Prices of gasoline and diesel fuel are crazy high and oil refiners are earning stupendous profits. But the refiners, who convert crude oil into consumable products, aren’t price gouging — that is, they aren’t deliberately charging an unfairly high price.
Highlighting that combination of facts isn’t convenient for either side in the debate over what to do about high fuel prices. The refiners don’t like attention being called to their fat profit margins. And proponents of anti-gouging legislation — such as the Consumer Fuel Price Gouging Prevention Act, which passed the House on Thursday — don’t like to hear that their solution is based on a false premise.
One thing no one can deny is that fuel prices have skyrocketed. For regular gasoline, the national average retail price is $4.49 a gallon, up $1.46 from a year earlier, the Energy Information Administration reported on May 18. For on-highway diesel the increase has been even more extreme, to $5.61 a gallon, up $2.36 from a year earlier.
It’s also undeniable that refiners’ profit margins have widened. The following chart explains why. It shows what’s known as a “crack spread,” which is the difference between the price of crude oil and the price of products made from it. This chart shows the spread, measured at New York Harbor, between the cost of two barrels of crude (the input) and one barrel of gasoline plus one barrel of diesel (the outputs). The spread has roughly quintupled this year. It doesn’t reflect the fixed costs of running a refinery, but when it widens out the way it has, you can be sure refiners are doing very well.
So isn’t this prima facie evidence of price gouging? I would say no. To gouge, which is by definition a deliberate action, you have to be able to control the price you charge. But refiners have little to no control in the short term over the prices they get for the products they make. In the language of antitrust, refiners are “price takers,” not “price setters.”
Refined products such as gasoline and diesel are pure commodities: standardized, storable, easily tradable and produced by thousands of competitors in a global market. A company that tried to charge a dime more than its competitors would quickly lose customers. Prices never diverge much from the going price in the futures market, where traders are “buying and selling based on their perceptions of market supply and demand,” Andrew Lipow, president of Lipow Oil Associates, a consulting firm in Houston, told me.
In the futures market, “you don’t know who you’re buying from and who you’re selling to,” said Susan Grissom, chief industry analyst at the American Fuel & Petrochemical Manufacturers association.
Monopolists can and do raise prices by withholding supply from the market, but refiners generally can’t do that. They are producing about as much as they can — not because they’re good citizens but because the more product each one produces, the more money it can make.
President Biden, frustrated by high inflation, is threatening oil producers and refiners with federal investigations over their pricing practices. In November, even before prices really took off, he asked the Federal Trade Commission to look for evidence of gouging. He wrote to the commission’s chair, Lina Khan, “I do not accept hard-working Americans paying more for gas because of anti-competitive or otherwise potentially illegal conduct.”
But forcing refiners to accept lower prices for their products would only create shortages. The demand for gasoline, diesel, jet fuel and other refined products at the artificially low price would be greater than the supply, a recipe for chaos. Lawrence Summers of Harvard, who served as Treasury secretary in the Clinton administration, told Bloomberg Television this month, “The ‘price gouging at the pump’ stuff, the more general price gouging stuff, is to economic science what President Trump’s remarks about disinfectant in your veins was to medical science.”
The Federal Trade Commission has been asked several times over the years to investigate allegations of profiteering in oil and gas, and has consistently found that price spikes are a result of naturally “inelastic” supply and demand: In the short term, it takes a big price increase to significantly discourage people and businesses from buying fossil fuels and petrochemicals. Supply is even harder to affect with price since refiners generally are already operating at or close to full capacity.
That’s not to say everything’s fine. It’s clearly not. Today’s high prices have many causes, including an unexpectedly rapid recovery in consumer demand, increased exports of refined products to Europe and the cutoff of supply of hydrocarbons from Russia, including vacuum gas oil, an important input for US refineries.
A more enduring cause of high prices is a reduction in US refining capacity. A major refinery in South Philadelphia experienced an explosion and fire in 2019 and has never reopened. Other refineries have shut down in California, Louisiana, New Mexico, North Dakota and Wyoming. Industrywide operating capacity is down 5 percent since the start of 2020. “No country has lost more capacity than ours, though global projects are planned that will make up for the losses within the decade,” Ericka Perryman, a spokeswoman for American Fuel & Petrochemical Manufacturers, wrote in an email.
While refiners have a short-term incentive to produce as much as they can, their long-term incentive is to be cautious about adding capacity. The world needs to move away from hydrocarbon fuels as quickly as possible to save the planet from climate change. Knowing that, refiners are reluctant to invest heavily in plants that could soon be rendered obsolete by regulation or renewable forms of energy. “How do you invest in long-lived assets if the administration is signaling that they want you out of business by 2030?” asked Dean Foreman, chief economist at the American Petroleum Institute.
Investors were alarmed by the big losses that refiners suffered in 2020, when the pandemic shutdown killed demand and the price of crude oil famously turned negative for a day. Wall Street would rather have refiners pay down debt, raise dividends and buy back shares than build more refining capacity. That was clear last month from the questions asked by securities analysts in the first-quarter earnings calls of two big refiners, Valero and Phillips 66. “Would you consider moving the leverage target lower?” — that is, paying off more debt — Phil Gresh, an analyst for JPMorgan Securities, asked on the Valero call on April 26.
What goes for refiners also goes for oil and gas producers. When asked for the primary reason that they were restraining production despite the high prices they could fetch, 59 percent of 132 oil and gas firms cited investor pressure to be prudent in how they manage their capital in a March survey by the Federal Reserve Bank of Dallas.
This is shaping up to be a decades-long balancing act — making sure there’s an adequate supply of fossil fuels while trying to wean the economy off them.
Senator Elizabeth Warren, Democrat of Massachusetts, and 11 other senators have proposed a windfall profits tax that would capture the portion of profits that exceed what refiners need to justify continued investment. But even Thomas Philippon, a New York University economist who is a foe of excessive corporate profits, warned in an email to me that such a tax could be set too high — and would need to take account of periods when companies are losing money, not just when they’re earning a lot. The American Petroleum Institute calculates that since 2015, average profit margins have been lower for refiners than for electric utilities.
Moralizing about “profiteering” and “gouging” isn’t the solution to high fuel prices. Refiners aren’t setting prices too high, because they aren’t setting prices at all. They receive the going rate for their products. At the moment that is extremely profitable.
The New York Times
