There is a two word explanation for why consumers continue to pay high gasoline prices despite the falling oil price: refining margins.
Refining margins refer to the profits available from processing crude oil into gasoline and other petroleum products. U.S refiners currently make a hefty $26 (U.S.) a barrel converting oil into gasoline, as the first chart, below, shows. This compares with $17 a barrel a year ago. The added fee for refining is passed on to consumers through the average price of gasoline per litre.
Refiners can afford to charge the current high amount because they are working much closer to maximum capacity than in previous years. It is the usual functioning of supply and demand – the sharp rise in U.S. oil production in recent years has dramatically increased the demand for refinery services, which allow refineries to charge more. This increases the price of gasoline.
The stress on the refining sector is underscored by the second, lower chart. Capacity utilization in the refining sector – the percentage of available facilities in operation – has climbed every year for the past three. The sector is currently working at 95-per-cent capacity, above the 93.5 level of July, 2014, and 91.3 per cent in July, 2013. (The reason refiners can't work at 100-per-cent capacity is the high temperatures and chemical processes require frequent periods of shutdown for maintenance.)
Refining margins, or "crack spreads" as they're called in the industry, have major effects on corporate profitability in the energy sector. For example, refining margins are among the primary reasons (along with cost cutting) that Suncor was able to raise its dividend Thursday, while other domestic producers without substantial refining operations have been forced to cut their payouts. In the most recent quarter, Suncor generated 61 per cent of revenue and 100 per cent of profits from refining operations. The stocks for companies specializing in refining have seen outsized performance. The S&P refining and marketing index has jumped 17 per cent so far in 2015.
The fat profit margins have refiners happily operating near full capacity for now. But, we are only a few weeks away from the season when operations shut down both for maintenance and to retool for the transition from driving season to heating oil and other winter-related petroleum products. In the lower chart, the sharp drop in capacity utilization beginning every September is evident.
Much depends on the demand for gasoline on both sides of the border, but the risk is that, with substantial capacity off-line as we head into fall, active refiners will be able to charge even more per barrel to produce gasoline. This would put even more upward pressure on consumer prices at the pump.
Scott Barlow, Globe Investor's in-house market strategist, writes exclusively for our subscribers at Inside the Market.
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