As many of us are planning upcoming Spring Break trips, there may be some new sticker shock for travel costs. I know that I have seen airline flight costs increasing, and the price of gas at the pump will be making road trips more expensive as well. We have dealt with various types of inflation since the Covid period, but this one is a little more specific. We know it is based on the current military conflict in Iran.
Some people seem surprised by this, because the United States produces more oil than we consume. As you can see in the link below from the U.S. Energy Information Administration, that is currently true. So why would our oil prices be affected by what is happening in the Middle East? There are three important reasons: international spot prices of oil, the type of oil refineries we have, and the for-profit businesses that produce and refine the oil.
https://www.eia.gov/tools/faqs/faq.php?id=709&t=6
For the international spot price topic, ~20% of the oil in in the world travels through the Strait of Hormuz on tanker ships. By launching rockets and setting mines in the water, Iran has effectively shut down that waterway for the time being as a response to the attacks on their country by the US and Israel. Since basic economics tell us prices are determined by the dynamics of supply and demand, when you reduce global supply by ~20%, prices will go up. OK, but what does the international spot price have to do with us, since we produce more than we use? Why should that affect what we pay?
In general, the refineries in the USA have had a key issue that has made the international spot price important to what we pay at the pump: the type of oil we pump in the US is not well aligned with the type of oil our refineries were built to process. You may have heard of “Light Sweet Crude” versus “Heavy Crude” oil. Essentially our modern refineries were built to mainly process heavy oil, because that is what we had the most access to when they were built. However, the modern drilling techniques in the USA are now producing a much larger amount light sweet crude. See the link from the American Fuel & Petrochemical Manufacturers about this topic, which explains why we actually import much of the oil that goes to the refineries in the USA, because those plants need heavy crude to run properly. We simultaneously export a lot of the light sweet crude we produce here, again because our refineries weren’t built to process it well. That is why the international spot price directly affects what we pay at the pump currently.
So why don’t we just build new refineries suited to process the USA-produced light sweet crude? That is the NIMBY issue. The “Not In My Back Yard” stance that many parts of the country have taken when it comes to having new refineries built in their areas. Many parts of the country have balked at refinery construction due to environmental, health, and safety concerns. At least partially because of the NIMBY responses, it has been nearly 50 years since a new major oil refinery has been built in the USA. As the press release below notes, there was a recent announcement about a new refinery that is being planned in Texas, which is being designed to primarily process light sweet crude. It is important to note that this will not affect your gas prices anytime soon. That is because it will take a few years to build this new refinery, and it is not going to be a significant volume percentage of the refined products we use. Per the press release they expect to refine ~60 million barrels of oil per year, while the USA uses 20 million barrels per day as noted in the EIA.gov link above. That means the new refinery will be less than 1% of what we refine in the USA. We would need many more new refineries designed and built over many years to process light sweet crude, to reduce the simultaneous importing and exporting of oil that is currently done every day.
The final issue with the price at the pump, is that the oil producers, the oil refineries, and the gas stations we fill up at are all for-profit businesses. Any given oil producer has an obligation to their shareholders to earn profits. If they can sell a barrel of oil for a higher price today than they did last month or last year, they will. Wherever the oil is drilled, it is going to be sold based on international pricing, not at a discount within the USA for altruistic purposes. The only way that would change would be if the USA nationalized the oil business, which generally is not a concept that our free-market society has supported.
So as you grin and bear the higher fuel costs we are seeing now, let’s all hope the Strait of Hormuz gets back to normal shipping traffic before too long!
Anders, Kurt, Maggie and Molly