National Geographic Daily News
Refinery picture: Standard Oil refinery in California

The capacity of oil refineries, a crucial link between crude oil supply and final gasoline product at the pump, can have a significant effect on U.S. fuel prices. Shown here: a Standard Oil refinery in California.

Photograph by James L. Stanfield, National Geographic

Brad Scriber

National Geographic News

Published February 25, 2013

"We produce more oil at home than we have in 15 years," President Barack Obama observed in his much-watched, much-covered State of the Union message. So U.S. drivers might wonder why the price demanded at their neighborhood gas station has soared by about 45 cents in recent weeks.

The usual reaction to such a rapid increase has been an irritated glance in the direction of foreign oil producers. This time, however, analysis reveals that the primary pumper-uppers of pump prices reside much closer to home. They are the nation's oil refiners, the crucial middlemen who "crack" crude oil into gasoline, heating oil, and other derivative products. (See related quiz: What You Don't Know About Gas Prices.)

A new analysis released by the Energy Information Administration, the U.S. government's energy statistics and analysis agency, suggests that "about two-thirds of the rise in gasoline prices since the start of the year" can be traced to a rise in the "crack spread," a measure of refinery profit margins. In comparison, only about 15 cents of the rise is due to worldwide increases in crude oil prices. (See related: "Pictures—Oil States: Are They Stable? Why it Matters.")

A Double Boost

Larry Goldstein, trustee and director for special projects at the Energy Policy Research Foundation, explains that refiners have enjoyed two boosts to their profits in recent years, both driven by the use of hydraulic fracking. The first is the access they now have to cheap crude oil pumped from the Eagle Ford formation in Texas and the Bakken Shale oil deposits in North Dakota. (See related story: "The New Oil Landscape.")

A second windfall is the low cost of the natural gas that powers their refinery equipment. "No one could say that refineries are not doing well," Goldstein comments. "They are doing exceptionally well. They have access to the cheapest crude available, and they sell the product at world market prices." (See related story: "Crude Reality: Gas Prices Rocket Because They Can.")

True, the price of crude plus taxes explains most of the price at the pump. "It's basically simple for the most part," Goldstein explained, "but that doesn't mean the rest is trivial. It's not." And, he notes, the "last 20 percent is complicated."

How much are refiners prospering? Houston's Phillips 66, the largest U.S. independent refiner, reported earnings from refining up fivefold in the fourth quarter of 2012; for San Antonio, Texas-based Valero, net income was up an astounding 22-fold. Large diversified oil companies like Exxon and Chevron were able to report buoyant profits despite sagging returns on oil and natural gas production, thanks to the healthy income from U.S. refineries that analysts and investors long viewed as a drag on their operations.

But refiners note that profits vary significantly across the industry and from year to year. The maintenance outages that are currently reducing capacity, many of them planned years in advance, are necessary to keep plants operating safely, says Charles T. Drevna, president of the American Fuel and Petrochemicals Manufacturers, the industry's largest trade association. "Refiners have every incentive to get back to full production as quickly as possible," he said.

Location is another important factor in profits. Regional variations in refinery capacity and limitations on moving refined gasoline between regions exacerbate price differences across the country. Pipelines from the Gulf Coast to the East Coast are limited, and the only vessels permitted to move goods between U.S. ports are those built, owned, operated, and crewed by U.S. citizens and registered under the U.S. flag. That's what is currently depriving the East Coast of the full benefit of the cheap crude produced in the middle of the country and refined along the Gulf Coast. (See related story: "With Gas Prices High, U.S. Refinery Closures Hit Workers and Drivers.") Instead, East Coast consumers must pay the higher rates that prevail on the world market.

The EIA report also points to planned and unplanned maintenance at refineries as the source of a reduction in capacity of about 9 percent. Other factors include the changeover from winter grade products to summer grade products to meet U.S. emissions requirements, and very low profit margins for refiners prior to the current run-up.

"We have had a lot of bad luck on the refining front across the country," says Phil Flynn, senior market analyst for the PRICE Futures Group. Flynn points to additional factors, including the lasting impact of Hurricane Sandy and a shift by European refineries to producing more heating oil because of an extremely cold winter. That in turn has driven up prices differentially along the East Coast given the region's reliance on imports from Europe for supply.

