you're wondering, there aren't any politicians with novel, sound ideas on how to reduce fuel prices. Newt Gingrich's promise to bring prices below $2.50 a gallon is as attainable as Michelle Bachmann's plucked-out-of-the-air promise of $2 gasoline.

Thankfully though, there is some relief on the horizon. First, we'll tackle the issues. Then we'll outline some developments that should ease the pain.

A Two-Part Problem

Two main forces are driving fuel prices upward in the United States: high global oil prices and the state of the US oil transportation and refining industry.

High oil prices are the more obvious part of the problem and are certainly the part that attracts the most attention. Tensions in the Middle East have been elevated since Tunisia's revolution kick-started the Arab Spring in January 2011. Subsequent revolutions in Egypt and Libya as well as the oftentimes violent suppression of dissent in Bahrain, Jordan, and now Syria have kept questions about the stability of supplies from the oil-important Middle East front and center all year.

Now, of course, it's Iran that is keeping oil traders up at night. Between oil embargoes against the country and threats from Iran to block the Strait of Hormuz (a maritime passageway vital to the oil industry), the growing rift between Iran and the Western world is threatening supplies from the world's fourth-largest producer. That's a surefire way to push oil prices skyward.

The result: Brent North Sea (the pricing benchmark for crude oil traded in Europe) climbed above US$100 per barrel a year ago and hasn't looked back. Since last February Brent crude has traded above US$110 per barrel more often than not, and has regularly topped US$120 per barrel.

The Middle East's ongoing tensions also lifted crude prices in North America: After sitting comfortably near US$80 per barrel for most of 2010, the price for West Texas Intermediate (WTI) rose above US$100 several times during 2011 and averaged close to US$90. Yes, it moved much less than did Brent; moreover, not all crude oils in North America had similar boosts. To understand that situation, we have to delve into America's oil transportation and refining system.

The US is divided into five oil districts, which were originally designed to ensure energy security during World War II. Things have certainly evolved since then, but the districts remain less connected than you might think. Crude oil cannot necessarily flow from one side of the country to the other or from one producing region to another refining area. The system's disconnectedness means that refiners in different regions are forced to pay whatever the price may be for the crude oil they can access – and those prices differ significantly.

East-Coast refiners have traditionally relied on imported oil from Europe and West Africa, which means they pay Brent pricing for most of their crude. As such, Brent's surging price has dealt a blow to East-Coast refiners, hitting several so hard that they are shutting down. No fewer than four refineries serving the East Coast are going or have gone offline since 2010, eliminating almost half of the gasoline previously supplied to the US Northeast. Knowing that, high gasoline prices in the Northeast start to make a bit more sense: Refiners' costs have been sky high, and refinery shutdowns have eliminated a huge chunk of supply.

Similarly, refiners on the West Coast receive some supply from Alaska but depend on internationally priced crude for the bulk of their input. Their need to pay Brent pricing explains why gas prices in California are regularly among the highest in the nation.

At the other end of the spectrum are refiners in the Midwest. The oil hub at Cushing, Oklahoma, is being increasingly inundated with crude oil as production ramps up in North Dakota's Bakken formation and in Canada's oil sands. Crude from both of those rapidly-expanding oil regions flows primarily to Cushing, where refineries process as much as they can. Those refiners are able to buy at WTI pricing, which has held a roughly 20% discount to Brent crude for the last year. That helps keep gasoline prices in the Midwest a little lower.

However, Midwest refineries are generally designed to process light, sweet oil, which means they can handle output from the Bakken but are not up to processing heavy oil from the sands. Oil-sands crude needs to go to the Gulf Coast, where an army of sophisticated refineries are thirsty for heavy oil. All that is lacking is a pipeline to connect supply with demand, but at the moment there is no such pipe; thus, the supply glut at Cushing has discounted heavy oil significantly. Western Canada Select, the benchmark crude oil coming out of Canada's oil sands, closed at US$74.73 per barrel on March 5, a 30% discount to WTI and a 40% discount to Brent.

