In July 2015, gas prices in LA shot up overnight. Some stations downtown posted prices as high as $4.99 a gallon.
“I’m mad as hell,” one driver fumed to a reporter for the Los Angeles Times as he pumped $4.65 gas into his car. “What can you do? It’s crazy, man. It is crazy.”
They had right to be angry. Gas should have been cheap. Oil prices tumbled 50 percent over the previous 12 months and were down around $50 a barrel.
Nobody really seemed to have a clue what sent Los Angeles gas prices soaring 70 cents over that Fourth of July weekend. That’s just how things go in California, experts said.
The story of what happened in Los Angeles emerged at a hearing this month before the Petroleum Market Advisory Committee, which has been trying for two years to explain the nature of such price spikes.
The LA gas price spike offers a window into the hidden world of gasoline trading in California. The picture that emerges is of a thinly traded gasoline market that is not for the faint of heart. Rumors precede facts and whip up wild price swings that can turn a sure bet into a big money loser in an instant.
The LA gas spike is evidence that California’s gas market “is prime to being manipulated and is being manipulated,” said Bob Van Der Valk, senior editor of Baaken Oil Business Journal, who told the story to the Petroleum Market Advisory Committee.
The West Coast used to be one of the best markets in the world for gasoline importers. It was a huge market. It was the most populous state in the country after all. Almost everyone, especially in Southern California, got around by car.
But over the past 15 years, as California imposed more and more environmental rules, that has changed. Huge trading outfits with deep pockets and resources like Glencore, Vitol and Trafigura have walked away from California, said Dolores Santos, who traded fuel for nearly 40 years in the state before joining the Oil Price Information Service. Today, only a handful of gasoline traders are left.
There is a saying among traders: Buy on the rumors and sell on the facts. And the rumor in July 2015 was that the Exxon Mobil refinery in Torrance, California, just outside LA, was about to come back on line.
The Torrance refinery produces 1.8 billion gallons of gasoline per year, or about 8 percent of the state’s supply. A massive explosion had ripped through the refinery in February, instantly cutting off critical supplies of gasoline. The resulting shortage had sent Southern California prices soaring in successive waves.
To make up for the lost supply, traders had been buying up gas from refineries in Singapore or India, shipping it to California, and selling it on what is known as the “spot” market. A cargo full of gas had been arriving in the Port of Los Angeles every three days on average. That had helped alleviate some of the strain.
But the rumor making its way around California’s small gas trading community was that the big Exxon Mobil refinery would resume operations July 15. That would alleviate the strains in Southern California’s gas market. There would be no need for imports.
Except it wasn’t true. The Exxon Mobil refinery would not resume operations until September.
The rumor carried the day, however, not the facts. It chased away cargoes of gasoline even the spot price at the time was good enough to attract imports.
Supplies were pretty tight in Southern California around the Fourth of July. And that’s when some big gas refiners stepped in to do something that drove prices even higher.
Two big oil companies had gone out and bought every barrel of gasoline available on the spot market, Bob Van der Valk told the Petroleum Market Advisory Committee this month. Van der Valk, who got the story from gas traders he knows from years of covering the energy business, wouldn’t say which companies were responsible.
“The last desperate step for a major is to go out in the spot market,” he said. “They know full well when they do they’ll drive up prices.”
If this is true, then it confirms all the bad things that people say about oil companies. Consumer advocates have long believed believe that the players in the state’s gas market have used “market power” to drive up prices by curtailing supply in times of shortage. That’s exactly what happened in July.
The gas price spike allows refiners to make extraordinary profits but they don’t last long enough to prompt changes in demand. If gas remained at $5 or higher year after year, you would see a rise in the use of public transportation, fewer cars on the road, and higher sales of more efficient vehicles. But gas price spikes don’t last much longer than a few weeks, so all people can do is shake their fists and hand over their wallets.
There are two factors that give refiners enormous leverage in California:
- California’s gas market is isolated from the rest of the country. (See my previous post on Why Gas Prices Are So High in California – Part I)
- Whether you are rich or poor, whether gas is cheap or expensive, people still buy the same amount of gas.
There are nearly 29 million cars in California. Most people have to drive to get where they are going. In economic terms, it’s “inelastic” demand.
California’s gas market is an oligopoly, dominated by a few firms. Two companies produce half the gasoline in the entire state. In San Diego, where I live, Tesoro — through its USA Stations, Arco and some Shell stations — controls 40 percent of the market.
Keith Casey, Tesoro’s executive vice president of operations, told analysts and investors on Dec. 9 that the company had made millions on LA gas price spikes in 2015:
…in 2015 we had very strong product demand in California, and we move about 50,000 barrels a day of intermediates and blendstocks across our system, and through our movements of octane to support that demand in southern California from the rest of our system, we made about $15 million to $20 million being able to supply that and optimizing from the entire system.
Here Tesoro is effectively saying that we able to make $15 to $20 million selling gas quickly in Southern California during times of shortages. And of course the July shortage may have been made worse by the oil companies themselves.
Tesoro has built a business around these price spikes in Southern California. The company can quickly switch between gasoline and diesel production to take advantage of volatility:
And that’s why we believe flexibility and agility are really the key for competitive advantage. Importantly, our swing capability, which we have driven this 10% capability of our production to swing, is incredibly agile. We can often execute that in less than one 12-hour operating shift to meet the market demands.
Since 2010, this volatility has earned Tesoro $8 a barrel on average. During extreme price spikes Tesoro can earn as much as $60 a barrel, according to Casey. Since there are 42 gallons a barrel, this means Tesoro is earning as much as $1.42 per gallon of gasoline sold. That’s huge.
