• Heading into the travel-heavy July 4th weekend, consumers face decade-high gas prices.1
• Higher crude oil “crack spreads”2 indicate acute refining capacity shortages as refinery utilizations approach pre-pandemic levels.3
• Although crude oil prices have recently softened,4 high gasoline prices may persist as adding refining capacity requires decade-long lead times along with an unfavorable regulatory environment, uncertain long-term demand and persistent supply chain issues.5
Peak Seasonal Demand for Gasoline
July 4th is the traditional start of summer travel season. As Americans load up their SUVs and head out for summer vacations (and peak seasonal demand for gasoline), they face decade-high gas prices.
While crude oil is off its recent highs, gas prices have remained persistently elevated with a recent national average of $4.55 per gallon - about $1.75 higher than last year.6
So what other factors may be contributing to persistently high gas prices?
Crude Oil “Crack Spreads”
A crack spread is the difference in price between a refined group of products and crude oil. It is rough indicator of energy market conditions, approximating the margin from processing crude through a cracking configuration refinery. The 3:2:1 crack spread is the approximate yield at a representative US refinery: for every three barrels of crude oil the refinery processes, it makes two barrels of gasoline and one barrel of distillate fuel.
The chart nearby illustrates gasoline prices and the 3:2:1 crack spread for the past decade. Historically, the crack spread was roughly in line with the cost of gasoline with an average of $18.91 for the decade of May 2012 to May 2021. As the economy emerged from pandemic shut downs in late 2021, the spread jumped to $51.20, an increase of 170%, indicating acute capacity shortages, albeit significantly higher margins for refiners.
The Shrinking US Oil Refinery
One of the key causes of rising crack spreads is the decline of refining capacity. Nearby is a chart of US Crude Oil Refining capacity, indicating a current refining capacity of approximately 18 million barrels per day (a level not seen since May of 2015).
Note that over the past two years, capacity has declined 6%.
With favorable economics, high margins and robust market demand, we would expect oil companies to be adding refining capacity. However, several significant factors provide disincentives for investment:
- Oil companies (and lenders) are still licking their wounds from the energy loan debt default waves of 2015-2016. This experience likely raises their cost of capital and increases the required project investment returns.
- These projects often have a payback period of a decade or more. A cloudy future for gasoline demand (as the country pursues energy transition) and an unfavorable regulatory environment creates additional project risks and raises the investment threshold and payback period.
- Refineries are highly complex and massive endeavors. Oil companies face many of the same worker shortages, manufacturing and parts shortages, and overall supply chain issues that are affecting other industries.
Without significant changes in gasoline demand, the regulatory environment and/or improvement in global supply chains, it is unlikely that refiners will be adding capacity. Higher crack spreads, and consequently gas prices, are likely to persist.
Important Disclosures & Definitions
1 US Energy Information Administration, as of 05/31/2022
2 Crack Spreads: the difference in price between a refined product (or group of products) and crude oil. It is used as a rough indicator of market conditions, roughly approximating the margin from processing crude oil through a refinery.
3 US Energy Information Administration, as of 05/31/2022
4 Bloomberg, West Texas Intermediate (WTI) Crude Oil, as of 05/31/2022
5 Bloomberg, as of 06/03/2022. Chevron CEO Says No More US Oil Refineries.
6 US Energy Information Administration, as of 05/31/2022
Bloomberg Nymex WTI Cushing Crude Oil First Month 321 Crack Spread Index: an index that measures the difference between three crude oil futures contracts versus two gasoline futures contracts and one heating oil futures contract. One may not invest directly in an index.
Performance data quoted represents past performance. Past performance is no guarantee of future results; current performance may be higher or lower than performance quoted.