Publications: Notes at the Margin

Arbitrage Works: Crisis Over?

Refining and Marketing: Petroleum's Achilles' Heel (November 21, 2022)


This Notes at the Margin addresses two, perhaps two and a half, issues.


We begin by noting that arbitrage works. One week ago, the spot price of ultralow sulfur diesel (ULSD) in New York Harbor exceeded the December futures price by $1.20 per gallon. The large gap suggested that the settlement of December futures at the end of November could be quite chaotic. Seven days later, the gap had closed to $0.09. Cash prices had dropped by twenty-four percent. The firms holding physical oil had suffered losses measured in the billions on paper.


Crude oil prices collapsed with the ULSD price crash. Consequently, markets are now little changed from year-ago levels. It may be possible to say the energy crisis has ended. This is our “half” issue. We note that many indicators have returned to normal. However, one must worry that market turmoil will return with the upcoming G7 price cap on Russian oil.


Our second focus relates to whether the separation of refining and marketing from crude oil production will complicate crude oil producer efforts to keep renewables from rapidly replacing oil.


We note that natural gas and coal producers are closely tied to their consumers. The oil industry, in contrast, is not. Integrated companies shed their refining and marketing arms over the past three decades, seeking higher returns. Refiners have done the same with marketing. Oil producers today now rely on companies such as Walmart and Costco in the United States and hypermarkets in Europe to perpetuate consumer “addiction” to gasoline and diesel. These firms, though, are focused on earning profits by heeding consumer preferences. They will do little to extend petroleum sales should their customers decide to shun gasoline and diesel.


Refiners may also shift away from petroleum quickly as governments boost incentives to produce renewable diesel and jet fuel. Such a change could reduce world crude demand.


These possibilities suggest that global oil demand might drop far faster than demand for coal or natural gas. Refining and marketing, then, may represent the “weakest link” in the global fossil fuels supply chain, to crib from the title of a popular BBC game show. Many readers will recall how the game’s losers were dismissed with a curt “you are the weakest link. Goodbye.” Oil may suffer the same rejection.


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