But not everyone is satisfied with these explanations. Marc Cooper, director of research for the Consumer Federation of America, blames bad management and financial speculation. "The market," says Cooper, "is insufficiently competitive to make people behave better and plan better."

A Gasoline Stockpile?

One way to prepare for such circumstances would be to maintain a reserve of processed gasoline. The Strategic Petroleum Reserve currently holds crude oil to protect from a disruption in supply of raw materials, but it does not store refined products to deal with a tightening of refinery capacity.  Since the Reserve's creation in 1975, the U.S. Department of Energy has repeatedly studied the idea of creating a reserve of refined products, but dismissed the idea in 1977, 1982, 1989, and again in 1998.

In 2000, however, Congress created the Northeast Home Heating Oil Reserve, which now holds about two million barrels of heating oil to protect from a severe supply interruption to the region. The stockpile was tapped for the first time after Hurricane Sandy caused extensive infrastructure damage in the Northeast. Several bills that would create a national gasoline reserve have been introduced in Congress; Massachusetts Representative Ed Markey and Illinois Senator Richard Durbin, both Democrats, proposed such legislation in previous sessions. At present, there are no such bills before Congress.

Stockpiling gasoline in a reserve has been dismissed mainly because of the traditional surplus of supply available in Europe and the higher cost of storing and maintaining a reserve of gasoline compared to the cost of storing crude oil. Cooper says, "If you go back to Katrina, the Europeans were going to respond by sending some product our way. Why? They have the product reserve."

Cooper thinks the broad economic costs of refinery disruptions support giving gasoline stockpiles a try. When these disruptions occur, "we don't get cost benefit analysis. We get these remarkable stories of bad luck," Cooper says. "In this interconnected world, we need to plan for bad luck."

Private companies are unlikely to build such reserves, Goldstein points out.  Stockpiling gasoline doesn't make economic sense for private firms because prices don't predictably go up in a way that would make a return on investment likely. Indeed, analysts at the EIA and elsewhere don't believe the current pressure on U.S. gasoline prices will last long. (And it's always worth recalling that, even after the recent run-up, gas prices in the U.S. remain low compared with those in European Union countries, where prices now average 1.55 euros per liter, or $7.72 per gallon.)

Flynn, for one, sees a radically different outlook for gasoline buyers down the road. "From a long-term perspective, I am freaking totally excited. I think we're at the end of an era of high gasoline prices," he says. With the U.S. on track to become one of the biggest producers of oil, and downward pressure on diesel prices as buses, taxis, and lighter duty truck fleets switch over to natural gas, Flynn foresees more refinery capacity available to process gasoline. (Related: "Natural Gas Nation: EIA Sees U.S. Future Shaped by Fracking") "That's going to take the heat off some of our refiners," he notes. And cool down tempers at the pump as well.

This story is part of a special series that explores energy issues. For more, visit The Great Energy Challenge.

28 comments
Jerry Howe
Jerry Howe

Another example why  of why the "free market" does not always benefit the consumer. We have been led to believe for far too long that the "private sector" and  "free enterprise" will drive down prices. Time and time again it has  proven that all this does is  screw the middle class consumer.

More government regulation is required through ALL sectors of the business economy.  Let us not be fooled by those of the likes of the Koch brothers.

michael arpino
michael arpino

You forgot to note that several refineries have shut down in the east due to lack of profitability recently. So, if a few other surviving refiners actually do make some money in a few quarters and return it as investments in their refineries for more efficient and cleaner operations give them a break! And, you didn't mention that oil is priced on the US dollar and as the dollar devalues due to the Fed QE programs the relative price of oil products will cost more in dollars (like gold fluctuates).

Thomas Mccluskey
Thomas Mccluskey

I'm not sure if everyone else is seeing the same stuff, but I'm intrigued by the fact that a story about the price of gasoline is on a page that proudly displays at the top, "National Geographic Daily News, sponsored by Shell." This could certainly be just a coincidence and perhaps Shell has been sponsoring NatGeo's daily news for years. It's just one of those things that typically gets a disclaimer at the bottom, saying, "Seriously, Shell and the money they provide us had nothing to do with this article."