There is cheap oil available in the United States. You just have to be able to transport the crude from Cushing to your personal refinery to take advantage of it.

One final element is making matters worse: Refineries are currently starting to shift to producing spring-summer gasoline blends, which are lighter and therefore usually cost about 10¢ more per gallon than fall-winter blends. And this year, the quick refinery shutdowns needed to enact the seasonal shift are creating slight supply gaps because some of the "swing" refineries that usually help bridge the gap are no longer operating. For example, the Hovensa refinery in the US Virgin Islands – a joint venture between Hess Corp. (NYSE.HES) and Petroleos de Venezuela – used to produce extra volume during the seasonal transition, but it was closed down a few weeks ago after losing $1.3 billion over the last three years.

Lights on the Horizon

Both sides of the problem – high oil prices and insufficiencies in America's oil infrastructure – will develop over the next 12 months. On the infrastructure side, we can be pretty certain that the developments will be positive. One pipeline that for years has carried oil north from the Gulf to Cushing is being reversed, which will start to ease the heavy-oil glut within weeks. TransCanada recently announced that it is seeking expedited approval to start construction of the southern leg of its Keystone XL pipeline, which will also connect Cushing to the Gulf Coast. Since there is nothing controversial about the southern portion of the project it should be approved quickly, in which case TransCanada hopes to have the pipeline built and operational by the middle of next year.

These pipelines will enable America's army of Gulf Coast oil refineries to purchase North American crude oil. When that happens, Western Canada Select will not maintain its current 40% discount to Brent, but it will almost certainly remain cheaper than its European counterpart, creating cost savings for US refiners that they will pass on to consumers.

As for high oil prices in general, the biggest question there is Iran. If Iran blockades the Strait of Hormuz, oil prices will shoot up. If Israel or the US sends in air strikes against Iran's nuclear facilities, the same thing will happen. The average price of gas in the United States would likely top US$5 per gallon. However, if war can be avoided, the price of oil should start to recede as fears abate; if oil sanctions against Iran stay in place, Saudi Arabia should be able to step up production enough to replace the lost volumes. Under this scenario the price of a barrel of Brent oil could fall below $100.

The level of warmongering from all sides seems to change on a daily basis, so we are not prepared to make any predictions about whether an attack on Iran is imminent. However, there are ways savvy energy investors can profit from this uncertain situation as well as other shifting trends. Get our free 2012 Energy Forecast to get started today.

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mophead's picture

The reason oil is climbing is because of massive global currency devaluation. That's all you need to know.

r101958's picture

That is one of the reasons and seems to be the most popular. It is only one of the reasons though.

ZerOhead's picture

Prices are also up by 50% in Venezuela year over year. Of course Americans who support 'free markets' would be rioting in the street if they only had to pay the ridiculous 18 cents per gallon the Venezuelans pay at the pumps.

http://www.msnbc.msn.com/id/46580113/ns/business/#.T1k7m4Elt1I

sun tzu's picture

The government/citizens are subsidizing that 18 cents per gallon gas. It's coming out of the citizens' pockets either way. They could sell that gas at market prices overseas and bring in billion more in revenues or they can sell it for a fraction of the cost at home. 

mophead's picture

Devaluation is Thee reason and only reason.

With that said, I should clarify: money printing alone does not cause price inflation. Most people believe the dollar is being devalued through excessive credit creation/money printing. But that has a limited effect. It actually works the other way around: price inflation is caused through the upward manipulation of core commodities and core services, which then trickle-down to the finished goods and services we buy. Naturally, oil is a key component in that it drives up gas prices, then transportation, etc.

Taint Boil's picture

 

 

Well according to this chart the supply is pretty flat no matter what the price. You can buy a gallon of gas for a dime.

tabasco71's picture

Sorry, but the bears taught me all I needed to know about this... 

