Biden Administration’s Latest Energy Blunder: Refinery Capacity

The Biden administration continues to show a lack of understanding on how energy markets work as the public calls for solutions to gasoline prices hitting a record high $5 per gallon nation average. Most recently, the president sent a letter to major U.S. oil companies demanding they increase refining capacity and blaming them for “blunting the impact of the historic actions my Administration has taken to address Vladimir Putin’s Price Hike and…driving up costs for consumers.”

The irony is strong here: throughout the 2020 campaign, and during the current legislative term, Biden and fringe Democrats on Capitol Hill have seemingly done everything in their power to undermine confidence in America’s oil and natural gas industry, but are now demanding an increase in the refining capacity to lower gasoline prices.

Further adding to this, Sen. Ron Wyden (D-Ore.) floated a proposal to raise taxes on American oil companies yesterday that a top White House economic advisor appeared to embrace, stating:

“We’re not ruling that out of consideration. We’ve made that clear.”

As has been explained multiple times, a tax of this nature has been shown historically to decrease production, not increase it.

Wednesday’s letter was no different with Biden misrepresenting the situation around gasoline refining by demanding that the companies “take immediate actions to increase the supply of gasoline, diesel, and other refined product you are producing and supplying to the United States market. With prices for your product where they are today, you have ample market incentive to take these actions.”

However, U.S. refining capacity is already near its current operational peak to meet increased demand, according to the Energy Information Administration, which wrote last week:

“In response to these high prices, we expect that refinery utilization will reach a monthly average level of 96 percent twice this summer, near the upper limits of what refiners can consistently maintain. We expect refinery utilization to average 96 percent in June, 94 percent in July, and 96 percent in August.” (emphasis added)

Covering Biden’s letter, CNBC also noted that refining is essentially at peak capacity and that refining is a complex operation that can’t ramp up immediately:

“Refiners can’t just ramp up output, and utilization rates are already above 90%. Additionally, some refiners are now being reconfigured to make alternate products like biofuel.

“… Still, there is no easy solution. John Kilduff, partner at Again Capital, said refiners are working at historically high level. ‘There is nothing left to ramp up,’ he said.

The bigger issue – as even Biden acknowledges in his letter – is that refining capacity scaled back in 2020 as demand dropped off due to the COVID-19 pandemic and hasn’t been able to keep pace with rising demand after economies sprung back into life. This coupled with several other factors including “present and projected future fuel demand, the political environment as well as facility locations and their individual market access,” according to the American Fuel & Petrochemical Manufacturers:

Political and financial pressure to move away from petroleum derived fuels, costs associated with federal, and state regulatory compliance and facilities’ singular economic performance all inform these decisions. The sharp drop in fuel demand over the course of the pandemic certainly sped up the timeframe for refining contractions, closures and transitions, but many of these moves were already planned or underway… Refining is a long-view industry. Facility closures and transitions are not knee-jerk decisions, and they were never intended to be undone. They are meticulously reasoned and based on far more than short-term, transitory data.” (emphasis added)

As EIA wrote in its June 2022 Short-Term Energy Outlook:

“Despite our expectation that refinery utilization will be at or near the highest levels in the past five years, operable refinery capacity is about 900,000 b/d less than at the end of 2019, and as a result, we do not expect total refinery output of products to reach its highest level in the past five years.”

And AFPM further explains that it’s not as simple as just turning on more capacity, even from recently closed facilities:

“Lost capacity cannot be restored with the flip of a switch. We don’t just have 1.1 million barrels of daily capacity sitting there idle and ready to go back into production. More than half of the refining capacity lost in the United States over the past couple years is in the process of being transitioned to full-time renewable fuel production or it’s being dismantled.

“Even if that wasn’t the case, reopening a refinery is a major effort. It would require significant lead time to inspect machinery and attain necessary operating permits. Staff would need to be reassembled and/or recruited and trained. And the facilities themselves would need to be reintegrated with supply chains. A hypothetical restart is not a quick-turn project, and the investment cannot be based on short-term data.” (emphasis added)

While expansion projects for several refineries have been underway for years, as EIA notes, the last new refinery “with significant downstream unit capacity” was built in 1977. CNBC is reporting the same issue:

“Kilduff noted that no new refineries have been built in decades, but existing units have been expanded. Prior to the pandemic, there had been excess refining capacity, which pressured profits.”