Fred Flintsone
Fred Flintsone

If any of this article were true gas would not have hit $4 gallon with supplies high and demand low.The US still consumes 25% of world oil and we are now almost energy self sufficient(85%). No matter how many supplies they discover or produce they can never keep up with the demand for paper traded energy shares

John C.
John C.

Here's a solution for liberals wailing over obscene profits made by oil companies: buy their publically traded stock and share the profit.

And you can assuage your conscience knowing that making a bundle off fossil fuels has the Al-Jazeera Gore seal of approval.

Brian B.
Brian B.

Why is this article on National Geographic? Seems it would be more at home on one of the various news or political sites. 

Mel in MT Frosty
Mel in MT Frosty

PEAK OIL = NOT!

I disagree. There are over 20 different "shale oil fields" known and defined within the USA right now, all over our states! In just one field, where "proof of engineering design" was undertaken 5 yr ago, we now have 500k BOPD of NEW PRODUCTION with draw-down cruves that are NOT BELL SHAPED - nor, are they mathimatically projected to become bell shaped anytime soon! And, this field does NOT have the infrastructure/pipeline tie-in to truely produce to capacity yet.. Over HALF of these 20+ fields are more than DOUBLE the size of this one now producing at constrained rates. Do the math, we'll hit 10MBOPD constant flowrate/delivered as lifted, long before we run out of acres to drill on. AND, our nation's debt could be greatly reduced over time by intellegent lease wording/doc requirements! NOT TO MENTION our vast COAL reserves waiting to be gasified and/or reformed into liquids like Germany did WW-II.

George Russert
George Russert

This article can be condensed to one word...GREED.

That's why prices are high. We, the consumer, are being gouged. Period, end of story.

Bobby Rutherford
Bobby Rutherford

Gasoline stockpile??? -- The reason no one stockpiles gasoline is it will degrade over time and become varnish.

paul mcnamara
paul mcnamara

How about building new refineries with the enormous subsidies we give to these "GREEDY BASTARDS' every year. The only reason for gas fracking is to ruin our water tables. The gas comes from the oil that is underneath!!! Too many people went to colleges where "common sense" is a mixed drink!! If someone were to prosecute someone!!! What happened to anti-trust laws???

Joel Hunnicutt
Joel Hunnicutt

heeeeheeeeheeeeeheeeeee..."Explaining" high gas prices! GOOD one Nat Geo!  Oh, also kudos, and thanks for the laughs, to all those who "explain" why the price is caused by geology, why the price is determined by reserves vs flow rate, etc (in other words, apologists and shills).  

Now if someone can just explain the 2200% increase in profits...


Joel Hunnicutt
Joel Hunnicutt

heeeeheeeeheeeeeheeeeee..."Explaining" high gas prices! GOOD one Nat Geo!  Oh, also kudos, and thanks for the laughs, to all those who "explain" why the price is caused by geology, why the price is determined by reserves vs flow rate, etc (in other words, apologists and shills).  

Now if someone can just explain the 2200% increase in profits...


Bruce Carter
Bruce Carter

One thing that would help - get the Idiot In Chief to lift the ban on drilling in the Gulf.  Talk about overreaction to a set of bad circumstances!  Now the American public is paying the price, at the gas pump.  I also suspect paying for BP's fines at the gas pump.  What - you think BP is going to pay the fine?  Nope, they are going to pass it right along to consumers.

Bruce Williams
Bruce Williams

huge profits make people insane.  we should be saving the stuff for limited strategic uses, not burning it up like there's no tomorrow.   try flying a jet or making plastic without fossil petroleum.

Jim Melvin
Jim Melvin

Telling us how bad Europe and the UK have it ($7.20) is just a tactic to deflect our attention, what they don't tell us is that almost half of that $7.20 is taxes on the fuel, and from what I have seen in The UK that tax sure does not go into the roads. If oil was back up to around $150 a barrel instead of approx $93 a barrel, would we be paying 7 or 8 dollars a gallon? Lets get real. I am not much for nationalization of a business but maybe we should nationalize the refineries. looks like even our government is more efficient than these people (refineries).

Fred Flintsone
Fred Flintsone

Unfortunately all the supplies in the world cannot keep up with the demand from shares of paper traded energy ETFs. With the economies of Europe, Japan and US contracting in the 4th quarter,  industry citing lower demand and margins shutting down refineries in this country   gas hits $4 a gallon. Price of gas has very little to do with fundamentals these days.

