US Refiners Rule the Oil Market

As Opec-plus gathers in Vienna for an in-person meeting on Jun. 4, many attendees may anticipate that crude oil prices will rise toward the end of 2023 as global supply and demand balances tighten. However, unless Opec-plus countries make large production cuts, crude oil prices will instead come under intense pressure if the expected supply and demand gap does not materialize. High interest rates could also prompt key US independent refiners and other companies to shrink their inventories by purchasing less crude oil. Indeed the reality now is that US refiners govern the global oil market, not Opec-plus. The Big Four US independent oil refiners (Valero, Phillips 66, Marathon Petroleum and PBF Energy) also know that President Joe Biden has their back — that is, he will provide the crude they require if an emergency occurs. Welcome to oil’s new world.

US independent refiners have every reason to squeeze markets and keep margins high. These firms have also used the California market to perfect their tactics for maintaining high margins — margins that will “rob” the oil producers absent a further production cut. US Gulf Coast refiners have additional advantages relative to the rest of the world: they have easy access to domestic light, sweet crude and, when needed, the capacity to refine high-sulfur heavy crude. The very low US natural gas price makes the latter profitable.

These refiners can game the system further because the potential crude volumes available for export exceed the export capacity. By substituting or threatening to substitute heavy, sour imports for domestic crude, they can (and have) forced US sellers to accept substantially lower prices. These discounts are now affecting the global crude price too.

US Refiner Advantages

The US is the world’s largest oil consumer. It is also the world’s largest oil producer, but still relies on imports to fill the consumption-production gap. In the past, being dependent on imports left the country vulnerable to oil exporters’ market power. The market power, defined as “the relative ability to manipulate the price of an item in the marketplace by manipulating the level of supply, demand, or both,” in oil, however, has shifted from exporting countries to the US and its Big Four refining companies, which together can process up to 8 million barrels per day.

The Big Four’s capacity on the US Gulf Coast is 3 million b/d, one-third of the region’s total. They have an additional advantage that most of their refineries are complex facilities that can process light sweet crude like West Texas Intermediate or heavy Canadian or Middle Eastern crude. And under current circumstances, Valero and the other Big Four firms can push US crude prices down, and these actions can influence global crude prices. The market control these companies exercise comes from their ability to increase or decrease their crude oil and product inventories, change their crude mix, and adjust processing rates to keep product inventories tight.

The Big Four also benefit from the US crude market being open while the US petroleum product market is not. Thanks to the export ban being lifted in 2016, US producers can export crude oil without limits. Export facility capacity is limited, however. Thus, US sellers must accept lower offers from US refiners, particularly the Big Four, fight to get their oil exported, or store the oil in a backwardated market where the loss ranges from $1.50 to $3 per barrel.

US refiners are additionally advantaged by domestic product terminals’ constrained capacity. High processing margins could not be maintained if large volumes of product imports were reaching US markets. They have been helped, too, by US willingness to use its Strategic Petroleum Reserve (SPR). The release conducted to offset the impact of Russia’s invasion of Ukraine allowed these firms to earn huge financial returns over the last 12 months.

Offsetting the Opec-Plus Challenge

Independent refiners in the US, especially the Big Four, will want to maintain the extraordinary margins they achieved over the last year even as oil-exporting countries attempt to adjust their oil output and boost crude prices.

While Opec-plus chances of achieving its goal will be difficult if consumption does not increase as some forecasters expect, refinery margins could also see significant pressure over the rest of the year — especially as new refineries come on stream and discounted Russian products get pushed into markets once dominated by US exports.

However, unique circumstances in 2023 may support continued high margins in the US. The key special conditions are the US refiners’ willingness to cut crude runs, the changes made by Platts in calculating the dated Brent price used to determine many oil transactions globally, and the central bank interest rate increases. Given good margins today and the dearth of terminals to receive foreign product imports, US refiners could respond to an economic slowdown and export losses.

US Treasury Aid

Interest rate changes will also affect the quantity of finished goods or commodities that firms hold in stock — with stocks seeming to decline when interest rates rise and when storage costs rise. Both have risen sharply over the last year, and we expect a significant stock cutback over the rest of the year and possibly well into 2024. Our very rough econometric estimates point to a reduction of 200 million to 400 million bbl.

The pressure to bring inventories down will be heightened by the oil industry’s greater fragmentation. The large, well-capitalized integrated companies have been replaced by smaller firms in many areas, and the latter will be less willing and sometimes less able to fund stocks.

The Republican party’s failure to extend the US government’s debt ceiling early this year will add to downward pressure on inventories over the next six months because the government will borrow perhaps a trillion dollars soon, squeezing other borrowers out and driving interest rates and oil storage costs higher. The situation will worsen because the Federal Reserve has been cutting the money supply by selling assets accumulated during monetary easing in 2020 and 2021.

Shares prices for major consumer marketing firms have increased sharply over the last year as these firms have consistently been able to boost profit margins while cutting volumes. The gains sometimes come at the expense of producers. Consumers in Europe and North America have paid up. US oil refiners have learned the lesson and are perusing the same strategy. The days of low margins may be past until consumption declines.

Philip Verleger is an economist who has written about energy markets for over 40 years. A graduate of MIT, he has served two presidents, taught at Yale and helped develop energy commodity markets since 1980. Kim Pederson is editorial director of PKVerleger LLC. The views expressed in this article are those of the author.