One thing that has confused me in reports of the rise in the price of oil - a lack of refining capacity is repeatedly mentioned as one of the factors driving up the price of oil. This doesn’t make sense to me. I would have thought that a lack of refining capacity would drive the price of oil down, not up.
My thinking is that once you buy oil, you -generally speaking - have to refine it in order to resell it at a profit. If you can’t refine it, you are stuck with the oil (yes, I know there are some uses for unrefined oil, but largely speaking, refined products are what the market wants). So, if refinery capacity is limited, I would expect the price of refined products to go up, but the cost of the crude oil to go down. But the talking heads say the lack of refining capacity is causing the price of both oil and refined products to go up.
Think of it in supply and demand terms. If the total of refineries can process X amount of oil into gasoline then you’re fine as long as demand is at X.
But if demand goes to X+20% then gasoline prices go up. And when price at the pump goes up oil becomes a more attractive buy on the market because there’s a higher potential return. Therefore the price of oil goes up.
Media types and readers of their news reports have the same level of blindness.
Crude oil prices and gasoline prices are not recognized as different things.
But that wasn’t the question. The question was why lack of refinery capacity causes the price of **crude **to go up, not the price of refined product. I think it’s a good question.
Actually, JM, JC’s answer makes sense to me. Lack of refining capacity makes the price of gasoline go up. If you want to take advantage of the higher price of gasoline, you have to have crude oil to make into gasoline. So there’s more demand for crude, and the price goes up.
But if we are refinery capacity constrained, there is no advantage to having more crude, at least not short term. I was thinking of it this way: If demand rises faster than refining capacity, or if capacity decreases (due to storms or refinery outages), then suddenly there is a glut of oil (raw material). Gluts usually mean decreasing prices. Perhaps the storability of oil makes it somewhat immune to this process, and the market sees the future value of that oil as being greater.
Your natural instincts are correct John. Part of the reason price is going up is because the market (well, the players) are predicting that the demand will increase. They are correct, imo. As more and more third world countries join the first world, demand will naturally increase. If your a futures player, oil is a good bet according to this logic. However, as others have posted (like yourself, I believe), there is money to be made in increasing refineries and capacity, so, by this logic, oil futures is not so good a bet. Personally, I’m betting on increasing demand. I like free trade and I like to see countries develop, though not overtly for altruistic reasons (I like cheap stuff). As long as refinement and production increase their efficiencies (or I get paid more, I prefer the latter), oil prices do not concern me too much.
However, if the refinery refuses to purchase to crude oil at present prices, the producer will just sell it to someone else. When the refinery wants the oil once again, the pipeline is gone, the crude producer says, why should I disrupt my present setup? The refinery must induce the crude producer by offering increased prices. So it may be to the advantage to stockpile, then to lose touch with your supplier.
When you see an oil story, it often reports prices or gas and or crude with refinery issues. When crude goes up and the story also reports refinery problems, our minds play tricks on us, thinking the two things are connected by cause and effect.
But much of the time the story doesn’t actually claim refinery problems CAUSED the crude price increase–the elements are only connected by topic.
Theoritically at least, lesser refinery capacity will increase the cost of gasoline and decrease the cost of crude.
So, let’s take the recent news item: Katrina. Why has this driven up the price of crude (I keep wanting to write “crud” )? Was the disruption to offshore drilling significant?
Exactly correct. A lot of the high price of oil right now is due to speculation. You’ll frequently see reports that oil companies are making record profits right now. That’s because they’re selling oil reserves that they bought at $30-40 for the current market price of $60-70 and making an absolute killing.
People are trying to do the same thing now. Since oil production is pretty much running at capacity for current producers, with no major capacity increases set to go online in the near future, there probably won’t be a large increase in oil supply. Meanwhile, demand is only increasing. So you have the expectation of higher prices, which further drives up current demand and current prices as oil companies, refineries, general speculators, etc., plan to store the oil they buy now and sell it at a profit later when prices are even higher.
Another misleading factoid about refineries in the US that “certain people” constantly bring up is that the number of refineries has decreased. The number of refineries does not matter. It’s the total thruput of the refineries that matters. So watch out when someone suggests giving away closed US bases to oil companies to build refineries.
I’m going to throw my vote in with the, are-you-sure-about-this? camp. However, it may well be that your perceptions are correct based on this blog, it would appear that you are correct about the assertions.
I think you can dismiss the assertions out of hand as DIY economics rather than an understanding of what’s going on. I think the news folk are just confused.
If refinery capacity is near capacity, that can cause prices of gasoline to go up, as noted above. Because producing at that level means that refineries can’t do preventative maintenance and stuff like that, it drives the prices up. (Also, if people are demanding more gasoline than refineries can produce at a given price, then the price will rise until the quantity demanded matches the quantity being supplied.)
As long as we are on the topic of refinery capacity and supply and demand, and prices, etc. etc.
One thing that has always confused me is the notion that the demand for refined products would fluctuate enough to influence prices in the short term.
I can understand a long term generally constant increase in demand, but our lives and economy seem so tied to these products that short of drastically changing our life-style, or a significant change in the economy overall, the short term demand should be relatively constant.
I think I understand what you are saying, that you don’t understand the reason for short term price fluctuations, right? Well, every industry is cyclical. I haven’t seen one yet, and the gasoline/oil industry is no exception. Weather, the economy as well as vacation time, to name some reasons, have a huge role to play in the short term. Prices will always rise during winter, when it’s blustery cold outside. Likewise, prices will fall when the weather is temperate, and people aren’t going anywhere (no major holiday, kids are in school), etc.
I’m thinking there might be some confusion in the news reports about this. In addition to refineries shut down and possibly damaged the oil platforms in the gulf are also questionable and that latter affects the supply of crude oil. And so with a questionable future supply of crude the futures on crude oil rise. And they won’t go down until the status of the gulf drilling rigs is settled, if ever.
So the possibility of short term shortages of crude from reduced drilling capacity in the gulf raises the price of crude futures and the shortage of refineries raises the price of gasoline directly. Gasoline also goes up because of the price of crude because when a retailer sells a gallon of gasoline he might have to replace it at a higher cost because of all the storm disrubption.
I’ve also heard the claim repeated many times on the radio (I don’t watch TV news) that “lack of adequate refining capacity” is driving up the price of crude oil. I’ve heard it said too many times to believe that it’s due just to misunderstanding, or simply conflating crude oil with refined petroleum products like gasoline. I’ve even heard this assertion credited to Saudi Arabian officials.
I’m still not following how an increased price of gasoline will drive up crude when refineries are operating at peak. I would think that would create a shortage and motivation to build more refineries.
Now, I fully understand that other market forces (war, supply uncertainty, weather, etc.) will drive up crude prices, but that’s not the assertion being made. And I’m not comfortable accepting that it’s “media confusion” because some of the people I’ve heard make these assertions are purportedly “experts in the industry”.
A lack of refining capacity makes the ‘crack spread’ increase. Much of the price increase of gasoline is that crack spreads are at record highs. The Saudis could pump all the oil they want and drive down the price of crude but unless the refiners add capacity, it isn’t turning into gasoline anytime soon. If you want to get even deeper into it, the spread on heavy vs. light crude is also quite high because most of the incremental increase in supply is heavy high-sulpher crude of which the capacity to refine is even more limited.
The price increase of crude vis a vis the hurricane is due to the potential damage to the gulf drilling rigs. We are using just as much oil (if not more oil) every day but are pulling less out of the ground. At least for the next few weeks.
Admittedly some of the increase is also due to speculation by hedge funds in response to the panic, but that isn’t a huge impact on the price, It just exacerbates a bad situation.
As to why no one is building a ton of refinery capacity, its a huge capital investment for an uncertain future. Oil companies already got burned by building too much capacity. They won’t make the same mistake again. I believe there is also a go-slow approach because they don’t know if the government will come in and impose price controls, limiting their potential gains. Finally, its hard as hell to build one. You don’t want one in your back yard and no one else does either. Permits, environmental studies, lawsuits from concerned citizens. F*** it. They are just adding capacity at existing refineries in response to supply/demand considerations.
I’ve heard news reports off and on over the last two days that crude prices are increasing on concerns that gulf production will be impacted by Katrina. Interviews with the gulf production people are saying they won’t know until they can get helicopters out there to inspect – naturally, all their facilities have been evacuated. A characteristic of markets is to react to rumors and speculation and then settle down once the real facts are known.
)? Was the disruption to offshore drilling significant?