04 April 2012

Avgas Prices

The price of automotive gasoline jumped about four cents a litre last night across most of the country and, of course avgas prices will soon rise along with that.

As the price of one fuel goes up the other follows, because they all come from the same feedstock and the same factors, like refining and transportation affect the prices of both. Avgas remains higher in price, mostly because it is more expensive to make with the special handling required due to its tetraethyl lead content.

Today, 4 April 2012, in Ottawa auto fuel is at $1.324 per litre. The Smith's Falls Flying Club is good enough to post their avgas price on their website and keep it up to date and they are selling 100LL for $1.816.

Of course the comments on CBC articles about this story are full of the usual whining and conspiracy theories about why gas prices are so high.

One CBC commenter said "Crude shortage not the problem. No... the problem is greed."

Others take the "government should do something about this" approach. Another CBC commenter said "People are hurting. Yet what does the government do to relieve the pressure on strapped Canadian families? Nothing. Absolutely nothing."

In a free market, and our current federal government very much believes in the free market, the government has no role to play in supply and demand. The market will sort prices and supply out on its own. In 2008 our current PM was asked to lower taxes on gas and he refused, pointing out he would have to raise other taxes to make up the loss.

The truth about what is going on with prices lies not in a lack of government action or even in oil company gouging, but elsewhere. As John Quarterman explained in his talk to Flight 8 in March 2010 these higher prices have been long expected and fairly accurately predicted as well. Marion King Hubbert told us this was coming early in the 21st century, back in 1956 and here we are.

We know that world oil production has been flat since the end of 2005. We also know that world demand for oil overall is up. The OECD countries' demand is generally down, including the USA which has reduced demand by about 5% over last year, mostly through high and persistent unemployment, but demand in India and China is way up, more than compensating.

We also know that the cheap and easy to find oil was burned long ago. Oil today comes from very deep wells in places like the deep water off shore. Production of this oil is expensive.

The growing threat of war in the Middle East is also a factor. The Iranian government has predicted that oil will go to $440 a barrel if anyone attacks them and that they will take military action in the Straits of Hormuz. Every day 25% of the world's oil passes through the straits, so $440 a barrel might turn out to be an understatement. Hopefully we will find a diplomatic solution and then we won't find out if they are right or not.

There are more reasons for price increases and closer to home, though.

Roger McKnight with Oshawa-based En-Pro International Inc is quoted in that same CBC article and he has hit one of the major reasons why prices are going up and are likely to stay up. The reason is refinery capacity.

Many years ago oil companies were very "vertically-integrated", meaning that they owned the whole supply chain. They did exploration for oil, drilled wells, produced the oil, transported it, refined it and retailed it. Then the oil company economists looked at what they were doing and discovered that some parts of the operation were making money and other parts weren't. Retailing and refining were money-losers and were mostly were sold off.

Today anyone running a gas station will tell you that they make almost zero money selling gas. They make their money selling milk and lottery tickets to people who stop for gas. At least they have a model that works for them. Most refiners don't.

Refiners buy crude oil, refine it and then sell the product to the retailers. Their costs are very high, a new refinery can cost $10 billion to build and their margins are so low that they are mostly losing money here in North America. With US gasoline consumption down it doesn't make sense to build new refineries or even to fix old ones. The money losing ones are being closed and refining consolidated. So far, of the five existing US east coast refineries four have been closed and the last one is on the chopping block, up for sale with no one lining up to buy it. If it isn't bought it will be closed this summer.

ASPO says: "The loss of refining capacity in the Northeastern US continues to pressure prices. The EIA says the operating refinery capacity in the region is down to 1.2 million b/d from 1.6 last summer. There is still no word on the sale of the Philadelphia area Sunoco refinery which may be closed in July sending the region’s gasoline situation into crisis."

"That region" is us.

With Montreal's refineries long closed, the Ottawa area has been supplied by those closed (and closing) east coast refineries. So where will we get our avgas and car gas from in the future? From the US Gulf of Mexico coast refineries. Yes, they will truck gas all the way here from Louisiana.

Even a few years ago Ottawa had gas storage tanks on West Hunt Club, but those are mostly gone now. Nobody stores gasoline anymore, if they can avoid it, as it is too expensive to do that. Imagine the insurance costs alone on an urban tank farm. No, instead we do "just-in-time delivery" now, meaning a steady stream of tank trucks driving from Louisiana to Ottawa to keep our gas station and airport retail tanks full, all arriving just as the tanks empty. The transportation costs will be high and so gas prices have to rise to pay for it, but not as far as if new refineries had to be built.

The greater danger, especially with a long supply chain like that is disruptions, like a refinery fire, a hurricane (the gulf coast gets those), highway closures or tanker trucks breaking down, will occur. Any one of those could mean local fuel supply shortages in Ottawa. That long supply route will mean higher gas prices this summer, but it also might add up to a period of time where we have no gas at all - not for planes and not for cars, either.