BlackVoid's picture

No, the number one reason is falling oil exports in the last few years.

Hedgetard55's picture

No mention of Central Bank liquidity tsunami???

 

FAIL.

lunaticfringe's picture

Shit you guys are unmerciful. Other than the currency devaluation meme, I thought the info was good and made sense. Shit, cut somebody a break...

espirit's picture

Perhaps consideration could be given to nationalization of those refineries shutting down.  Shouldn't constriction of this national resource be considered domestic terrorism?

Rules to play by - Call DHS.

Doubleguns's picture

Plunging dollar bitchez. Priced in ounces of gold oil is still reasonable.

Zero_Sum's picture

The author completely overlooks the cost of crude production. Yes, we're producing more crude than we were in 2008. But the methods we have to use to produce crude now (shale, sands, deepwater drilling) are much more costly and energy intensive. This effectively places a floor under the base price.

T. Boone Pickens gave an interview where he talked about oil sands. He said he visited the Canadian fields in the 70's and walked away laughing. "You'd need $50/barrel oil for that to be profitable!" he'd said at the time. That would be $50/barrel in 1970's dollars. Our current methods of production are only profitable enough to continue as long as prices stay high.

...or let me sum it up more simply: Peak Oil, Bitchez!

 

FrankDrakman's picture

T. Boone Pickens gave an interview where he talked about oil sands. He said he visited the Canadian fields in the 70's and walked away laughing. "You'd need $50/barrel oil for that to be profitable!"

That would be the same savant who invested millions in Texas wind farms, only to shut them down when the government gravy ran out? Here are some facts on oil sand production costs and profits:

As of 2007, crude oil prices were significantly in excess of the average cost of production, which was about $28 per barrel of bitumen. However, bitumen production costs are rising rapidly, with production cost increases of 55% from 2005 to 2007, due to shortages of labor and materials.

In mid-2007, Royal Dutch Shell announced that in 2006 its Canadian oil sands unit made an after tax profit of $21.75 per barrel, nearly double its worldwide profit of $12.41 per barrel on conventional crude oil.

Papasmurf's picture

Pickens didn't care about wind farms.  His motive was a land grab to build a water pipelines from the Ogallala aquifer.

Augustus's picture

Nonsense.  He bought hundreds of millions of dallars of the whirlygigs that became a writeoff when they could not be used.

Stop the nonsense of the smear.

sun tzu's picture

That's also $50/brl in 1970's technology. Oilsands companies like PetroCanada, Imperial Oil, and Suncor are making a killing. It's more around the $40/brl range now depending on the type of soil and density of the oil

Mr. Lucky's picture

No mention of how user friendly the EPA is.

asteroids's picture

Oil should be refined where its pumped out of the ground.

Vampyroteuthis infernalis's picture

That works until the hole goes dry. Refineries are expensive and NOT portable.

r101958's picture

Oh no!! they never go dry....just think of all that abiotic oil bubbling up.  It is just speculators and govt printing and greedy oil companies and and and and and and....

Actually they don't go dry - they just start to cost more than they are worth. However, now some 100 bl a day plays are getting uncapped because oil prices are high enough that they can again produce a profit. Oh wait...profit is a bad word, right?

leathaface's picture

These pipelines will enable America's army of Gulf Coast oil refineries to purchase North American crude oil. When that happens, Western Canada Select will not maintain its current 40% discount to Brent, but it will almost certainly remain cheaper than its European counterpart, creating cost savings for US refiners that they will pass on to consumers.

dont think that is going to happen.

sun tzu's picture

refiners don't control the cost of gas. if you want to blame anyone, blame the futures traders. look at the profit margins for refiners. it's usually less than 10%. they live on razor thin margins. if it was such a profitab;e business, there would be refineries popping up everywhere (subject to EPA approval)

leathaface's picture

just sayin, that i dont think most, if any, companies are passing along savings to customers.  seems like it is all being kept for execs and the like

Let them eat iPads's picture

Long story short, China keeps using more oil.

