Part I discussed recently high U.S. gasoline and diesel prices and dug deeper into oil, the largest component of the price of petroleum products. Specifically domestic oil supply, oil imports and exports.
In addition to domestic production, the U.S. net imported (imports less exports) three million barrels of oil per day over the last year. While that is a substantial reduction in net imports in recent years, the U.S. is still reliant on foreign oil.
So what gives? Why import and export oil? Read on to find out.
Refinery Inputs & Outputs
Consumers don't drive or fly with oil, but rather gasoline, diesel and jet fuel which are produced at refineries. Refineries use heat, pressure and chemical catalyst to break oil down into its components: gasoline, diesel, jet fuel, propane and other petroleum products.
Refineries are large, complex industrial facilities that operate nearly non-stop and generally turn a barrel of oil into 44-45 gallons of petroleum products. A standard barrel of oil equals 42 gallons with processing gains being additive to production.
Domestic production as a percentage of total refinery inputs has increased in recent years alongside the U.S. oil production increase.
In addition to oil, inputs into the refining and blending process include plant liquids, gasoline additives and ethanol.
Gasoline and diesel represent approximately 80% of produced petroleum products.
Refinery product yields have stayed relatively consistent over time, with distillate/diesel yields increasing the most, largely as a result of adding coking and other secondary processing capacity to the distillation process, in addition to the grade or blends being chosen as inputs.
No material greenfield refining capacity has been added to the U.S. system in decades. Operable capacity is a function of brownfield expansion and closures, with the latter mostly driven by economics and regulation.
Not All Oil is Created Equal
S&P recent put out a great data visualization highlighting the different type of oil around the world.
The focus here will be on the changing profile of U.S. oil production. American Petroleum Institute gravity, or API gravity, is a measure of how heavy or light a petroleum liquid is compared to water.
Higher API gravity = lighter oil; lower API gravity = heavier oil.
Likewise, sweet or sour oil is a concept around parts per million of sulfur content, sour oil having more sulfur content.
Generally speaking, light sweet oil can more easily produce high-value light products such as gasoline, whereas heavier and more sour oils need more processing to produce the same products.
U.S. oil has become lighter (higher API gravity) as a result of the shale oil boom. The buttons allow you to toggle through different states and regions to see the extent of crude API changes.
As domestic production became lighter, refineries offset the high API domestic oil by importing less light oil. The gravity of imported oils dropped significantly starting around the time the shale oil boom kicked off in the 2008/2009 timeframe.
How does a very light supply of domestic oil production match up with the U.S. refining system configuration? Not well. The average slate of oil run by refineries is around 33 whereas the biggest components of U.S. production are 35 API and higher. Put simply, we have an API mismatch.
So we can summarize the weighted-average differences in oil API:
Refinery API = 33
Imports API = 26
U.S. domestic oil production API = 40
U.S. domestic oil refinery run API = 38
Blending 38 API oil produced domestically with 26 API oil imported at their respective refinery input percentages gets U.S. refineries to their 33 API slate.
Said differently and more specifically, the U.S. has to import heavier oil and export lighter oil to get to the desired refinery slate.
Refineries could re-configure for a lighter oil slate, but they are only 15-20 yrs removed from configuring for heavier slates. The investments are enormous and regardless the U.S. does need to run some heavier oil grades in order to produce all the product desired.
Refinery Profitability: Crack Spreads
The gross margin a refinery makes - before operating or other expenses - is estimated using crack spreads. Cracking refers to breaking oil into its components with heat and other catalysts.
As discussed previously a barrel of oil converts into 42 gallons. Single product cracks can be calculated using oil and product prices, but the standard convention is for them to be quoted in similar ratios to refining yields, ie 3-2-1 crack spread.
Gasoline crack spread = 42 x wholesale price of gasoline - price of oil
Diesel crack spread = 42 x wholesale price of diesel - price of oil
3-2-1 crack spread = 2/3 gasoline crack + 1/3 diesel crack
At recent prices of $105 for oil and $30.25 for the gasoline crack spread we can convert into a $/gallon basis of $2.50/gal and $0.72/gal, respectively for a total cost of $3.20/gallon before state and federal taxes, transport costs and retail margins.
Petroleum Product Demand
Why are product/refining margin high? Demand has come roaring back post-COVID, exacerbated by recent global sanctions and supply concerns.
The most frequently cited measure for petroleum product demand is Products Supplied reported by the EIA and defined as:
Approximately represents consumption of petroleum products because it measures the disappearance of these products from primary sources, i.e., refineries, natural gas processing plants, blending plants, pipelines, and bulk terminals. In general, product supplied of each product in any given period is computed as follows: field production, plus refinery production, plus imports, plus unaccounted for crude oil, (plus net receipts when calculated on a PAD District basis), minus stock change, minus crude oil losses, minus refinery inputs, minus exports.
Visually it is apparent below that product demand is outstripping U.S. refining capacity by the widest margin in some time.
What is different this time vs prior U.S. tightness, is we export much more product than we import. U.S. markets are more intertwined with global markets and global supply and demand than ever.
Roughly 50% of U.S. product imports are comprised of higher-value gasoline, diesel and jet fuel, whereas 46% of of exports are represented by those products. The U.S. imports a lot of unfinished oils and exports significant amounts of propane.
Demand for petroleum products can be most immediately seen in stocks (storage levels).
Check out our interactive storage data visualization.
Petroleum Product Imports & Exports By Country
The U.S. has been importing a fair amount of products, largely unfinished plant oil, from Russia whereas Russian oil imports are de minimus.
Mexico is twice as large as the 2nd largest product export partner.
State and Federal Taxes
State gasoline excise taxes average $0.26 per gallon. Sales and other state taxes make the average state tax $0.31/gallon. Federal gasoline taxes are $0.18/gallon. All-in, the average tax per gallon of gasoline is $0.49/gallon across the U.S. with a low of $0.27/gallon in Alaska and a high of $0.77/gallon in Pennsylvania, California and Illinois.
Together with the $3.20/gallon cost of oil and refining margin, $0.49/gallon in state and federal taxes equals $3.69/gallon. Transport costs and retail margins run another $0.50 to $0.60, taking the price at the pump to approximately $4.25/gallon, right around the recent weekly national midrange gasoline price.
Part I detailed U.S. oil markets, focusing on domestic supplies, imports and exports. Part II attempted to described what we do with that oil, how it works its way through the refinery system and becomes product that is consumed or exported. Refinery margins and the total cost of gasoline from oil to the retail pump were covered.
Gasoline prices are political. If anything, oil & gas producers are taking heat today for historically large refining margins. But as the U.S. became a large exporter of both oil and petroleum markets its markets became global, subject to global supply and demand.
Sign up for Part III where we will provide an analysis of U.S. oil production on Federal leases where the reality and the rhetoric seem disconnected.