Alec Sevins
Alec Sevins

Mr. Flynn is typical of Peak Oil deniers who won't do the math. The idea that there's some vast quantity of "new oil" that will "bring down prices" totally ignores the history of oil exploration and the peaking phenomenon of all known oil wells (abiotic oil has never been proved and fits no models). It's almost criminal that the public has been given such vague information. You have to account for total U.S. consumption vs. production, not just short term gains like Bakken drilling. People say they trust the market to set prices, but when it does they just jive their way out of admitting it!

In short, if all the world's oil was in a big lake, like the Tahoe basin, you could sink a bunch of pipes into it and the flow-rate would be nearly constant (hence constant prices) until the oil was nearly all gone. But in the real world of porous rocks that contain most oil, it depletes in a bell-curve where flow-rates decline inexorably once roughly half the resource is gone. The U.S. experienced a flow-rate apex way back around 1970. Alaska, our last great hope of free-flowing (aka cheap) conventional oil, peaked around 1989, and no amount of drilling technology will reverse the basic geology.

Beware of non-geologists who spread false hype about what's really going on with that finite resource. They are pushing the old lie of getting something from nothing just to appear "optimistic" or boost share prices.

Alec Sevins
Alec Sevins

This sort of short-term analysis keeps people deluded about the root cause of "high gas prices." It's geology, folks.

Millions of Americans fail to understand the critical difference between abstract oil reserves and practical flow-rates. They ignore what the term "peak oil" actually means in terms of free-flowing cheap oil, vs. "tight oil" with declining EROEI. Kerogen shale is especially weak in terms of EROEI, yet it's been called a new Saudi Arabia by people with no clue about geology.

U.S. sources of tight oil (e.g. "wet" shale like the Bakken) are a boom-town drop in the bucket in terms of total supply vs. demand. There's a lot of blind optimism with poor understanding of geology. American will likely never see flow-rates close to the 1970 historical peak of 10 mbpd, and world crude oil production peaked in 2006 per the IEA. 

People need to admit that oil is a finite resource that depletes in a bell curve, not a linear manner. Just because they lived through abundant times doesn't make cheap oil a birthright.

Wayne Patterson
Wayne Patterson

I think the oil companies are trying to get a jump on this years profits example: Exxon last years profits 45 BILLON they must be shooting for 90 BILLON this year.

Jerry Howe
Jerry Howe

@Thomas Mccluskey Your assumption of the obvious relationship between Shell and National Geographic  is entirely correct. Don't be fooled by advertising. In California we are barraged by ads from Chevron that  imply how environmentally conscious they are and how much they are oriented toward the young and progressive minded. This is all a ploy to make it easier for them to continue to exploit the consumer

Jan West
Jan West

@Bobby Rutherford Large stockpiles of perishable fluids don't work like that. Don't think of large holding tanks storing gas for months/years until it is needed... rather think in terms of building a small lake on a river. The gasoline would be constantly replenished on a first in, first out basis. Not cheap, but It can be done.

Eric Paul
Eric Paul

@Joel Hunnicutt - Exactly Joel.  As I stated below, this has nothing to do with cost and everything to do with demand and the LACK OF ALTERNATIVES for consumers.  They have us by the lemons and they're not afraid to squeeze!

Michael Miller
Michael Miller

@Bruce Carter The proven US Gulf oil reserves amount to a few months of the US's full demands. Meanwhile, proven US oil reserves in oil shale deposits are a century or more of current US needs. Oil shale doesn't spill, unlike Gulf wells. Oil pipelines can be shut down with the flip of a switch, and spills on land don't spread nearly as far as Gulf spills. So why bother with such a buggy, limited resource as Gulf oil when there are better alternatives within the US?

Eric Paul
Eric Paul

Irony at it's best...speaking about an "overreaction"!!!  Drilling in the Gulf will do nothing about supply and demand...which is what this is ALL about people.  Until we can develop alternative fuels to run cars off of, this situation will NEVER go away.  Now that oil companies have realized their ability to make record profits AGAIN with collusion within the industry (like cell phone service industry, cable industry, diamond industry, etc...) you will always see record profits no matter the supply.  Get real people and start supporting alternatives wherever/whenever possible!

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