High Gasoline Prices and Refineries

I’m paying almost $3.50 a gallon for gasoline here in Los Angeles right now so when Bill Polley raises the refinery issue, I definitely take notice. Bill notes that WCCO-TV blames a shortage of refineries:

Average gas prices in the Twin Cities are flirting with $3 per gallon again. They have already topped that in other states and hit a new national average record of $3.07 per gallon. Experts said it’s a supply problem. We’re paying more because our refineries can’t pump out enough gas to meet our demand. So why don’t we just build more of them? “We’re dealing with the same spigot,” said Dr. Akshay Rao, a business professor at the University of Minnesota. He said the last refinery built in the United States was in 1976 and many have since closed. In fact, in 1985 there were 254 operating refineries. Today, there are approximately 142. “There were marginal refineries that weren’t making enough money closed,” said Rao. Existing refineries have been expanded and are actually producing record output. They process about 17 million barrels of oil each day, but Americans consume about 22 million. The difference is imported.

Dr. Rao starts with the declining number of refineries canard but then notes their output is up AND we can address shortages with imports. Bill Polley notes that the decision to make a new refinery is a long-term investment decision so even if refinery margins have temporarily spiked, that’s not going to necessarily induce a surge in refinery investment.

I tend to produce on occassion a time series based on this data, which alas goes only through March 2007. My time series is deflated by the consumer price index such that the price-level is unity for the first quarter of 2005. It shows that the relative price of gasoline had risen from $1.50 a gallon as of early 2000 to $2.50 as of March 2007 with peaks near $3 as of September 2005 and July 2006. We also show the components of gasoline prices among the price of oil, the refinery margin, and “other” (taxes plus the distributor margin). Much of the rise in gasoline prices from January 2000 to March 2007 is attributable to higher oil prices. Refinery margins have been quite volatile but there does not appear to be a clear upward trend. Now the current high prices might be to another jump in refinery margins, but I’m willing to bet that this is just another transitory event. Which would mean that the incentives to do a lot of refinery investment just won’t be there.