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Cheaper Canadian Oil for Refiners in Midwest Not Reflected in Prices at the Pump

Refiners are keeping windfall profits from flood of tar sands oil for themselves, undermining a key national interest argument in favor of the Keystone XL.

Jul 1, 2013
Gas prices no longer follow the cost of oil

For nearly two years, refineries in the Midwest have been buying crude oil at steep discounts thanks to a glut of U.S. and Canadian oil. But drivers in the Midwest haven't seen a corresponding decrease in gasoline prices. In fact, they sometimes pay more at the pump than people in other parts of the country, even as windfall profits flow to BP, Koch Industries Inc. and other large Midwestern refiners.

"It's good to be a refiner," said Tom Kloza, chief oil analyst at the Oil Price Information Service, a company that tracks energy markets. "For 20 years, the rule of thumb was that if you made $5 a barrel east of the Rockies, that was a good profit for a refinery. Recently, we saw a period in the Midwest where refiners were making $40, or $50, or even $60 a barrel on gasoline."

The disparity of fortunes between Midwest refiners and consumers isn't a surprise to industry analysts.

In today's complex fuel market, retail gasoline prices are no longer just a reflection of the cost of oil. A host of other factors—such as refinery fires, power outages and damage from extreme weather events—now have an increasing impact, in part because there are fewer refineries fulfilling the nation's thirst for fuel.  

The correlation between the price of oil and the price of gasoline has become so skewed that analysts say it calls into question one of the central benefits touted by supporters of the controversial Keystone XL pipeline: That the project would lower U.S. gas prices by providing Gulf Coast refiners with a steady flow of cheaper oil from Canada. 

"Now there are all sorts of wild cards—all sorts of additional complexities," said Patrick DeHaan, senior petroleum analyst at GasBuddy.com, which helps drivers find low gas prices. "Sometimes it doesn't matter if you're putting $100 oil into that refinery or $60 Canadian oil, because we're becoming more subject to these refining limitations and outages."

Nowhere has this shift been more obvious than in the Midwest, where ramped up tar sands oil production and construction of new and expanded pipelines helped create an oil glut that first surfaced in 2011.

Although Midwest pump prices have periodically dipped a bit, refiners that bought the cheaper crude kept most of the gains for themselves. Earnings reports show they processed the discounted oil, then sold the resulting fuel to distributors and consumers at prices that were pushed up by Midwest fuel shortages and by the higher cost of other kinds of crude oil.

In mid-December, for instance, when the discount peaked, refiners could buy Canadian heavy oil for about $44 per barrel—almost half the going price of $88.32 per barrel for West Texas Intermediate, the U.S. benchmark oil. Gas prices in the Midwest sank to the year's lowest average, $3.14 a gallon. But that was still 10 cents more than drivers were paying on the Gulf Coast and only 11 cents cheaper than the national average, according to figures from the U.S. Energy Information Administration.

So far this year, retail gas prices in the Midwest have been mixed. They were below the national average until the end of April, but in late May, additional refinery problems sent them soaring to 20 cents above the national average. The price spike dissipated after some of the problems were solved. But industry-watchers expect the gyrations at the pump to continue.   

"We've had crazy up and we've had crazy down in the Midwest," said Kloza, of the energy price tracking company. "Everything we've seen so far in 2013 in the Midwest has had nothing to do with crude. It's had nothing to do with [uncertainty around the] Keystone."

Complex Fuel Market

The biggest factor in the region's gas prices has been the partial shutdown of the Midwest's largest refinery—BP's plant in Whiting, Ind.—so it can be upgraded to process larger amounts of Canada's heavy crude. The project is taking longer than planned, and analysts expect it to be at least a few more months before the refinery runs at full capacity.

Several other Midwest refineries have also had problems. A maintenance project in Joliet, Ill. took almost twice as long as planned. There was a fire in Detroit. Lightning struck a plant in Lemont, Ill.  There were pipeline spills in Wisconsin.

"The Midwest has just had a lot of bad luck," said Phil Flynn, a Chicago-based energy trader at the Price Futures Group. "We also had power outages during a storm that slowed production. We had that pipeline in Minnesota, because of the floods, knocked out of commission."

Because of those glitches, gasoline inventories in the Midwest fell close to 25-year lows. 

The region's refiners aren't complaining, though. Even though Canada's heavy crude has gotten a lot more expensive in 2013—it’s now trading at $82.34 per barrel compared to $96.50 per barrel for U.S. benchmark oil—refiners that buy it still pocket a double-digit discount that doesn't get passed along in lower gasoline prices.

The strongest profit margins have been in the Midwest, but refiners elsewhere also benefited from snags in gasoline supplies that sent pump prices soaring well above production costs. Refinery problems on the West Coast last year triggered California’s fastest and largest spike in gasoline prices. When Hurricane Sandy hit the Northeast, it led to gas lines, fuel shortages and higher gas prices that lasted long after normal fuel flows were restored.  

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