But thanks for the long winded explanation.

Crisismode's picture

"China keeps using more oil."

 

Not for very much longer.

China is about to go bust.

 

Coast Watcher's picture

If China goes bust, demand should drop, but I've been reading that China is about to go bust for three years now. So far, no bust. Not even a very good bustline, but silicone is a miracle drug over there.

r101958's picture

Oh yes, and not a word about oil being a finite resource. Oblivious.

LaLiLuLeLo's picture

the ice caps are melting! HOORAY!!! Drill baby DRILL!... 

Worthless humans - we don't deserve this gem of a planet

Neo's picture

Yes, your are correct. Please do the planet a favor and kill yourself.

sun tzu's picture

yes we must all pay carbon taxes to the bankers lest the world will boil like a teapot

DaveyJones's picture

this may be a shock, but supporting the carbon tax and understanding the humans' effect on the environment are two different things  

Bear's picture

Are you running your blogging computer on wind power?

Baleful Runes 4 U's picture

Yeah, the blind delusion is impenetrable.

uno's picture

just watched Gasland last night, so depressing the pollution from NATGAS.  Having been through much of the country, felt like knowing someone dying watching the destruction of nature; then add in BP oil spill, Japan Nuke meltdown, depleted uranium droppings anywhere the military goes - wonder how long Earth puts up with it.

The full documentary is on Youtube.

blueridgeviews's picture

Yeah, the world was so much cleaner before we started using oil and natural gas.  Google Pittsburgh in the 1850's and see how pretty and clean the world used to be. Heck, Google Pennsylvania Station and look at what all the soot did to that marvelous structure. They tore it down because it was black and disgusting looking.

The world is cleaner now in the US then anytime before. POeople live to ripe old ages and we enjoy (or enjoyed) the best living standards in the world. God bless petroleum and all it's carbon sibblings.

Crisismode's picture

Here's someone who has bought into the whole MSM bullshit.

 

Keep smoking that fine dope, blueridge boy.

Augustus's picture

GasLand is a prima facia case of pure propaganda.  They have beeen fracing wells for 50 years in the southwest.  No problems from the fracing.

There have been instances or poor well control with some surface spills.  The bugs take care of it, as they did in the GoMm.   However, it is impossible to have milk without some cowshit.

steve from virginia's picture

 

'They' tore down Pennsylvania Station b/c the railroad wanted to build an office building. Then, the railroad went bankrupt, most likely due to their poor judgement.

Not mentioned anywhere is China/India demand along with increasing consumption within oil-producing countries.

BTW, the increase in US production @ Bakken and elsewhere is about 300k barrels per day. The US imports 11 million barrels per day. The conventional domestic o' fields such as @ Prudhoe Bay are declining in the meantime.

BTW, when Prudhoe production drops below 400k barrels per day there will not be enough to push through the Alyeska pipeline. Right now it looks like 399kbpd to zero ...

Gas fracking turns out to be a scam, reserves are booked based on the initial flow from wells which tapers off very quickly.  The reserves help inflate stock prices which fund more drilling. Meanwhile, costs run away.

 

bbq on whitehouse lawn's picture

Lamp oil gave rise to kerosene that gave rise to gasoline that gave rise to diesel that gave rise to asphalt and plastics.

If you remove demand for any one, it becomes an unprofitable waste product and may not be worth the costs of of operation.

Hence more refinerys shuting down. If the plant was built around makeing gasoline it may no longer be profitable to operate if the demand is not there.

Fiatfan's picture

Garbage.  May be accurate or true but missed the pink elephant stepping on all our toes.  Dilution of currency on a global scale.  End the Fed.  Consequence the fraudsters.  Hang em high!  That is the entire story, the rest is just inconsequential stuff of minimal impact.  Deal with the Fed and you deal with the problem.  

