Summer’s Perplexing Paradox: Cheaper Crude and Costly Gasoline
Don’t look for a big drop in gasoline prices to brighten the summer driving season merely because the price of crude oil has tumbled again. And don’t weep for the big oil companies just yet.
The cumbersome global system that transports oil from the ground into cars, planes and furnaces is operating in especially kinky fashion this year, economists and oil peddlers say, tightening supplies of gasoline even as the world drowns in oil.
Refinery outages, a drop in gasoline yield per barrel and even the drought are blamed for an anomaly: Although there was 9.5% more crude oil in storage in the United States last week than a year earlier, there was 9% less gasoline around.
This is a convenient state of affairs for oil companies that sell both crude and refined oil. They stand to make so much money this summer from selling gasoline and chemicals that most major companies will hardly notice the nose dive in the price fetched by its basic feedstock.
But it means no relief for motorists as they head into the peak driving months of the year and tends to rob the economy of some of the anti-inflationary effect that is supposed to be the chief benefit of lower oil prices.
A prolonged decline in the price of crude--which has fallen to between $14 and $15 this week from an $18.60 peak in mid-April--would eventually make its way to the gasoline pumps and take its toll on oil companies.
But economists call the current imbalance an extreme distortion, even in a world where retailers delay price cuts as long as they can and gasoline prices tend to strengthen in the summer anyway.
“We seem to have had an abnormally high concentration of problems which have created somewhat of a dichotomy in which crude is going down and gasoline is remaining strong,” said James Huccaby, manager of pricing at Chevron U.S.A. in San Francisco.
Said Philip K. Verleger Jr., energy economist at Charles River Associates in Washington: “This is quite unusual.”
Analysts further say it will be September before pump prices soften, by which time some expect the price of crude to be on its way back up with the approach of the winter heating season.
“I’m sure the public wonders what’s going on,” says a Mobil official.
Here are some explanations from oil company executives, energy economists, consultants and investment analysts:
- Refinery problems nationwide, including a major fire at a big Shell Oil plant in Norcross, La., and partial shutdowns of at least seven Southern California refineries, have helped drive gasoline inventories to unusually low levels for this time of year. Verleger says the Shell refinery, still out of commission, represents 2% of national production.
Locally, partial outages at Arco and Mobil refineries in Carson and Torrance in May and June alone removed about 2.6 million barrels a day of gasoline from production, roughly 14% of the region’s consumption. At least five other area refineries were down to varying degrees this spring, industry sources say.
By July 8 in the four Western states, gasoline inventories had dropped to 27.3 million barrels--off 14% from the same time a year ago.
Such spring cutbacks are scheduled for maintenance purposes and normally begin after gasoline inventories are built up during the slack-demand winter season. But a December fire at the Mobil refinery has depressed production all year, and it didn’t have the desired inventories heading into May, a spokesman said.
- Federal regulations as of Jan. 1 cut the amount of lead that can be used to raise octane, forcing refiners into techniques that consume more crude per gallon of gasoline. With the public’s growing appetite for higher-octane gasoline, refiners are getting less gasoline from each barrel of crude, said consultant Duvall Webster of Turner, Mason & Co. in Houston.
This lower yield is estimated to have cut gasoline production by 100,000 to 200,000 barrels a day, equivalent to closing down a sizable refinery.
- The seepage of salt water into the Mississippi River at the mouth of the Gulf of Mexico, a result of the river’s low level during the drought, has forced some refineries in that area to reduce output, says Verleger. The refineries use fresh water for cooling.
- European and Far East refineries that normally export gasoline to tight U.S. markets could not supply the lower-lead, higher-octane products in demand, said oil analyst Stephen Smith of Bear, Stearns & Co. in New York.
Strong Profit Margins
With little slack in the system--the nation’s refineries overall are operating at a strong 86% of capacity, according to the American Petroleum Institute--there is little prospect of alleviating the tight gasoline supply during the peak-demand season.
All this adds up to strong profit margins at refineries, and Wall Street expects that to offset the negative effects of today’s low crude prices for major oil companies.
“The refiners are making a killing,” said Joseph Rault Jr., president of Rault Resources, a New Orleans oil and gas producer.
Refining profits, the belt-tightening that has already taken hold throughout the industry, and a boom in the chemicals business--a key part of the oil industry--are expected to drive up industry earnings as much as 40% for the second quarter.
Long-Term View
Refining could account for more than half the industry’s profits, the first time that has happened since the 1960s.
In turn, the industry has so far maintained its ambitious exploration and production spending plans for this year despite the bleak oil price picture, a Salomon Bros. survey found. One firm, Phillips Petroleum, even announced plans last week to boost its exploration spending by 15% above the budgeted 1988 level.
That is taking the long-term view. Analyst Smith of Bear Stearns, referring to the mixed blessing of low crude prices, said:
“These guys are being spared a lot of the pain right now. But it leaves them in a very iffy position with respect to the bread and butter of their business. They have got to have a price high enough to enable them to replace their oil reserve base or they will gradually liquidate themselves.”
