Crude Oil is trading at around $110 a barrel – expensive but not extortionate. The bad news is that inflation in producing crude Oil products in normal times would mean crude Oil would be between $150 and $275 a barrel. See this same effect in the recent price charts of crude Oil and subsequent Oil products in the chart below and learn more here.
What’s changed? Refining margins have exploded. And that means energy inflation is far stronger than it appears.
Oil refineries are complex machines capable of processing multiple streams of crude into dozens of different petroleum products. The industry measures refining margins using a rough calculation called the “3-2-1 crack spread”: for every three barrels of WTI crude oil the refinery processes, it makes two barrels of gasoline and one barrel of distillate fuel like diesel and jet fuel.
From 1985 to 2021, the crack spread averaged about $10.50 a barrel. More recently, the crack spread has edged higher, but the crack spread rarely surpassed $30. Recently, however, the margin jumped to a record high of nearly $55. Crack margins for diesel and other petroleum products surged much higher. See this in the chart below.
Here are four reasons some have given for the explosion in refining margins.
- Demand, particularly for diesel, has rebounded strongly, depleting global inventories.
- The US and its allies have tapped their strategic petroleum reserves to cap the rally in crude Oil prices but don’t affect the Oil products pricing.
- Refining capacity has declined where it matters for the market now, and the plants that are operating are struggling to process enough crude to satisfy the demand for fuel.
- Sanctions and unilateral embargos on Russian oil.
As of April 2021, the US had 18.1 million barrels per day of petroleum refining capacity. US refining capacity had reached a record high of nearly 19.0 million barrels per day as of January 1, 2020, but several refineries have closed since then, resulting in a capacity decline of 4.5 percent.
While the US has been shuttering refineries, China has invested in them. In fact, for most of 2020, China’s refineries processed more crude than U.S. refineries. In April 2020, more crude oil was being refined in China’s refineries than in U.S. refineries for the first time on record, and the trend continued for all remaining months in 2020 except for July and August. See this in the chart below and learn more here.
So these crack spreads could remain high and may even go higher. The US is simply not investing in Oil, whether it be in exploration or in Oil products production. Hence, higher prices are to come. Why, you may ask?
It’s part of the New Green Deal … we are saving the planet. China? They don’t seem so concerned about saving the planet, do they?