Crude oil prices have recently hit a new two-month high, driven be an announcement by China that the extended Covid lockdown of factories in Shanghai was about to be lifted, increasing the level of Chinese oil consumption by 1.2 million barrels a day. However, less-severe Covid restrictions remain in place in other major Chinese cities, including Beijing and Tianjin. Because of these lockdowns, economic activity in China declined for a third straight month in May.
While the reopening of Shanghai is expected to give China’s economy a lift, as long as the Chinese government continues to maintain its zero-tolerance policy towards new Covid outbreaks, additional lockdowns and business closures are expected to continue to hamper its growth rate. As a result, last week, Barclays bank cut its forecast for the growth of the Chinese economy for 2022 to 3.3%, well short of the 5.5% growth rate which is the target of the Chinese government.
Another major factor in the most recent rise in the cost of crude oil was the announcement of an agreement among European Union countries to end the current importation of about 2.1 million barrels of Russian oil a day.
The expected increase in Chinese oil usage, combined with the cutoff in Russian oil shipments, represents a net loss of about 3% of the current total worldwide oil usage of 100 million barrels a day. The news prompted an increase in the price of benchmark Brent crude oil and West Texas Intermediate grades to near $120 a barrel. As a result, in May, Brent recorded the sharpest one-month advance in the price of crude since February, when Russia first invaded Ukraine.
At the same time, average US gas prices over the Memorial Day weekend reached another all-time high of $4.619 per gallon. In addition, the 38% rise in the annual rate of energy cost increases in Germany has accelerated overall consumer price growth in that country to the fastest pace since 1973.
But the main factor driving up gasoline prices today is not the shortage in the supply of crude oil, but rather the lack of adequate global refining capacity needed to convert all the available crude oil into gasoline and other fuels.
WORLWIDE REFINERY CAPACITY HAS FALLEN BEHIND DEMAND
In the past, an increase in crude oil prices was routinely passed along by the refiners within a few weeks in the form of higher prices for consumers at the pump, but with no reduction in supply. However, a lack of refining capacity will result in even sharper price increases as retailers are forced to bid against one another for the limited amount of fuel available at the wholesale level.
Worldwide demand for gasoline, diesel fuel, and other refined oil products has now almost fully recovered from the past two years of reduced economic activity due to the pandemic. According to the US Energy Information Administration (EIA), nationwide gasoline demand peaked in 2018 at about 9.33 million barrels a day, and then fell during the pandemic to about eight million barrels a day. Current usage has now returned to around 8.9 million barrels a day. In addition to the growing post-pandemic usage of private cars, demand for diesel, the primary fuel for the trucking industry and other industrial users, has also been soaring with the increase in overall economic activity.
Jonathan Wolff, an associate professor of Economics at Miami University of Ohio, told the Wall Street Journal that, “Few could have predicted the speed with which the U.S. economy recovered from the initial shutdown. A growing economy means a growing demand for energy.”
But the main worry today is that there is no longer sufficient global refinery capacity to meet global demand, even at today’s slightly reduced levels, as there had been before the pandemic began.
A CASUALTY OF THE TRANSITION TO GREEN ENERGY
The refinery capacity shortage has been developing for a long time. It is the result of aggressive plans in most developed countries to phase out their use of greenhouse gas-emitting refined oil-based fuels, in favor of zero-emission renewable energy sources.
Because refined fossil fuel usage was expected to continue declining after the pandemic with the continued development of new green energy sources, many refiners around the world permanently closed their older and less profitable plants, rather than invest the large amount of money needed to bring them up to current industry standards. According to industry experts at JPMorgan Chase, around three million barrels a day of global refining capacity was closed during the pandemic, including one million barrels a day of US refining capacity.
Some additional American refining capacity is now offline because of the severe hurricane damage done to the world’s largest petrochemical complex along the Gulf of Mexico. Some oil companies are also performing routine maintenance on their refineries right now, keeping their capacity offline as well.
Because of this reduced refinery capacity and the increase in demand, the current utilization rate for US refineries is now at about 90%, which, according to the EIA, is the maximum sustainable rate — but it is still insufficient to meet the current elevated US demand for refined fuels.
