Gasoline prices and the "tight oligopolies" of refining operations

[swag]

James Surowiecki in the June 12, 2006 New Yorker

. . .

Unfortunately, the lack of capacity that Washington sees as a crisis looks like an ideal business model to oil refiners. There are so few refineries in the U.S. now that they are run tight to the bone, typically using about ninety per cent of their total capacity. The result is that refining—which, until recently, was a tough, low-margin business—has become tremendously lucrative. Last year, refiners’ profits jumped thirty-nine per cent, to twenty-four billion dollars, and this year should be even better. In California, gasoline prices have risen forty-eight per cent since the end of last year, even though crude-oil prices are up just seventeen per cent. Most of that difference has gone straight into refiners’ pockets.

In a normal marketplace, of course, high prices and profits would drive companies to expand, in an attempt to capture more of the market, or else new players would emerge, hoping to outmaneuver a risk-averse establishment. But the refining industry isn’t a normal marketplace. For one thing, refineries are huge investments—a new one costs at least two billion dollars—and they take a long time to open. This means that although refiners might make more money by opening new facilities and thus serving more customers, they’d rather take the sure money than gamble. It also means it’s hard for new competitors to raise enough capital to enter the market at all.

What’s more, over the past fifteen years refiners have been buying each other up, creating an industry that’s highly consolidated. In 1993, the five biggest refiners in the U.S. controlled thirty-five per cent of the market. By 2004, they controlled fifty-six per cent. And refining is primarily a regional business. The government allows different states to use different formulations of gasoline—some formulations burn cleaner than others—and in some urban areas a federal requirement determines what formula can be used, depending on the quality of their air. That makes it hard to ship gas across state lines, and shrinks the number of refiners that provide a particular blend of gas, giving each refiner more power. As a result, in many areas the refinery business is more like an oligopoly than like a competitive market. In 2002, a Senate report identified “tight oligopolies” operating in twenty-eight states; in California in 2003, ninety-five per cent of the refining market was in the hands of just seven companies.

Markets with few players selling a product as necessary as gasoline have unusual dynamics. In most businesses, there is no upside to having a plant or a store shut down: you lose sales, your stock goes bad, and your customers leave. In refining, though, you can sometimes make more money by selling less gas, or vice versa. Far from needing to add capacity, refiners can flourish even when they subtract it. When Hurricanes Katrina and Rita hit the Gulf Coast, for instance, Marathon Oil had to shut down two of its refineries, including Garyville. But the price spike that followed was so big that Marathon made twice as much from its refining operations in the third quarter of 2005 as it had a year earlier. There has never been evidence of refineries’ deliberately taking themselves offline, but it’s not unthinkable. During the California electricity crisis of 2001, after all, energy producers like Williams Energy found that it made economic sense to withhold power from the California market—to turn down sales—because doing so sent prices way up.

Some have suggested that the lack of new refineries points to collusion on the part of refiners—an agreement to reduce capacity and divvy up the market, much as opec does for crude oil. But in refining today there’s no need for a cartel; the investment decisions that the companies make have such a direct impact on prices that it’s rational for each of them individually to limit capacity. And if Washington wants a scapegoat it might take a look at itself. By not vetting mergers more carefully, government regulators allowed many refiners to achieve “market power” (the ability to influence the market price of what they sell), and other regulators enhanced that power by mandating gasoline standards without considering competition. High gas prices usually provoke one of two explanations: either they’re evidence of a conspiracy or they’re just the result of the free market at work. The good news is that there’s no conspiracy. The bad news is that there’s also no free market.

[freexone]

1. cynical me...maybe

I'm not too much a conspiracy theorist BUT I really do believe that there is more to this oil.high gas price than meets the eye.
In my opinion, the big oil companies are squeezing us for evey penny that they can since we are literally dependant upon gas because
they know that the E85 revolution and hybrid situation is slowly but surely taking away their customers. I'm not dumb enough to think that gas will ever go away but I sincerely believe that big oil knows what is coming down the pike and THAT is why we are paying so much at the pump. Refinery issues and Katrina has zero to do with it. We're still pumping the same amount if not more now as we were several years ago. Big Oil wants to stay rich...Bush wants his fair share too since he has given big oil all the breaks and no investigations into gauging.

[mrcheerful]

2. I been saying this every since Reagan deregulated oil refineries in the

1980's and saw that independent refineries were being bought out and closed. But NOOOOOOOOOOOOO, I was just being paranoid and oil companies were to be trusted. Yeah same old repuke plan put wolves in charge of protecting the sheep. 1928 all over only this time around there won't be an american industrial base to pull us out of the puke mess, can you spare a dime buddy?