On Tuesday, August 29, over 26 inches of rain fell in Port Arthur, Texas. The 50,000 residents of that city, north and east of Houston, are suffering severe flooding and personal loss. Port Arthur is also the home of the largest refinery in the United States, Motiva, which has been shut down due to massive flooding. In addition, the nearby Valero Energy VLO -0.45% and ExxonMobil XOM +0.3% refineries were shut and the Colonial Pipeline (distributing refined products across the Southeast and north to Tennessee) has been disrupted. About 22% of U.S. refining capacity is offline due to the natural disaster. All told, it now appears that the impact Harvey will have on the energy industry is worse than expected and could very well, in a worst case scenario, lead to a serious macro-economic problem.
There are two major categories of oil markets. There are the crude oil markets (WTI, Brent, etc.) and the downstream refined markets (gasoline, jet fuel, plastics and other petroleum products). Hurricane Harvey has created a situation in which the pricing of the two markets—which usually run fairly parallel in ordinary circumstances—are diverging significantly.
However, now there is a serious disruption to the downstream refinery process and the transportation and distribution of refined products. Because refineries are down, there is nowhere for crude oil to go in the Southern U.S. (there is low demand for crude) so the price of crude oil globally is dropping. At the same time, the disruption of refined product (there is low supply of refined product) raises the price of products like gasoline.
As a result, gas prices are already rising across much of the U.S. If the refineries do not resume operations quickly and the transportation problems are not resolved, the price of gasoline could spike dramatically and stay high. Before the Hurricane, there was already a significant amount of gasoline in storage in the U.S. This storage will now be drawn down, which will result in higher prices. Before the Hurricane and at most times, U.S. refineries already operate at nearly full capacity around the clock, so there will not be any spare volume after they reopen to recover from storage drawdowns. The longer the refinery outages last, the greater the chance that gas prices stay high longer.
Tankers of gasoline and jet fuel are leaving Europe and Asia for ports on the Atlantic and Pacific because of the market opportunity in the U.S. However, these tankers will take weeks, not days to arrive. The dispatch of these tankers is more an indicator of the likelihood of long-term disruptions than a sign of coming relief.
When gas prices and other refined products become more expensive, the economy suffers. The cost of plastics and many chemical products become more expensive. It is more expensive to ship goods, so items like your groceries cost more. It becomes more expensive for you to buy a plane ticket for Thanksgiving, commute to work or pick up your daughter from ballet. Typically, when gasoline prices are high, a saving grace is that the U.S. energy industry thrives. Not this time.
Crude oil prices have been low since 2015, but the disruption of U.S. refining has caused crude oil prices to drop further. If the U.S. refining situation does not fully recover soon, the price of WTI crude oil could continue to fall. This natural disaster is only adding to the already extreme oversupply of crude oil in the world, which could lead to a further divergence between crude and gasoline prices. When gasoline prices are high, the economy suffers. Without the saving grace of high crude oil prices buoying growth in the energy sector, the impact on U.S. economic growth could be severe.
Even global crude producers are suffering from this storm. Saudi Aramco, which owns the Motiva refinery, has not been able to distribute crude there. