Gouging is an Idiotic Explanation

Not my words, but I have expressed similar sentiments. Paul Sankey, an analyst with Deutsche Bank, testified on May 15th before the Senate Committee on Energy and Natural Resources. I would guess some jaws dropped during his testimony, as some of the Senators on the committee have certainly suggested that gouging is going on. Below are some extended excerpts from Mr. Sankey’s testimony. While I have some minor quibbles here and there, for the most part he told it like it is.

Update: Here is the full online version: Gouging is an Idiotic Explanation; there are some very good graphs in there. Thanks to KingofKaty for that link.

Gouging is an idiotic explanation – Senate Testimony of Paul Sankey

Anybody who blames record high US gasoline prices on “gouging” at the pump simply reveals their total ignorance of global oil supply and demand fundamentals. The real reason for high pump prices is the lack of global gasoline supply relative to demand. Just in the US, overall US refining capacity, at 17 million barrels per day (mb/d), is far below demand at 22 mb/d. In turn, pump prices are effectively set by import prices. With strong demand outside the US on the back of global economic growth and a weak dollar, the era of abundant US oil supply augmented by willing international sellers is dead.

The investment cycle drives the story – but it is 30 years long

High gasoline prices will cure high gasoline prices. The reason for the massive recent run up in prices can be traced back to the last significant period of high prices, in the late 1970s, which forced lower gasoline demand, then more efficient cars, which led to excess refining capacity, which led to years of poor returns in refining (and cheap gasoline prices), which disincentivised investment in refining and encouraged demand, and which has ultimately led to today’s intense market tightness. It is fair to say that as we enter driving season in 2007, we are one major incident away from a 1970s-style gasoline crisis. There is now US gasoline inventory, at record lows, for just twenty days of consumption.

The poor returns of the 1980s and 1990s have indirectly caused some additional external events that have played into the problems. The years of losing money caused companies to neglect refining investment, culminating in BP’s Texas City disaster. Texas City has now rightly caused other refiners to operate more cautiously – and so less capacity is available.

Nevertheless, because the industry is so stretched, there have been subsequent accidents, for example, a further BP issue at the company’s Whiting, Indiana plant. These two BP refineries alone are two of the five biggest US refineries, now running at half capacity, with some 400 kb/d shut down, and the remaining operating sub-optimally, running rare light sweet crude when they should be using more abundant heavy sour grades. Not all problems are with BP, for example a fire at Valero’s McKee refinery has tightened the Mid-Continental refining balance.

A second impact of years of reduced investment has been a lack of qualified engineering, procurement and construction staff. One vital issue here is that the tightness of US refining capacity at this time is not because companies are unwilling to invest in more capacity, it is that they are unable. There is competition from non-refining investment to exacerbate the problem, notably in Canadian heavy oil sands.

Then, just when imports are needed more than ever, European and Asian demand strength has combined with a weak dollar to leave margins higher elsewhere, crimping import levels. In this tight context the government has mandated tougher-to-make fuels, requiring more refining and plant maintenance. The law of unintended consequences results in government mandated ultra-low sulfur diesel (ULSD) being so hard to transport around the country that it excludes higher sulfur off-road diesel from the pipeline system, forcing farmers to use higher quality, more expensive, more difficult to make diesel than they would legally have to, and encouraging the export of off-road diesel to competing global markets.

US policy makers must stop attempting to re-create a 20th century of abundant and cheap US gasoline, it is as dead as the geology that leaves no more cheap US oil. Avoid additional mandates and allow the market to direct capital towards the areas of tightness. Returns are now high, so US refining capacity IS being added, as fast as reasonably possible, and demand IS slowing. It is vital to allow US gasoline prices to reflect the true cost of supply, which even now they arguably do not do (awful geopolitics, the suffering environment). For this summer, be prepared to take emergency measures (lifting environmental restrictions, emergency IEA gasoline inventory drawdown) should an emergency develop. We are not there yet, but we are close.

Refinery utilization is very low

US refinery utilization (essentially supply) has been particularly low this year.

There are several possible reasons for this. We believe it is some combination of the following:

Extended maintenance – Refiners have universally pointed to longer maintenance periods (turnarounds) due to (1) tighter fuel specifications that require more frequent plant maintenance (2) the difficulty in finding and retaining skilled contract labor and (3) the considerable damage to machinery that has been pushed to the limits by strong product demand over the past few years.

Product specifications – Tightened product specifications for transportation fuels (i.e. Tier II gasoline, ultra-low sulfur diesel) have made it more difficult to produce fuels. Problems which used to cause a refiner to alter operations now cause one to shut down until necessary repairs are made.

Safety concerns – In the wake of the deadly explosion at BP’s Texas City refinery in 2005, refiners are more concerned about safety than ever. As such, they are much quicker to halt operations than in the past.

31 thoughts on “Gouging is an Idiotic Explanation”

  1. Given the virtual impossibility of building plain, ordinary refineries in this country…what are the odds that if a good alternative fuel source *does* come along, it can be put in production in any realistic time frame?

    My suspicion is that any attempt to build *anything* on a large scale, whether it be coal-to-liquids, shale oil, cellulosic ethanol, nuclear-to-hydrogen, whatever…will be met with years if not decades of litigation.

  2. If real shortages develop, an angry public won’t put up with the usual shenanigans of activists and their legal beagles. Thus, the problem will be solved, but sub-optimally. Avoidable supply disruptions won’t be avoided, and hastily-executed fixes won’t be as well-thought-out as they might have been.

  3. H. L. Menken defined a demagogue as: “one who preaches doctrines he knows to be untrue to men he knows to be idiots.”

    I will leave it for the readers of this blog to decide whether Menken’s words apply to certain politicians.

    Mr. Sankey has spanked the senate committee with the truth. Sadly, I’d be willing to bet there was only 1 or 2 senators in the room when he said it.

    Here is the link to his testimony:

    Gouging is an Idiotic Explanation

    Geoff Sundstrom of AAA, which represents 50 million drivers in North America, doesn’t blame gouging or the energy companies for the problem. He rightly says that demand is up, supply is down.

  4. My vote for idiot of the week – go to the senate hearing webcast (requires Real Network player) and fast forward to the 1:36:00 mark in the hearing.

    Senate Energy Hearing Webcast

    Some wacko sitting behind Paul Sankey is holding up a “NO WAR FOR OIL” sign.

    My earlier comment was incorrect. In fact most of the Senate committee members attended the hearing and were engaged in asking questions.

  5. The testimony is a non-event, because unfortunately, we all know that there wasn’t a single person in that hearing that listened to one word he said!

  6. David:
    …will be met with years if not decades of litigation.

    How about a lawyer->liquid fuel solution, that would solve a lot of problems. If it was a hybrid lawyer/politician -> fuel system that would be even better. 🙂

    kidding… I love lawyers and politicians.

    RR:
    The “gouging” mentality is going to cause an acceleration of the energy issue. My opinion is that the oil industry is “the messenger” in the rising demand/depleting easy supply situation and the public is going to do their best to kill the messenger and ignore the news.

    If oil exploration and refinery enhancements get cut back due to the public forcing the petroleum industry into a loss situation so they can get cheap gas, the downside of the curve doesn’t look too promising. If we are short of refining capacity with Conoco showing a 12% profit, how do they expect infrastructure to get built if a windfall tax cuts out that profit.

    …remember anything about farming?

  7. Ethanol’s Bitter Taste

    Isn’t it amazing how short-sighted our political leaders can be? This will go down as one of the biggest boondoggles in this country’s history.

  8. The testimony is a non-event, because unfortunately, we all know that there wasn’t a single person in that hearing that listened to one word he said!

    That was also my experience when I testified before the Montana legislature. Some were paying attention, and some knew how they were going to vote and couldn’t care less.

  9. If we are short of refining capacity with Conoco showing a 12% profit, how do they expect infrastructure to get built if a windfall tax cuts out that profit.

    That’s exactly what happened the last time they instituted a windfall profits tax: investments into the industry fell. What these people don’t realize is that these multi-billion dollar profits are made as a result of multi-billion dollar investments. But they don’t understand the difference between a profit and a profit margin.

  10. From King’s link: The hugely influential National Cattlemen’s Beef Association has gone so far as to outline a series of public demands, including an end to any government tax credits (subsidies) for ethanol and an axe to the import tariff on foreign ethanol. Put another way, the cattlemen are so angry that they are demanding free markets and free trade–a first. Maybe ethanol really is a miracle fuel.

    Economics 101 caught up with the stupidity. Who would have thought? The only question to be answered is: How much money (taxes AND higher food prices) did this halfheaded strategy by our dearly elected cost the average American? Go ahead, Congressman, we are waiting for an answer…

  11. A study was released yesterday from the heart of ethanol country on that issue. Note that this doesn’t include any subsidies, this is just the costs due to increased food prices:

    Increased corn prices driven by rapidly expanding U.S. ethanol production already have increased U.S. retail food prices by $14 billion annually, according to a new study officially released today.

    Further, the study finds that the increase in U.S. retail food prices could reach $20 billion annually…

    The study found that neither corn stover nor switchgrass planting as replacement feedstocks for ethanol makes economic sense….

    The study was conducted by the Center for Agricultural and Rural Development at Iowa State University, Ames, Iowa.

  12. Economics 101 caught up with the stupidity
    Increased corn prices driven by…

    In 1972, corn was $3/bu, Canadian Hard Red Spring Wheat was $4.50/bu., Diesel was $0.20/L, urea $100/tonne.

    Corn is now $4/bu, CHRS Wheat $5/bu and Diesel $0.85/L, urea $550/tonne.

    Corn has to go to $15/bu to just adjust for inflation.

    If you applied Conoco’s profit margin and return on investment to Canadian agriculture wheat would be $20/bu not $5/bu.

    The corn price spike isn’t real, it’s commodity speculation. Feed grains have been undervalued due to subsidies for the last 30 years and they are being jumped on. Do you think they actually got enough ethanol production online in the last 8 months to really use up all the surplus corn in the US?

  13. As it is Friday, I intend to consume products from both the National Cattlemen’s Beef Association, and the ethanol industry. My ethanol is potato based infused with herbs and added to a little quinine water and lime for medicinal purposes only.

    I find that ethanol greatly improves the taste. And after all, one can not take enough precautions – given all the time I’ve spent in the malarial infested jungles of africa and south america looking for ethanol substitutes whilst dodging restless natives, drug cartels, venomous reptiles, and islamic fundamentalist kidnappers.

    Cheers!

  14. “Senate Energy Hearing Webcast”

    I am watching this now. Very impressed with Sankey: Knowledgeable and direct. The guy from AAA is cracking me up. He sounds like he is about to cry.

  15. I just watched Senator Wyden from Oregon on the webcast, and he left me with a very unfavorable impression. He kept asking why the oil companies weren’t reinvesting their profits, and Sankey kept saying that they were. Wyden must have repeated this 3 or 4 times, and then he closed with it. He wasn’t interested in Sankey’s view, he just wanted to assert that profits aren’t being reinvested.

    That’s my first and only impression of him, but I think he is probably pretty typical. They don’t actually want to listen to what you have to say.

  16. If you applied Conoco’s profit margin and return on investment to Canadian agriculture wheat would be $20/bu not $5/bu.
    Two words: Supply & Demand.

    The corn price spike isn’t real, it’s commodity speculation.
    With all due respect, that statement is speculation. With close to 20% of the corn harvest going to ethanol, the ethanol effect overshadows speculation. Read what these guys project for corn in the coming year.

    Feed grains have been undervalued due to subsidies for the last 30 years and they are being jumped on.
    Ah, yes, the free market and its non-application to agriculture. We need a whole new blog to discuss that one!

    Do you think they actually got enough ethanol production online in the last 8 months to really use up all the surplus corn in the US?
    Between 2005 and 2006 ethanol production increased by ~25% and that was before the latest mad rush to build ethanol plants. Bubble anyone?

  17. I went over to the FCTR website to see what nonsense they were up to. I was stunned to see the proposals from CA Assembly speaker Fabian Nunez. Nunez wants to make refineries report to the California Energy Commission and essentially get permission to shut down units.

    “If the proposals pass as proposed, said Nunez, they would “Grant the CEC authority to share key data with the Attorney General” if wrongdoing is suspected. The Board of Equalization, the state’s chief taxing body, could offer pertinent information to the CEC.

    He said “penalties will be very stiff,” with violations charged as felonies.

    Felonies are criminal and punishable by 1 or more years in the state pennitentiary. So, if I’m a refinery manager who decides to shut a unit down for safety reasons, I could face jail time. But if I don’t shut down the unit and something bad happens, I could face jail time for harming people or the environment and my company could face huge fines and lawsuits.

    Wow, so everyone who wants to go work in California step forward!

  18. Optimist,

    When I said subsidize, in Canada that mostly means that almost all family farms have an off-farm income supporting the lifestyle.

    the ethanol effect overshadows speculation

    You posted a link from an Alberta Pork group. Do you think that Pork producers in Alberta might have been happy to buy surplus and cheap US corn and be a bit biased?

    I would think the numbers are accurate, but does 20% of the corn crop mean there isn’t enough domestic feed in the US or that it’s no longer being dumped in Alberta?

    They were feeding US corn because it was cheap. Now they will have to buy local corn and barley. The pig feedlot that buys all it’s feed has to suck up higher feed prices and the market doesn’t see the input increase until pork supply drops.

    When corn hits $5/bu, do you think the ethanol plants running on VC funding can carry on buying it?

    Ethanol using up corn will solve itself rather quickly. People will have to pay more for corn and meat, but unless we run out of petroleum next week, ethanol plants will start losing money and their demand will drop off.

    The corporate/large beef and hog feedlots that are buying all of their feed are going to get burned in the process of a feed grain price increase and many will fold and cause a short supply and then the meat price will go up until it balances.

    The small mixed farm that grows their own feed could care less about the price of corn in the US, except that there might be more money in selling it than feeding it.

  19. When corn hits $5/bu, do you think the ethanol plants running on VC funding can carry on buying it?
    BINGO!

    Ethanol using up corn will solve itself rather quickly. People will have to pay more for corn and meat, but unless we run out of petroleum next week, ethanol plants will start losing money and their demand will drop off.
    I completely agree. I am amazed at how much pain our elected officials inflicted with so little effort. Must be some kind of record for political productivity.

  20. I think Mark Twain got it right. A few quotes:

    Fleas can be taught nearly anything that a Congressman can.

    Suppose you were an idiot. And suppose you were a member of Congress. But I repeat myself.

    Congressman is the trivialest distinction for a full grown man. [Notebook #14, 11/1877 – 7/1878]

    All Congresses and Parliaments have a kindly feeling for idiots, and a compassion for them, on ac-count of personal experience and heredity. [Autobiography]

    It could probably be shown by facts and figures that there is no distinctly native American criminal class except Congress. [Pudd’nhead Wilson’s New Calendar]

    It is the foreign element that commits our crimes. There is no native criminal class except Congress. [More Maxims of Mark, Johnson, 1927]

    Whiskey is carried into committee rooms in demijohns and carried out in demagogues. [Notebook, 1868]

    …I never can think of Judas Iscariot without losing my temper. To my mind Judas Iscariot was nothing but a low, mean, premature, Congressman. [Foster’s Case, New York Tribune, 3/10/1873]

  21. rohar1,

    Your ignorance of economics continues to astound me. You said.

    The corporate/large beef and hog feedlots that are buying all of their feed are going to get burned in the process of a feed grain price increase and many will fold and cause a short supply and then the meat price will go up until it balances.

    Who to you think supplies the feeder cattle to the large beef feedlots? That would be yearling / stocker operators that are much smaller in size then the feedlots. Who supplies calves to the folks who run yearlings? Cow calf producers who are often smaller in size then the yearling operators.

    What do you think happens when the feedlots make less money or lose money? Those losses roll down hill to the yearling operators and cow calf producers.

    A very fine screw you the cattle producers are getting. They are getting it because the politicians are willing to do almost anything to provide a market for ADM ethanol.

    This market would not exist if the government did not mandate it. A market that does not reduce oil consumption and causes lower gas mileage and higher prices for autombile drivers.

    Cheers,

    TJIT

  22. TJIT:
    Everyone hates corn based ethanol..

    Nope.
    Everyone you listed loved $2.00 corn.

    I have a Canadian grain farm, and I love US ethanol and $5 corn.

    It should be adjusted to be in line with diesel from 1972, which puts it at $24/bu.

  23. And TJIT one more thing.. as RR said at the end of his Comments on Senate Hearing
    “Good God, we’re doomed.”

    Well…
    I grew up with grandparents who raised 5 kids in the 1930’s depression living on the same farmyard and something must have rubbed off.

    You have to live within your means and account for the good times coming to an end, whether thats personal or running a feedlot on $2 corn.

    I don’t have any debt, I own a good chunk of farmland and I know how to do everything from grow my own food, dress and butcher to carpentry and mechanics and if need be I could figure out how to run a tractor on wood gas. I don’t imagine if things turn ugly that my computer skills are going to keep me employed and probably the skills I picked up putting up 5-6 cords of firewood over several winters have more value. I am not going to freeze in the dark and my kids aren’t going to go hungry regardless of what happens to the economy and global energy.

    But.. I guess you are astounded by my lack of understanding of economics.

  24. I have a Canadian grain farm, and I love US ethanol and $5 corn.

    Not an unusual attitude, I see it with many US farmers also. It can be summarized as “I love what I get from the government and to hell with everybody and anything else that gets hurt in the process of getting me my government money”.

    You have to live within your means and account for the good times coming to an end, whether thats personal or running a feedlot on $2 corn.

    The feedlots will adapt to higher corn prices. They will just pay lower prices to the small cattle raisers that supply them with cattle. But you got your $5 corn courtesy of a government boondoggle so I guess any damage to other people is beside the point.

    I don’t have any debt, I own a good chunk of farmland and I know how to do everything from grow my own food, dress and butcher to carpentry and mechanics and if need be I could figure out how to run a tractor on wood gas.

    But.. I guess you are astounded by my lack of understanding of economics.

    I am impressed by your personal fiscal responsibility. However, individual fiscal responsibility requires little, if any knowledge of economics.

    Not so impressed by your callous disregard for the damage the ethanol you like is doing to other people.

    TJIT

  25. TJIT:
    I love what I get from the government..

    That is a silly comment, insulting and ignorant.

    Canadian feed grains aren’t subsidized and the price was held down by subsidized US corn flooding the market at $2 for the last 15 years.

    Something realistic price wise for US corn or at least it being above the 1972 not adjusted for inflation price of $3/bu, means that we aren’t trying to compete with an artificially low commodity in a continual surplus.

    Canadian grains aren’t subsidized to any amount except for farm owners working second jobs.

    Oats went to $3 for the first time ever, other feed grains are up because the subsidized US corn supply was bought up.

    Because you can seed oats, barley and feed wheat in Canada with relatively low inputs and show a profit, more acres go into feed grains and that pushes oilseeds and specialty crops up.

    This just puts Saskatewan farming at a “potential” to break even, nevermind profitable or any kind of ROI.

    If you want to get a clue on Saskatchewan agricutural financials, look here: Sask. Ag & Food Stats

    It’s not a callous disregard for someone’s financial hardship due to a corn price increase. The corn price increase was going to happen anyway, ethanol just sped it up. Go out and plant and harvest enough corn for a bushel and tell me if your effort was only worth $2.

  26. rohar1,

    I’ve raised enough crops to appreciate the financial environment of farming.

    Unsubsidized Canadian farmers are in the same shoes as US producers of cattle and other unsubsidized commodities are. The price they receive is often driven down by US government farm policy . They are forced to compete against the US government and it has a lot of money to spend.

    You understand the problem Canadian feed grains aren’t subsidized and the price was held down by subsidized US corn flooding the market at $2 for the last 15 years I suspect the couple of years of higher grain prices ethanol policy has given will be overwhelmed by the inevitable corn glut it will produce.

    I am sometimes undiplomatic on this subject because I have many friends who raise crops and cattle who have had their finances seriously damaged by US government efforts to subsidize corn and wheat producers.

    I have other friends who would like to get into agriculture but can’t afford to because farm subsidies have artificially increased farming costs to an unaffordable level.

    How is the rain situation in your part of the world? Hope your getting good moisture for your crops.

    Cheers,
    TJIT

  27. I don’t actively farm. My brother’s nephew is renting our land this year and just finished seeding, it’s wet but a bit cold.

    If the price of food quadrupled to be realistic for the investment and effort involved, no one would be whining about $3 gas. A bit part of the energy problem is that food is too cheap, houses are overvalued and credit is too easy to obtain.

    I wouldn’t worry about a corn surplus in the future. Urea hit $550/tonne here this spring due to the soybean acres converted to corn causing a shortage. I used to work on the gas nominations system for the gas transportation company and during the winter, the NH3/urea plants get limited in the amount of gas they can use per day. Once the weather warms up and the heating usage stops, they can generally have as much as they want. I can bet they are running as hard as they can this summer.

    NG has no choice to go into short supply between the Tar Sands and NH3/urea increased usage. It’s going to get difficult to create a surplus when urea goes past $1000/tonne, even if the price for corn stays up.

    Tell your friends to immigrate to Canada, if they have 2 years of farming experience and $400k to invest, it’s very easy to immigrate to Canada. You can buy prime farmland for $300-1000/acre. I guess I don’t paint that pretty of a picture of farming in Canada, but there are a lot of people that have to eat.
    🙂

    http://www.lanerealtycorp.com/
    http://www.aee.gov.sk.ca/immigration/

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