U.S. gasoline and diesel prices are at record highs and show no sign of falling or of denting demand.
Refining capacity has shrunk dramatically since 2020 due to the covid pandemic, driving fears of a supply crisis.
It is looking increasingly likely that the only cure for these high prices would be a recession, a cure that could be as bad as the disease.
U.S. gasoline and diesel prices are soaring to record highs nearly every day these days, as crude oil prices hold above $110 a barrel, the Russian invasion of Ukraine upends global crude and refined product trade flows, and refinery capacity globally is now lower than before the pandemic after some refineries—including in the United States—closed permanently after COVID crippled fuel demand in early 2020. There isn't a quick fix for all-time high fuel prices in America— or elsewhere — analysts say. The quickest fix is actually not one American consumers would want — a recession that would lead to job losses.
Despite the Biden Administration's months-long efforts to lower gasoline prices — including massive releases of crude from the Strategic Petroleum Reserve (SPR) and blaming oil companies for price gouging — U.S. refineries cannot catch up with demand.
Not that demand has soared so much. It's the capacity for supply, globally and in the U.S, that is now a few million barrels per day lower than it was before the pandemic.
U.S. Refinery Capacity Lowest Since 2015
Some 1 million barrels per day (bpd) of refinery capacity in America has been shut permanently since the start of the pandemic, as refiners have opted to either close losing facilities or convert some of them into biofuel production sites. Globally, refinery capacity is also stretched thin, especially after Western buyers — including in the U.S. — are no longer importing Russian vacuum gas oil (VGO) and other intermediate products necessary for refining crude into gasoline, diesel, and jet fuel.
The fuel market is extremely tight in Europe, too, considering that many refiners refuse to stock Russian crude and suppliers shun Russian diesel, even if the EU is still struggling to reach a common stance on an embargo on Russian oil imports.
In the U.S., refinery operable capacity was at just over 18 million bpd in 2021, the lowest since 2015, per EIA data.
"As you well know, 1 million barrels of distillation capacity has exited the system since pre-pandemic," Mike Jennings, CEO at refiner HF Sinclair and Holly Energy Partners, said on the Q1 earnings call last week.
Distillate refining margins are sky high due to a shortage of refined product, he added.
"How long that persists? I don't see any signs of it ending soon or well," Jennings said.
Rising demand since economies reopened and people returned to travel, combined with lower refining capacity and very tight distillate markets have drawn down U.S. product inventories to below seasonal averages and at multi-year lows, with record-low inventories reported on the East Coast.
Distillate fuel inventories fell by 900,000 barrels in the week ending May 6 and are about 23% below the five-year average for this time of year, the EIA said in its latest weekly inventory report. At 104 million barrels, distillate inventories — which include diesel — are at their lowest since 2008. On the East Coast, they are at their lowest ever, as the refinery capacity in the region has halved over the past decade to just 818,000 bpd now.
"We're Ripe for a Potential Supply Crisis"
Globally, around 3 million bpd of refining capacity has been shut down since early 2020, according to estimates from Wood Mackenzie.
"For companies with aging refineries that required significant investment to remain viable, it has been difficult to justify the spending in the face of a weak demand outlook, particularly for gasoline as a result of increased fuel efficiency and the rise of electric vehicles," Ed Crooks, Vice-Chair, Americas, at WoodMac wrote last week.
At the same time, new refining capacity in the Middle East and Asia is only now entering the market after being delayed, in part because of the pandemic and weak refining margins, Crooks notes.
"We're ripe for a potential supply crisis," John Auers, executive vice president at energy consultancy Turner, Mason & Co told Bloomberg last week.
As the summer driving season approaches, U.S. gasoline prices are at an all-time high but haven't dented demand yet.
Moreover, the paper market signals high prices for gasoline throughout the summer as gasoline futures in New York hit on Monday $4.00 a gallon for the first time ever.
"The continuous inventory withdrawal over the past few weeks has pushed US gasoline stocks to levels significantly below the five-year average at this point in the season and reflects acute supply tightness," ING strategists Warren Patterson and Wenyu Yao said on Monday, commenting on the record gasoline future prices.
The situation on the diesel market is even worse. Distillate stocks are 23% below the seasonal average and prices are at record highs, too.
"I wouldn't be surprised to see diesel being rationed on the East Coast this summer," John Catsimatidis, CEO at United Refining, told Bloomberg in an interview last week.
No Short-Term Fix
Prices are not expected to drop significantly from record highs any time soon, analysts and industry professionals say, as they note there isn't any quick fix for the fundamental tightness in the fuel product markets globally.
"I think that we can expect, assuming the economies stay reasonably strong, that commodity prices and, particularly prices of our products, are going to be relatively high," HF Sinclair's CEO Jennings said on the Q1 call last week.
Record-high diesel and gasoline prices are threatening economic growth, adding further upward pressure on U.S. inflation figures. As diesel prices impact every part of the economy, the fight against inflation becomes more complicated for the Fed, as steeper interest rate hikes could lead to the deterioration of economic activity and household spending and, ultimately, recession.
"When we look at the tight market, the natural conclusion is to say that a recession sorts this," Mark Williams, Wood Mackenzie's research director for short-term refining and oil product markets, said, commenting on the diesel market imbalance.
Right now, a recession may be the only short-term "fix" for the very tight fuel markets, but it's surely the least welcome cure for high gasoline and diesel prices.