Crude Oil and Gasoline: The Illusion of Equality

The time has come to once and for all put to rest the notion that crude oil and gasoline are joined at the hip as commodities in solidarity.

Yes, there's a thin veil of truth to the myth, born of the fact that the latter is refined from the former. But for all practical purposes, it's prudent to consider each separately from the other. The reason: each is driven by a separate, and at times dissimilar, set of supply and demand factors.

Still, the two appear to share a commonality in pricing trend at times, promoting the illusion of equality. But as the news from Iran reminds, the danger in the conceit carries more than a little risk for clear thinking on energy matters.

The casual observer may wonder why Iran, home to 10% of the world's proven oil reserves, and second in global crude production, has started rationing gasoline, which has sparked riots and unrest in the country. In fact, there's no great mystery here.

Iran produces far more crude oil than it consumes domestically, thus its high level of exports. But, its domestic gasoline production falls well short of internal demand. The reason should be familiar to Americans, namely, a lack of investment in refineries to slake rising consumption.

In 2005, Iran imported roughly one-third of its domestic gasoline consumption of 400,000 barrels a day, according to the Energy Information Agency. In an odd twist of fate, Iran's reliance on foreign gasoline makes it the world's second-largest importer of the fuel, after the United States.

Adding to Iran's challenge in solving its gasoline shortage, is the fact that the state imposes price caps on the fuel, thereby insulating the population from the market price for a commodity that's set globally by the forces of supply and demand. The New York Times, via the Houston Chronicle, reported that as a result, Tehran buys foreign gasoline for $2 a gallon, and sells it domestically for $0.34 cents. In addition to the ill-advised policy of promoting consumption, while domestic production is, at best, static, state-subsidized gasoline plants the seeds for social strife for the day when market forces inevitably shatter the myth that energy's inexpensive.

The moral of the story is that access to large quantities of crude oil doesn't necessarily translate into energy security for the man on the street. That truism doesn't stop some, if not most Iranians, from letting expectations run away from the reality on the ground.

"There is no reason why we should pay the same price as people outside Iran do," Amir Aram, a carpenter in Tehran, told the Times. "We have all this oil beneath our feet, and have to wait for hours in line to get our ration."

Politicians in Washington would do well to study the current Iranian energy crisis, and recognize the distinction between the markets for crude oil and gasoline, and the separate, but independent challenges looming in each, for the United States. Yes, each commodity requires sober analysis, and planning. But however that unfolds, accepting that the two aren't interchangeable for policy-making is essential.

The U.S. could have all the inexpensive oil in the world, but that alone doesn't put gasoline in Joe Sixpack's SUV tank. We can, and should, have an intelligent national debate about the country's long-term energy strategy. (Hey, there's a first time for everything.) But no matter the path we take, the choice must flow from a firm grasp of the facts. This begins with understanding the supply and demand dynamic that is the U.S. gasoline market.

Fact number 1: According to the EIA, there were 149 operating refineries in the United States in 2006, which is down 50% from 1982.

Fact number 2: From 1982 and 2006, the capacity of the operating U.S. refineries has fallen by 3.7%.

Fact number 3: Between 1982 and 2006, motor gasoline consumption in the U.S. increased by 40%.

Fact number 4: Gasoline imports to the U.S. have climbed by 140% from 1982 to 2006.

On the surface, the above stats don't look all that different from the dynamic of crude oil, i.e., rising consumption, falling domestic production, and the increasing reliance on imports. The difference is that when it comes to oil, geology has imposed its reality on the United States. In sharp contrast, whatever awaits for gasoline in this country will come solely as a self-inflicted scenario, a fact that these days, Iran understands all too well.

Comments

[forestgunk]

Isn't it amazing with the billions upon billions of profits our oil companies are making they cannot seem to build more refineries.

2007 Jul 02 10:52 AM

[Mmarrkk]

Have you tried to run the economic case for a new refinery? Have you looked at the time it takes to get a permit? Have you looked at the costs and cost inflation on a refinery? I'm guessing you haven't. Bottom line: investment in a refinery cannot be supported by rational economics. Changes in fuel requirements, government's subsidies of competing fuels and the drive to reduce consumption all weigh in to uncertainty regarding overall returns. Plus our lovely government seems to like to change the rules on taxation and investment credits (kind of like our buddy Chavez in VZ). Your comment is akin to me saying that since you make so much money, why don't you invest in snow machine at the North Pole. It doesn't matter how much profit you make, you still shouldn't make bad investments and refineries are bad investments. And remember, all of these "big bad oil companies" are public companies and have share holders to answer to. Making bad investments isn't their business. Making money is.

2007 Jul 02 11:10 AM

[carriere4]

Why should they build more refineries? With the gov't. granting ethanol subsidies to compete with the refinery's product, the difficulty in getting permits, the increasing costs of construction (labor, steel, etc.?) and that fact that in anything other than a stellar oil price + crack spread environment returns at refineries have been meager, what is their incentive to spend billions of dollars on a refinery?

2007 Jul 02 04:17 PM

[Phil Anthropy]

There is a great deal of data being thrown around by many people, much of it contradictory. It would be good to get some facts and sources for that data. For instance, recently on CNBC a talking head from the oil industry said that existing refineries had significantly increased their capacity over the years, even though no new refineries were built. That is at variance with the data in given in this article. Let's get some accurate sources, and find out the truth.

Part of the increase in gasoline consumption has been the elimination of the 55 mph speed limit and the increase in purchase of SUVs and other vehicles with low gas mileage. In the late 1970s, after the Arab oil embargo, Datsun and Nissan were making cars that regularly got over 40 mpg on the highway. The technology today should be able to nearly double that figure, albeit at a sacrifice of acceleration power due to redesigned gear ratios. However, the price of gas has evidently not increased enough in real dollars to affect driving behavior and motivate customers to demand automotive design changes. Hybrids are not a slam dunk solution, in my view. I suspect that their higher purchase price and additional parts and systems may increase life cycle maintenance costs, offsetting the savings on gasoline.

A recent tv showed a gas station owner closing his pumps and only offering repairs, because he claimed he was selling gasoline at less than his cost. This implies that the big profits are being made higher up the food chain. It is interesting that there has been little commentary on exactly how gasoline profits are divided within the chain of production/import and distribution. The finger pointing is reaching Oscar-winning levels of rhetorical artistry. Since companies might attempt to hide windfall profits through overinvestment in capital expenses, the smoke and mirrors may be largely impenetrable without detailed audits.

One might ask why there has been so little progress over the past 30 years in alternative energy. Oil shale died on the vine. I can recall driving through Grand Junction, Colorado many years ago, when it was nearly a ghost town (an overstatement, but not much), as the oil shale business failed. Maybe shale will fare better this go-round. Arco bought up a great deal of solar technology during the 1970s, with a lot of hoopla about how it would benefit the country. Where are all those solar panels, now that we need them?

People who embrace energy independence might wish to consider that perhaps U.S. energy policy is consistent and well executed, not chaotic, if based upon the premise of the greatest profit for the wealthy. This hasn't changed in decades, and doesn't seem likely to change anytime soon, regardless of who wins the elections.

2007 Jul 02 04:35 PM