Edit: Now if we ended the Fed and remained intact as a nation, then the rest would no longer be inconsequential.  

Yardfarmer's picture

this drivel sounds like paid public relations from Exxon/Mobil.

LaLiLuLeLo's picture

don't hold your breath

besnook's picture

or, since the price of gasoline is cheaper in terms of silver value than in 1964 and the price of oil is only about a 2/3 of an once more expensive than 1964 the price of oil and gas in 2012 are roughly about the same given that the price of silver is related to the value of the dollar when adjusted for the increased cost of extraction(slightly higher cost/barrel) and more efficient refining(slightly cheaper gasoline).

CrazyCooter's picture

Or maybe silver is presently undervalued ... you know, just a little bit ... in dollar terms ...

Regards,

Cooter

dbTX's picture

Bottom line: gas prices are where they are and going up because Obama wants it that way, period, over and out

espirit's picture

You mean to say Obama controls the costs of commodities?

Hoo Boy, another one of those who believes the TOTUS is in charge.

bob_dabolina's picture

This is part of the problem but this missive neglects the elephant in the room.

Sure, the cost of oil is rising. However, the cost of everything BUT housing is rising. I'm not sure if people understand how inflation works, or, if they just need someone to scapegoat their problems to. The fact is, in 2008 oil was trading in the $30 p/b ballpark range, than the money printing starts (by the trillions) and all of a sudden the price spike is due to - speculators, Iran, and infrastructure problems.

#1 Speculators play a small but crucial roll in ALL markets. There are those who speculate to the long side, and there are those that speculate to the short side. These evil speculators include the airlines whom try to keep ticket prices low by hedging higher fuel input costs. You can rid all speculators but be prepared to pay $1,200 a ticket (coach) for a 75 mile flight booked 2 months in advance. And speaking of that, why would you buy a plane ticket 3 months in advance instead of just before your flight? Are you speculating the cost will be cheaper if you buy the ticket months in advance? You, according to Obama, are a speculator and if rising ticket prices are occuring it's because evil people like you are speculating.

#2 Iran. The middle east has been blowing up since the Arabs grew brains capable of synapses. Last year around this time the Middle East was literally collapsing under the force of the Arab Spring. In fact, people were scared SAUDI ARABIA would collapse due to this uprising...the price of oil was LOWER than it is today. In fact Iran just PRAISED Obama - http://www.csmonitor.com/World/Middle-East/2012/0308/Iran-offers-rare-pr...

#3 Taxes. Do you live in New York, CT, or California and wonder why you're paying $4 - $5 a gallon when some people in other states are paying closer to $3.30? The politicians in those states could lower the price at the pump to $3.30 if they cut their gas taxes to that of what people pay in Wyoming...AND IT COULD HAPPEN OVERNIGHT. Here is a map of gas taxes by state - http://www.api.org/Oil-and-Natural-Gas-Overview/Industry-Economics/~/med...

....but it's more conducive to Nancy Pelosi's re-election to find some other mythical figure to demonize, rather than looking at her stretched out piece of foot ball leather (excuse me, her face) in the mirror.

#4 Infrastructure: Obama touts success in programs that were implemented under George Bush over 5 years ago (the increase in domestic oil supply) However, when was the last time an oil refinery was allowed to be built in the USA with the stringent EPA?

But the newest significant (or sophisticated) refinery began operating in 1977 in Garyville, Louisiana.

http://www.eia.gov/tools/faqs/faq.cfm?id=29&t=6

So how about we cut the bullshit and call a spade a spade. The price of oil is high because of POLITICIANS having a reckless fiscal policy which has resulted in loose monetary policy (monetizing debt), a harsh regulatory enviroment (POLITICIANS), and in some states - mainly states run by leftist pigs wanting higher taxes to fund overly generous social welfare programs (POLITICIANS)

The high gas price is due to POLITICIANS.