“Gas Prices Rise on Refineries’ Record Failures” Or the Cartel Conspiracy

The title is from a story by Jad Mouawad, which sort of gave me an excuse to summarize some data on retail gasoline prices from this source. I was looking for an excuse to go there ever since I purchased gasoline in Los Angeles for only $3 a gallon for the first time in a couple of months.

Our graphs report the real retail price per gallon – where my deflator is the CPI divided by 200, which effectively reports the retail price in terms of 2005QI constant dollars. The first graph shows that the price today is around twice what it was in early 2000. We first floated with $3 a gallon gasoline right after Katrina with gasoline prices being on a bit of a roller coaster ever since. Notice also that the oil components was around $0.75 a gallon in early 2000 and it’s around $1.50 a gallon now. So oil is about have the story with the doubling of gasoline prices corresponding with the doubling of the oil component.

But this also means that the sum of non-oil components – taxes, distribution margin, and refinery margin – has also doubled. Our second graph shows each of these components. The distribution margin has been quite volatile and at $0.40 per gallon is about twice what it was seven years ago. But this approximately $0.20 per gallon increased is partially offset by the $0.11 a gallon decline in taxes. So when discussions turn to refinery margins – this is certainly part of the story behind the increase in gasoline prices. And over the past two years, the volatility of oil prices appears to be attributable to the volatility of refinery margins.

Jad Mouawad tries to quickly dismiss one explanation of why refinery margins have increased:

Some critics of the industry have theorized on Internet blogs that the squeeze on gasoline and other refined products points to a deliberate effort among oil companies to bolster profits by keeping supplies tight. But experts point out that the companies have little incentive right now to hold back on fuel supplies. “Every refinery would like to run as much crude as possible but they simply can’t,” said David Greely, senior energy economist at Goldman Sachs, who in a recent report compared the drop in domestic refining with an “invisible hurricane.”

Mouawad and Greely must have never heard of cartels – a theme we’ll return to. Rather they see a perfectly competitive market at work:

There have been blazes at refineries in Louisiana, Texas, Indiana and California, some of them caused by lightning strikes. Plants have suffered power losses that disrupted operations; a midsize refinery in Kansas was flooded by torrential rains last month. American refiners are running roughly 5 percent below their normal levels at this time of the year. “You have a system that is taxed to the limit,” said Adam Robinson, an energy research analyst at Lehman Brothers. “This is what happens when spare capacity is eroded.” After Hurricanes Katrina and Rita disrupted the nation’s energy lifeline two years ago, oil companies delayed maintenance on many of their plants to make up for lost supplies and take advantage of the high prices. But, analysts say, they are now paying a price for deferring repairs. As a whole, refining disruptions have been considerably higher than in previous years: they averaged 1.5 million barrels a day in the first quarter, compared with 700,000 to 900,000 barrels a day from 2001 to 2005. In the days after the hurricanes, refiners were forced to briefly halt as many as five million barrels of production. In 2006, when refiners were still reeling from the impact of the hurricanes, disruptions in the first quarter averaged 1.35 million barrels a day. Many factors have led to the rise in gas prices, including disruptions in oil supplies from places like Nigeria and Norway. But analysts say the refining bottleneck in North America has been one of the main drivers of higher energy prices this year. The refining crunch has pushed wholesale gasoline prices up 35 percent this year and has contributed to a 23 percent gain for crude oil prices. Oil futures in New York closed at $75.57 a barrel on Friday.

In other words, Mother Nature is to blame for the reduction in refinery activity. Dean Baker, however is not so sure:

conspiracies do sometimes exist. In the case of energy pricing, we need only go back to the manipulations by those clever boys at Enron that earned the company hundreds of millions of dollars and sent electricity prices soaring in California back in 2001 … Of course any individual refinery would certainly benefit from pumping out more gas at the current price. But if there was a wink and nod agreement by a few of the biggest companies not to rush repairs, they all would benefit more from the higher prices that result from these refineries being kept off line. My guess is that there is no such agreement and the basic story of refineries being down for needed repairs is true. However, the conspiracy theory folks were right in California in 2001, and the dismissive experts were wrong.

If an effective refinery cartel were established, the refineries could benefit from withholding supply in order to drive up the wholesale price of gasoline. But as soon as refinery margins increased, the individual members of the cartel would be tempted to cheat in the form of sub-rosa price cuts in order to gain market share. A similar view had been put forth with respect to the OPEC cartel by M. A. Adelman many years ago. Could it be that the recent drop in refinery margins is a sign that this (alleged) cartel is breaking up?