Thursday, April 27, 2006

Economics 201

Well, as everybody's probably noticed by now, gas prices are through the roof again and the oil companies are posting record profits again. There oughta be a law, right? Don't the people that run those companies realize how badly they are hurting the American public? It makes you want to buy your gas in Canada, doesn't it? Well wait a minute... Canada's price per gallon is higher than ours. What about Europe? Yep, while we were paying $2.88 a gallon the week of 4/10/06, the UK was paying $6.13 a gallon.

What's going on here?

I don't want to get into a number crunching argument for several reasons. First, it is meaningless to discuss the percentage cost of taxes, the price of crude, transportation costs, and profits because the percentages are constantly changing. Second, each of these costs depend upon where you live. For example, the Federal tax on gasoline is 18.4 cents per gallon. The State of Indiana adds another 18 cents per gallon plus 6% sales tax while the State of Alaska adds only 8 cents per gallon with no sales tax and Wisconsin adds 31.1 cents per gallon. The transportation costs are different by region as well. Suffice it to say that for every expert who can form an opinion, there is another expert who can prove him wrong.

Between 1981 and 1989, the number of U.S. refineries fell from 324 to 204, representing a loss of 3 million bbl/d in operable capacity (from 18.6 million bbl/d to 15.7 million bbl/d), while refining capacity utilization increased from 69 percent to 87 percent. Most of the refineries that shut down weren't profitable to begin with and the increase in refining capacity utilization represents the "loss" of unproductive or underproductive refineries. Refinery closures have continued since 1989, bringing the total number of operable U.S. refineries to 148 as of January 1, 2005.

While no new refineries have been built in 30 years, existing refineries have expanded their capacities. As a result, capacity per operating refinery increased by 28 percent over the 1990 to 1998 period. Overall, since the mid-1990s, U.S. refinery capacity has increased from 15.0 million bbl/d in 1994 to 17.1 million bbl/d in September 2004. Note that we have still not achieved the capacity that we had 25 years ago. As of November 4, 2005, utilization of operating capacity at U.S. refineries was averaging around 84 percent, down from 91 percent prior to Hurricanes Katrina and Rita.

So, key element #1 -- limited refining capability equals limited supply.

Beginning on May 6th of this year, liability protection for suppliers of gasoline containing oxygenates such as the petroleum-based MTBE will be removed due to an act of Congress. For years MTBE was added to gasoline to reduce air pollution, but it wound up polluting groundwater, which led to lawsuits and state restrictions. When Congress refused to shield the oil industry from MTBE lawsuits, the oil industry en masse decided to switch to ethanol, whether the ethanol was available or not. The result of this is that refiners will no longer make MTBE oxygenated fuels. Congress knew this would happen and in fact were counting on it.

So, key element #2 -- retooling refineries to add ethanol costs money.

When oxygenates began to be added to gasoline, refiners had two primary choices: petroleum-based MTBE and biomass-based ethanol. MTBE became the primary choice in spite of the fact that ethanol contains twice as much oxygen per gallon. The reason: transportation. MTBE is more easily transported via pipelines. Ethanol absorbs moisture. That’s a benefit when ethanol is present in your car’s fuel system, but it causes problems during pipeline transport. Pipelines contain moisture and deposits that are absorbed by ethanol, thus changing its state during transport. To this point, the volume of ethanol has not been large enough to justify change in the pipeline infrastructure that would eliminate those deposits. However, as MTBE is phased out and more ethanol is used, such improvements will become necessary.

So, key element #3 -- infrastructure upgrades cost money.

Ethanol has been touted as a solution to America's energy problems, but this summer, it could be a source of trouble. The reason: There may not be enough to go around. Federal officials warned again of tight ethanol supplies and possible spot shortages this summer, particularly on the East Coast and in Texas.

If this occurs, it could mean price spikes at the gas pump, and challenges that the corn-based ethanol industry has never faced before. A price shock would put Minnesota in an odd spot. It's a leading ethanol producer. But state law also requires that all gasoline sold there contain at least 10 percent ethanol. If the price of ethanol skyrockets, Minnesota motorists will be hit harder than anywhere else.

Already, refiners in some regions have begun paying premium prices for ethanol, and that's pulling supply out of the Midwest, and into areas like Texas.

The oil industry used 155,000 barrels of MTBE each day, but only 25,000 barrels a day of replacement ethanol is coming online in the first half of the year. That has unleashed a scramble. As a result, gasoline suppliers today are repositioning ethanol from areas like the Midwest to the East Coast and Texas.

So, key element #4 -- ethenol shortages raise the price of ethanol.

This week, ExxonMobil’s earnings are in the news. But is there more to the story than the headlines? Their earnings are indeed at a record high, driven largely by the price of the commodities they sell. But if you compare profits per dollar of revenue across a wide range of U.S. companies — a true "apples to apples" evaluation — you see that oil earnings are not out of step with other major industries. The oil and gas industry earnings averaged 7.7 cents per dollar of revenue during the second quarter compared with the overall U.S. industry average of 7.9 cents. ExxonMobil earned 8.6 cents for every dollar of revenue. ExxonMobil owns $106 billion in property, plant and equipment alone. With that sort of investment, you'd expect a return.

So, key element #5 -- 8.6 cents per dollar in profit... excessive?

What is all the hubbub about?


Anonymous GM Roper said...

Bryan, excellent post and a great analysis. I'm adding you to my blogroll. Found you via Dr. Sanity and as one of her "PsychBloggers" I hereby pronounce you SANE! (As if you need me to tell you that, LOL)

9:59 PM  

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