Gasoline prices have been on a downward trend and are projected to stay low for the foreseeable future. Despite a recent increase in oil prices due to the Israel-Hamas war, the average U.S. gasoline price dropped from $3.70 per gallon on Monday to $3.68 per gallon on Tuesday.
The decline in gas prices is not expected to be short-lived, as there are larger economic factors influencing fuel markets. The ongoing production of gasoline by refiners, coupled with reduced consumption, is driving this long-term decrease in prices.
The economics of oil refining, rather than the broader oil industry, are primarily responsible for the current state of gas prices. Tom Kloza, global head of energy analysis at OPIS, predicts that even if crude oil prices rise once again, it will have limited impact on gasoline prices. Kloza believes that gas prices may further drop to approximately $3.25 to $3.50 per gallon.
According to Kloza, this downward trend is likely to continue until the middle of the first quarter of 2024. Therefore, consumers can expect affordable gasoline prices for the foreseeable future.
The Decline in Diesel Supply and Gasoline Demand
The recent decline in diesel supply can be traced back to OPEC and its allies, including Russia. OPEC has intentionally reduced oil production in order to boost oil prices. Russia and Saudi Arabia have also implemented additional cuts, with Russia reducing its daily supply by 300,000 barrels until the end of the year and Saudi Arabia reducing its supply by 1 million barrels.
One significant factor contributing to the shortage of diesel is the fact that Russian and Saudi crude oil is heavier compared to other grades, making it more suitable for the production of diesel fuel. As a result, the reduction in production from these countries has directly affected the availability of diesel.
To compensate for the loss of Saudi and Russian barrels, the United States has increased its oil production. However, the crude oil produced in the U.S. is classified as “light, sweet” crude, which yields less diesel compared to the Russian and Saudi varieties. The term “sweet” in this context refers to its low-sulfur content.
As a consequence of these shifts in the market, diesel margins have significantly risen to around $40 per barrel, a substantial increase from the usual margins of $10 to $15. This dramatic rise has served as an incentive for refiners to produce more diesel and take advantage of these lucrative margins.
However, there is a scientific limitation that prevents most refiners from exclusively producing diesel, even if they desired to do so. Refineries employ a process that converts each barrel of crude oil into a range of petroleum products. It is estimated that for every three barrels of crude oil, two barrels of gasoline and one barrel of diesel are produced. Although refiners can adjust their methods slightly to produce more diesel and less gasoline, the range of customization remains limited.
As a result, as refiners increase diesel production, they are also simultaneously increasing gasoline output, even if there is insufficient demand for gasoline to justify this increase. Recent data from the U.S. government reveals a decrease in driving activity compared to the previous year. In fact, J.P. Morgan reports that gasoline demand has reached a 22-year low. Consequently, gasoline “crack spreads,” or margins, have fallen to below $10 per barrel, representing only one-third of their levels from the same time last year.
Fuel Refineries: Pumping Out Diesel and Gasoline
Despite a narrow margin, fuel refineries are motivated to maintain high capacities in order to produce both diesel and gasoline. The combined profits from these two fuels are still higher than past averages, primarily due to the expensive cost of diesel, as stated by RBC Capital Markets analyst Michael Tran. It is interesting to note that gasoline, although widely recognized as a popular fuel, has essentially become a byproduct of the refining process, as pointed out by Tran.
Even in situations where refineries would face losses from gasoline production, industry expert Kloza believes they would continue to produce both fuels. Consequently, this would likely result in a drop in gasoline prices at the pump. However, it is important to note that consumers should not expect stations to pay them for taking gasoline away.