While oil prices boom, refinery profits contract
Although some of our political leaders assert that in response to high gas prices, we should build more refineries, according to this article, some American refineries have chosen to cut their production over the last year in response to sharply decreased revenues. Contributing to this decrease in profit is the dramatic increase in the price refiners must pay for the oil they purchase that is then refined, coupled with a shrinking domestic demand for gasoline. (Domestic oil consumption has dropped by over 3% in the past year.) As a result, while the price of raw oil has gone up 100%, the cost of refined gasoline has increased only 39%. Consequently, refiners have decreased their production capacities by about 5-10%.
It seems to us that if the high cost of gas was due to insufficient refinery capacity, then the existing refineries would be operating at full strength right now. (Indicating a demand greater than existing supply.) However, this is not the case. If anything, instead of insufficient refinery capacity, there is probably insufficient competition amongst refiners. Maybe industry consolidation has created a situation where refiners can voluntarily decrease their production levels, instead of ramping up to meet existing demand? Collusion is not always announced (a la OPEC) and can instead result from a marketplace controlled by only a handful of companies that can implicitly behave anticompetitively.
Finally, if there isn’t sufficient domestic demand for gasoline to take up all of the existing refiners’ capacity, then how come every time there is a storm or fire at a major refinery, the price of gasoline spikes dramatically. With the standard caveat that we do not have an economic or energy policy background, this does not seem to jive. It seems to us that refiners, along with most other parties along the global oil supply chain, have too little competition, and therefore too little incentive to produce their product at full capacity.
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