PROFITS ARE HIGH BUT REFINERS ARE NOT INVESTING TO EXPAND
The refined fuel shortage has already driven up the profit margin for gasoline refiners on the East Coast to nearly $50 a barrel, five times their typical $10 profit margin at the start of the pandemic, in March 2020. For diesel fuel, the refiner’s profit margin recently exceeded $100 per barrel, before settling back to $60.
Because of the increased demand for refined oil products and the shortage of capacity, Valero CEO Joseph Gorder said on a call with industry analysts in April that his company, the second largest refiner in the US, reported its largest profit margins in the first quarter of this year since 2015, and predicted that refined fuel supplies will remain tight, propping up their prices for the foreseeable future.
Ordinarily, increased demand for a highly profitable product would lead a company to make a major investment in more equipment to increase its production capacity. But America’s refiners are not rushing to make such investments, because before the pandemic, demand for refined fuels was already leveling off in the US, as well as European and other countries which had begun their own transition from fossil fuels to cleaner sources of energy.
Even though current demand for refined fossil fuels is high, the long-term outlook has not changed. As the international auto industry transitions to electrically powered vehicles in the years ahead, demand for fossil fuels is expected to gradually fall. Since refineries typically take 20 years to recoup their required initial investment, any new refinery built today is ultimately likely to become unprofitable. That is why there are no new refineries now on the drawing boards, and why so many older refineries in the US, Europe, and Australia were permanently shut down instead of upgraded during when they became idle during the pandemic.
Also, when Hurricane Ida seriously damaged the Phillips 66’s Alliance refinery in Louisiana in the summer of 2021, the company permanently shut the plant instead of investing the more than $1 billion that would have been needed to repair it and put it back into production.
MORE OLD REFINERIES CLOSING DOWN
Despite the current spike in demand for their products, more older US refineries are slated to be shut down, so that by the end of 2023, the country is expected to lose another 1.69 million barrels of refining capacity.
In addition, some of the larger oil companies, responding to growing pressure from their ESG (Environmental, Social, and Governance) motivated investors and stockholders, have begun converting some of their older refineries into plants that are capable of producing biofuels, as well as other more environmentally friendly products. For example, Phillips 66 recently announced that it will spend $850 million to convert its San Francisco Refinery in Rodeo, California, into a renewable fuel facility.
Because the shortage of refinery capacity is worldwide, there is no easy way to fix the problem by redistributing available supplies. For example, when US refiners on the East Coast tried to alleviate the critical immediate fuel shortage in Western Europe precipitated by Russia’s invasion of Ukraine, it only served to drain US diesel inventories, reducing them to the lowest levels in 17 years, as well as reducing US gasoline inventories to 8% below normal for this time of year. In addition, the annual summer vacation driving season, with its traditional surge in demand for gasoline, has just begun. This means that until those storage levels are replenished, there will be no prospect of significant price relief at the pump any time before the end of this year, at the earliest.
THE IMPACT OF SANCTIONS ON RUSSIA
Meanwhile, the refining industry continues to struggle to meet the current spike in demand for its products, as well as reduced fuel supplies from Russia due the Western sanctions. Russian refiners have already shut down 800,000 barrels a day of their capacity, a figure expected to soon rise to 1.4 million barrels a day, as the flow of Russian refined oil products to Europe grinds to halt. Russia supplied 10% of the EU region’s diesel fuel demand in 2021.
Negotiations within the EU over a proposed continent-wide ban on imported Russian oil had been stalled by objections from Hungary, which buys most of its crude oil via a pipeline from Russia. German Chancellor Olaf Scholz announced a compromise which would exempt Russian oil coming into Europe via the Druzhba pipeline and ban the three quarters of the 2.8 million barrels of crude oil that Europe had been importing from Russia by ship before the invasion of Ukraine. That ban will be phased in over the next several months, and news of the move shot up the price of global oil to over $120 a gallon.
In 2020, 29% of the EU’s crude-oil imports came from Russia, with the US, serving as the second-biggest supplier, providing 9%. The EU had been paying around $10 billion a month to Russia for crude oil and refined oil products.
Since Germany had already pledged to stop importing Russian crude through the northern branch of the Druzhba pipeline, the only remaining European pipeline imports of Russian crude would be 250,000 barrels a day arriving daily in Hungary, Slovakia, and the Czech Republic, which represents less than 10% of Russia’s former total oil export volume to Europe. Hungary has asked the EU for permission to continue buying Russian oil even if the shipments through the section of the pipeline passing through Ukraine get interrupted by the war.