Whether Tesoro is artificially raising prices in California isn’t clear, but the company is certainly rewarded if it does. As Tesoro’s CEO Greg Goff put it, 2015 was “somewhat of an exceptional year, particularly in California.”
Gas is cheap these days. Since 2014, the average price of a gallon of gas in the US has been cut in half to $1.70 and is headed still lower.
Except in California. A gallon of gas is $2.42 on average here. That’s more than 70 cents above the US average.
People in California are so used to paying more that this is seen as good news. Gas prices topped $4 in Los Angeles in the summer of 2015. So Californians are celebrating, not realizing that they are still paying more than the rest of the country.
Expensive is now normal in California. In 2015, a gallon of gas sold at the pump cost 70 cents above the U.S. average, according to the California Energy Commission. And for the month of January 2016, gas prices were 80.1 cents above the national average. That’s huge.
A difference of 70 cents may not sound like much, but multiply that by the 14.9 billion gallons of gasoline consumed in 2015 by drivers in the nation’s most populous state.
The number gets a lot bigger.
California drivers paid a whopping $10.4 billion more for gasoline in 2015 than the US average. Wow.
Why is this so? The reason frequently given is the state’s higher taxes and strict environmental regulations drive gas prices higher.
- California requires the world’s cleanest burning gasoline, which is more expensive to refine. Cost: 10-15 cents more per gallon.
- Anti global warming regulations add a pollution tax on refineries. Cost: 10-15 cents more per gallon.
- Gas taxes are higher in California. Cost in 2016: 10-15 cents.
So taking the low and high of these estimates (which like most of the information used in this post come testimony before a state panel) we get either 10+10+10 or 30 cents or at the high end, 15+15+15 or 45 cents. That accounts for less than half to two-thirds of the 70 cent-per-gallon difference between the average U.S. gas price and California’s.
Where does the other 25-40 cents go?
This, it turns out, is a vexing question, one that a state panel, the Petroleum Market Advisory Committee, has been trying for two years to answer.
Simply put, there isn’t enough gas supply to meet demand, especially in Southern California where most of the state’s population lives. That drives the average price of a gallon of gas higher.
In a properly functioning market economy, scarcity of gasoline, a widely available commodity, should serve as a signal to competitors. There’s money to be made selling gas in California! Competitors arrive with gas to sell. The supply increases until prices gradually fall back to normal.
But that’s not happening. Gas isn’t pouring into California, so prices remain stubbornly high.
The reason why is a bit surprising: A lot of it has to do with geography.
In old 16th and 17th European maps California was depicted as an island. In terms of gasoline, California is an island.
Almost all of California’s gasoline supply is produced inside the state by 13 refineries. And this put the state’s drivers at a major competitive disadvantage.
When everything is working smoothly, these refineries can supply enough gas to meet demand. In fact, California exports gasoline to Nevada and Arizona.
However, things don’t always work smoothly. Refineries break down or catch fire and the sudden shortage can cause prices to shoot up.
Gas prices have remained persistently high in Southern California since an explosion shut down Exxon Mobil’s Torrance refinery in 2015. The Torrance refinery produced somewhere around 10 percent of the state’s gasoline supply.
Outside California, when refineries hut down for routine maintenance or unplanned outages, drivers often don’t even realize it. Other refineries quickly make up the difference.
Take Florida. While California produces all its own gasoline, Florida is the opposite extreme. Florida has zero refineries. It is totally dependent on imported gas. So what does gas cost there? $1.75, a few pennies the national average.
Like most of the country, Florida gets its gasoline via pipeline from the Gulf region. The U.S. Gulf region is a giant gas exporting machine. Texas and Louisiana together account for half of the gasoline refining capacity for all of the United States.
Pipelines can move gas from Texas as far away as New York, but they don’t reach California. (Exactly why this is so is unclear, since a Gulf pipeline could reach Los Angeles through Arizona and New Mexico.)
Pipelines do link California to Nevada and Arizona, but the gas flows only in one direction: out of the state. Gas flows from the Bay Area to Northern Nevada and from Southern California to Las Vegas and Arizona.
If you look at the chart below, you’ll see that the arrows all point east. Also note there are no pipelines linking Northern and Southern California. This is another big problem.
Well, can’t ships bring gas to California to alleviate shortages? Why not ship gas from the Gulf to California in times of shortage?
California’s geography works against it. Outside California, there are only a few refineries in the world that produce gas known as CARB that meets the state’s strict standards. They are all far away.
The closest refinery that produces CARB gas is in the Gulf. It takes 10 days for a tanker from the Gulf to pass through the Panama Canal and reach California.
Due to a quirk of US law, it’s actually more expensive to ship gas to California from the Gulf than from refineries in Asia, even though the voyage from Asia is twice as long. It costs $10 per barrel to ship gas from the Gulf Coast to Los Angeles vs 6 a barrel from Asia.
Under a law known as the Jones Act, ships that sail from one U.S. port to another must be made in the USA and at least 75 percent of the crew has to be American citizens. There are very few Jones Act ships left.
It’s so hard to find a Jones Act ship that gas cannot easily move around even inside California. As noted earlier, there are no gasoline pipelines linking Northern California with Southern California.
At a hearing this month before the Petroleum Advisory Market Committee, an industry analyst noted that gas was 30 cents cheaper recently in Northern California than Southern California. But there was no way to move the gas south.
Few ships and no pipelines mean California’s gas market is isolated from the rest of the country. And this is the real reason why gas is much more expensive in California than the rest of the country.
We here in the Golden State are totally dependent on in-state refineries.
That doesn’t sit well with some people.
This concentration of power has given rise to charges that refiners are using market power to drive prices — and their profits — higher. We’ll take a look at this in our next post.