Anatomy of a Gas Price Spike – Why Are Gas Prices So High in California? Part II

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Rumors in the gas market sent gas prices soaring in the LA area in July 2015. (Courtesy: LA Times)

 

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.

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Exxon Mobil’s Torrance refinery damaged by an explosion in February 2015. (Source: LA Times)

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:

  1. 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)
  2. 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.

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If I had to guess which company bought up the available spot supply in July, my money would be on Tesoro.

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.”

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