According to EIA analysts, while Russia is likely to eventually find other buyers for the crude oil Europe will no longer be taking, the ban will still result in at least a short-term cut in its income from foreign oil sales.
Since Russia invaded Ukraine in February, many of its previous foreign customers have cut back on their orders for Russian crude oil, which, in turn, has forced Russia to start selling its excess oil at a steep discount to the world market price. Russia has also struggled to charter the ships it needs to transport its oil to purchasers in Asia, such as India and China, and money to finance those purchases, out of fear by insurers and banks fear that they could run afoul of the new EU and US sanctions on the Russian oil exports. Russian officials have also said that its oil production this year could decline by as much as 17% because of the Western sanctions already in place.
BIDEN STILL SENDING MIXED SIGNALS ON GAS PRICES
Meanwhile, President Joe Biden and his administration continue to send mixed messages about the current crude oil and refined fuel shortages, and the sharp cost increases they have imposed on American consumers. In an effort to minimize the political blowback, Biden has tried to convey his sympathies with families now struggling with the high price of gas at the pump, but in comments to reporters who accompanied him on a recent visit to Tokyo, he could not contain himself from expressing his satisfaction, declaring, “When it comes to the gas prices, we’re going through an incredible transition that is taking place that, G-d willing, when it’s over, we’ll be stronger, and the world will be stronger and less reliant on fossil fuels.”
Biden’s strategy for hastening America’s transition from its reliance on fossil fuels to green energy is heavily dependent upon forcing consumers to adopt electric-powered vehicles (EV), with record-high gasoline prices serving as an economic incentive. The US car industry has already invested heavily in the transition, but unfortunately, supply chain problems and computer chip shortages have restricted EV sales to less than 4% of the domestic new car market.
Yet another difficulty with the execution of Biden’s larger green-energy policy for this country is that so far, only about 20% of the electricity from the national power grid currently driving those EVs is coming from renewable sources, including 9.2% from wind turbines, 2.8% from solar panels, and 6.3% from hydroelectric plants. The other 80% of the nation’s electrical grid power is still coming from the fossil fuel and nuclear sources that Biden is trying to phase out. That includes 38% from carbon-dioxide-emitting natural gas, and 21.8% from the burning of even dirtier coal. As a result, the contribution of American EVs to the reduction of the carbon emissions has been minimal and will remain so for at least several years to come.
BIDEN HAS SPEEDED UP THE TRANSITION TIMETABLE
Biden’s current goal is to speed up the timetable for the country’s transition to EVs to be at least half completed by 2030, instead of the original target date of 2050. Unfortunately, many industry experts warn that the eight years remaining until 2030 are not nearly enough time to put the amount of support infrastructure and raw materials that will be required in place.
For example, lithium, the raw material used in high energy batteries powering EVs, is already in critically short supply. More lithium will also be needed to provide battery storage for solar panels and wind turbines, as well as for all the new cell phones and laptop computers.
Over the past year, the market price for lithium has increased by more than 400%, to what Tesla CEO Elon Musk has called “insane levels.” Lithium prices will continue to increase as many more lithium batteries will be needed in the years ahead to produce a replacement national fleet of electric vehicles and sufficient backup green energy power storage capacity.
According to Joe Lowry, who founded the metal producing company Global Lithium, there will be no quick fix to the shortage, because “you can build a battery factory in two years, but it takes up to a decade to bring on a lithium project.”
Lowry also notes that, “In [the original] 2050 [Green Energy transition] scenario, there’s time for everything to happen that needs to happen. But in 2030, it just isn’t going to happen. Just look at the mess we’re in from a lithium supply standpoint with less than 10% EV penetration.”
The same shortages are likely to develop in supplies of other critical raw materials that will be needed for the transition. For example, gasoline-powered cars typically use 18 to 49 pounds of copper, while EV-powered vehicles typically use 183 pounds, and the batteries will also require large quantities of nickel. In addition, a typical electric vehicle needs about twice as many computer chips as a gas-powered car.
