Gas prices, hurricanes, refineries and the commodities market

President Bush has asked all Americans to try and conserve fuel. While that may sound innocuous or even like a good idea, take a moment and think about it. How bad does it have to really be before a Texas oil man starts pushing for conservation? Just a thought…

Now then:
People complain that gas is too expensive, and while I agree it is, (discounting the effects of the hurricanes on stocks, I think the national average should be around $2.209 for a gallon of regular) oil and gasoline are commodities after all and therefore are subject to volatility and speculation. Yes, the oil companies are making a killing with $3 gas, but they also know that for every day prices are high enough to make the news is one day closer to congressional or state investigation (think about what Spitzer from NY would do), and the ensuing media scandal. They wish to drive down prices too, because they can still make money with gas at $2.30 or so and right now they would get a medal for doing it. However, as I said oil and gasoline are commodities, and the lead time between purchase and delivery is months. So, if they think prices is going to rise sharply, they buy all they can to ensure they get stocks as cheap as possible, so that drives up prices, so others get skittish and buy too, so prices go up more, etc. Then, prices get too high and everyone worries, "if I buy at this price will I get left holding the bag when prices go down"? So they stop buying till the prices go down, but that leaves them open to a demand they can’t meet, which causes them to buy stocks at current market value which means they get taken to the cleaners, or if they have bought too much at the peak and market value drops by the time they take delivery and they can’t make they margins, they are just as screwed.

Why are the prices so volatile?
Their is plenty of oil in the ground, despite what the environmentalists say (yes, we will run out sooner if we don’t conserve, but there is enough to meet today’s needs no problem, and that is my point.) The two bottlenecks are tankers, and refineries, (and to some extent pumping). Why? Because those things cost a fortune and have multi-year lead times. Say Exxon commits to building a new refinery today, it will cost >$5 billion dollars, and not be finished for a decade (a super tanker costs like $100 million and won’t be finished for 5 years, oh and material (metal) prices are really high so that just piles on). The oil companies know these high prices won’t last, so in 10 years what if gas is selling for $1.759 (I wish!), and they can’t pay for the capital cost? You say “that won’t happen, gas will never be so cheap again”, well that is what they said in the late 1970’s and then oil prices collapsed, and the whole industry nearly died! I am sure you are about to weep at the plight of the oil companies, but they are necessary and take incredible risks, so that American’s can even now pay half of what the rest of the world pays for a gallon of gas, when and where ever we want it.

Ok enough history, prices are so volatile since we have exactly enough or a little less than the necessary refining capacity if every plant runs at top output, and like most companies with "just in time delivery" (thanks FedEx, for the ever so safe business model) the oil companies keep just enough oil and gas in inventory to meet expectations. (Excess inventory in times like these is liability.) However, if demand exceeds expectations even regionally a shortage occurs, and heaven forbid say 30% of the nation's refining capacity was idle, (like it is now) then major shortage will occur. Look the US hasn’t built a new refinery since 1976, (a lot of nuclear reactors are newer than that, and that is saying something) advances in processing have allowed plants at >100% of designed capacity to meet demand, but they can’t even shut down for preventative maintenance without a hiccup in prices.

Ok I agree that it is a sad state of affairs when I am happy to see gas for $2.509, but if things are going to improve there are only two options: use less (and that is not really an option since the amount of conservation required to make a difference would have to be 10% or more, starting ASAP, and getting higher every year) or build new refineries. Right now the only refinery in the serious planning stage, is going to be owned by a foreign power, think middle eastern, and China wants to buy the 6th largest oil company in the world, and make it state run. Real oil independence (and national security) is American owned and operated oil companies and refineries. We can buy the oil from Russia if the Middle East gets too unpleasant, but if we can’t refine it we are just as screwed as not having it at all. This is not the politically correct thing to say but if you want to see cheap gas again, write your congressman and demand that they investigate the lack of refining capacity, and hope the mandate (read political pressure) will get ground broken on a couple new refineries, since only through excess capacity (or at least the perception of excess capacity) will the market be stabilized. (Or at least that is how commodity prices have been stabilized in the past.)

I recommend refineries be built in or near St. Louis, MO, Winston-Salem, NC, and Bakersfield, CA. Why? Because those areas are located near major areas of consumption, close to water deep enough for at least Panamax tankers to charge the delivery pipelines, (but far enough inland that “ocean spawned storms” are tempered), and have excellent transportation infrastructure in general. These areas also need the jobs, and are distributed enough that they will be served by different ships and pipelines, so they are not inter-dependent. Now I did pick these locations without at lot of thinking especially Bakersfield, CA (which thinking about it might be the earthquake capital of the world), so additional/alternate locations for refineries are NV/UT, The Rustbelts in PA & WV, and CO, which I picked for all the same reasons (the water access isn't great for those states but a nice pipeline can make anywhere "close" to the water.) (These areas might be better because the unemployed mine and steel workers of these regions should take well to the refinery jobs.)