Criticism of Profit Margins is Off the Mark

In his letter, Biden also criticized what he called the “historically high” profit margins of refining operations, but he fails to explain how this market works.

Before gasoline reaches the consumer, oil is bought and sold at several points in a complicated supply chain. Producers sell crude oil to refiners at a competitive price set by the global market. Generally, refiners both purchase crude oil and sell the refined product using futures contracts, with approximately one month in between the purchase date and the sale date.

Consequently, the price of retail gasoline more closely reflects the price of crude oil when it is purchased by the refining company than the price of crude oil the day the retail gasoline product is sold. Biden’s letter identifies two dates when the spot price of crude oil was equivalent – regardless of whether the spot price was part of an upward or downward trend – and apparently expects the price of retail gasoline to be equivalent as well.

This reflects a fundamental misunderstanding of the market and the supply chain. Worse yet, when the price of gasoline on those two given dates is not equal, Biden’s letter blames the difference on refining companies’ profits. However, the price of crude oil is by far the largest driver affecting the price of gasoline. And, over the last year, crude oil has increased its share of contributing cost more than any other factor, including refining.

According to data from the U.S. Energy Information Administration, in the first quarter of 2021, the price crude oil contributed 53.6 percent to the cost of regular gasoline, while refining costs and profits contributed 16.4 percent. In March 2022, EIA data show that the price of crude oil made up approximately 59 percent of the cost of regular gasoline. Refining costs and profits comprised only 18 percent of the cost of regular gasoline.

Lastly, Biden’s letter fails to mention one simple explanation for why retail gasoline prices might be higher in June 2022 than they were in March 2022: variation in consumer demand. In their May 2022 economic research, Dallas Federal Reserve economists Garrett Golding and Lutz Killian evaluate the mismatch between crude oil prices and gasoline prices:

“This indicates that retail gasoline prices remaining persistently high was not the result of an oil shortage or high oil prices. Rather, the elevated retail gasoline prices must be attributed to events in the U.S. retail gasoline market beyond the control of oil producers.”

One of those factors identified by Golding and Killian is variation in “seasonal demands,” like the start of the summer driving season. Prices usually climb during the summer driving months, starting in the beginning of June. However, Biden’s letter conveniently left out this point in its comparison of March gasoline prices with June prices.

Attacks on American Energy

The biggest irony in Biden’s letter is that he’s demanding greater output from America’s oil companies after spending the past three years attacking them for producing energy.

During his 2020 presidential campaign, Biden’s platform included “banning new oil and gas permitting on public lands and waters,” and at times he went even further by stating:

“No more subsidies for the fossil fuel industry. No more drilling on federal lands. No more drilling, including offshore. No ability for the oil industry to continue to drill – period, [it] ends, number one.”

During his first week in office, Biden immediately cancelled the Keystone XL pipeline and issued an illegal ban on federal leasing. Just this week, the administration once again delayed the first lease sales and is in the process of appealing the injunction to potentially not hold sales at all. Further, if lease sales ever do occur, producers now face a 50 percent increased royalty rate.

And top administration officials, including Gina McCarthy, have made it clear the administration doesn’t want to boost production, saying:

“President Biden remains absolutely committed to not moving forward with additional drilling on public lands.”

Meanwhile, Democrats in Congress have pushed legislation that further undercuts confidence in America’s energy industry, including baseless gasoline price gouging investigations and a windfall profits tax.

These mixed messages aren’t going unnoticed.

Rep. Cathy McMorris Rodgers (R-Wash.), the Republican Leader of the U.S. House Committee on Energy and Commerce appeared on CNBC this morning to slam Biden’s mixed messages.

Similarly, Mike Sommers, the president of the American Petroleum Institute, said:

“The administration’s misguided policy agenda shifting away from domestic oil and natural gas has compounded inflationary pressures and added headwinds to companies’ daily efforts to meet growing energy needs while reducing emissions.”

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