A MULTIFACETED EV INFRASTRUCTURE CHALLENGE
To gain a better understanding of the scale of the EV infrastructure challenge, consider the development that was needed to support the 20-fold growth of automobile ownership between the years of 1909 to 1918. In most places, the only place a car owner could buy gasoline was at pharmacy or hardware store, where it was typically sold in five-gallon jugs on the roadside. It took another 17 years, until 1935, to put a nationwide network of gasoline and service stations in place capable of refueling and servicing all the cars then in use.
Consider the current situation in Norway, where an aggressive government-sponsored transition program has resulted in EVs representing 75% of the new car market in that country today. To support all of those EVs, Norway has installed 313 EV charging stations in place for every 100,000 Norwegian citizens. By contrast, in the US today, the ratio is only 30 charging stations for every 100,000 people, and outside of California, especially in rural areas of the country, publicly available car charging stations tend to be few and far between.
Currently, in the entire country, there are only a total of 93,000 publicly available charging stations. To reach the same concentration of charging stations as in Norway today, the US will have to build more than one million additional charging stations. That is probably the minimum number necessary to give prospective new car buyers the confidence that they won’t get stuck on some lonely road because their electric-powered car’s rechargeable battery ran out of power.
HOW WILL THE NEW MONEY BE SPENT?
Despite an allocation of $7.5 billion in last year’s bipartisan infrastructure bill to get such a charging network off the ground, a far larger investment by private industry — and a good deal of time — will probably be necessary before such a network will be fully in place.
The new federal money for charging station development is to be distributed to the states, which will then decide how it will be allocated. However, there have been complaints that a similar arrangement for the distribution to states of $424 million for charging stations that came out of a settlement of a lawsuit a few years ago against Volkswagen, when the company got caught cheating on government diesel emission tests, has not gone well. Six states, including Connecticut and Illinois, have yet to allocate any of that money. Four other states say they plan to divert the VW settlement money originally intended for charging stations to other environmentally-friendly transportation projects, such as the purchase of new, lower-emissions bus fleets.
Another obstacle to maintaining a national fleet of EV cars is the amount of time it takes to recharge their batteries. At best, a full “fast” recharge takes 25-30 minutes, compared to less than five minutes to refill an empty car gas tank at the pump. But with the exception of the Tesla nationwide recharging network, most of the public charging stations in the US today do not have a “fast-charging” capability, and require hours to fully repower the depleted battery of a single electric vehicle.
Even if this country installed charging stations at every one of its estimated 145,000 gas stations, during busy periods, most of them will probably not have enough room for cars to wait in line for their turn to get recharged. In addition, the car industry will have to retrain virtually all of today’s auto mechanics to enable them to keep the new national fleet of EVs up and running.
Yet another requirement for a successful transition to electric vehicles is a major upgrade to this country’s power grid to handle the additional electricity demand generated by the need to periodically recharge all those new EVs. The federal government has already agreed to spend $73 billion on power grid upgrades, although experts suggest that the minimum required expenditure will probably be at least $125 billion.
WILL DRIVERS GIVE UP THEIR GAS-POWERED CARS?
Finally, regardless of the high price of gasoline, it is unrealistic to expect this country’s car owners to quickly replace their current vehicles, many of which have a remaining operational lifespan of a dozen years or more, especially given the large price premium that current EV models command over their conventionally powered autos.
Today’s record gas prices at the pump have definitely spurred additional public interest in EVs, as confirmed by Google Trends, which has recorded a sharp increase in search requests for information on electric vehicles. But while Americans bought more than 204,000 electric cars and trucks in the first four months of this year, up 60% from the same period last year, they still make up less than 1% of the total number of vehicles on the nation’s roads today.
Even if all those car owners were willing to buy an EV today, they would have a great deal of trouble finding one. Ford and Volkswagen say that they are essentially sold out of their popular electric cars and truck models through at least the end of this year, and the same is true for Tesla models.
High purchase prices are also still an issue. Even the cheapest, entry-level electric vehicle like the Chevy Bolt still cost nearly $15,000 more than an equivalent gas-powered car, such as a Chevy Malibu sedan. That price difference is more than three time the roughly $5,000 in savings that electric vehicle owners can expect to realize on fuel and maintenance over the first 10 years of ownership.
President Biden’s announced goal is to increase the share of electric vehicles to 50% of the American new car market by 2030, but given all of the practical obstacles we have discussed currently standing in the way, attaining that goal seems highly improbable.