The inability of refiners to make money refining over the last ten years has manifest itself in this long and very fragile just-in-time delivery system, that will be subject to disruptions. If we had accepted higher retail prices a few years ago to give refiners a better cut we wouldn't be in this situation, but we are here now.

Of course the general population will keep whining that it is all an oil company conspiracy and that the government should do something about it, but whining won't accomplish anything. The free market sets the prices and consumers of avgas and auto fuel will individually have to decide for themselves whether they are "in" or "out" of that market. When enough people drop out then demand will stabilize and so will prices.

These sorts of situations always have a silver lining, though. High fuel prices will result in fewer people driving and flying, so the roads and airports will be less busy. There will be less airline flying as ticket prices rise to account for the price of fuel, too.

The price of used aircraft will fall, too meaning this will be a good time to buy an airplane, as long as you can afford the gas!

Will this prove to be a price spike or a new permanent price for fuel? Probably both. Prices will probably spike this summer and then settle down to a new normal, that, with the long transportation chain will be higher than the old normal price. We'll have to see how it shakes out.

What will happen if we do have a period with no fuel available here, due to, say, a gulf coast hurricane? Well a bicycle would be a good idea. Just don't ask the government to do something about it.


Michael Shaw said...

All of this simply means we are getting closer to paying true cost (including for the negative externalities) of burning gasoline. The price of gas should to reflect the long term cost of its use, including dealing with air that kills, climate changes, lowered visibilities. I don't see greed as that negative, at least not for my investments, just yours!

Adam Hunt said...

Good points, Mike. Right now the environmental costs are not really included in the pump price. The current price really just reflects the cost of getting it from deep wells in inaccessible places and then the refinery and transportation issues. One of the ironies is that as the price of gas goes up the price of trucking it to Ottawa will also go up, which will result in the price going up, ad infinitum.

Adam Hunt said...

Here is some interesting news from ASPO on one of these closed refineries:

"Delta Air Lines’ proposal to acquire an idled Pennsylvania refinery is a bet that the airline
can cut its fuel bill at New York area airports and trade the refinery’s other products for
aviation fuel elsewhere in the US. Delta's plans, which emerged on Wednesday, were widely
dismissed by aviation and energy industry experts who said owning a refinery is a risky and
potentially costly undertaking for an airline"

Adam Hunt said...

More From ASPO this week:

"Stories that Delta Airlines was considering buying the
shuttered Sunoco refinery near Philadelphia served as a reminder that the possible closure of the
second and larger Sunoco refinery is only ten weeks away. Most analysts are skeptical that Delta
could be successful in running an aging refinery in a region where Sunoco says it has been losing
$1 million a day. Should the second Sunoco refinery close, many see serious problems in supplying
refined oil products to East Coast markets in the second half of the year."

Adam Hunt said...

From ASPO USA this week: "A number of factors combined to give the oil markets a weaker tone in the past three days. The “satisfactory” start to the Iranian nuclear talks served to lower tensions in the Middle East – at least for the time being. The release of weaker-than-expected Chinese economic data and an unsatisfactory Spanish bond auction served to increase worries that the EU and China are in for a period of lower growth. When the US stocks report on Wednesday showed an unexpectedly large increase of 3.8 million barrels of crude, NY oil fell to a close of $102.67. Brent closed Wednesday at $117.94, the lowest close in two months."

"US gasoline futures have fallen by 15 cents a gallon in the last four days helped by the falling price of Brent crude which is down by about $8 a barrel since the beginning of April. Fears about a refining shortage on the US East Coast this summer appear to be on hold for the minute as Delta Airlines is thought to be in negotiations to buy and restart a Sunoco refinery in the Philadelphia area."

Adam Hunt said...

This is a pretty good summary of the problems in oil refining in North America right now.

Adam Hunt said...

From ASPO this week "The Philadelphia refinery situation is still an open question. The larger of the two Sunoco refineries
is still scheduled to be closed in July and the reports that Delta Airlines is negotiating for the other are considered ludicrous by most observers. The price jump that comes with the transition to summer gasoline blends is still a few weeks away and sanctions on Iranian oil exports are still
tightening. All this suggests that predictions we have seen a peak in gasoline prices may be

Adam Hunt said...

From ASPO-US today "The Carlyle Group, a private equity firm, seems to be the new favorite to take over Sunoco’s refinery near Philadelphia which is due to be closed in July. Sunoco is said to be putting in the refinery while Carlyle puts the cash and will manage the joint venture. Carlyle is supposed to be in a better position to demand benefit and tax concessions from unions and local and state governments who are desperate to keep the refinery operating."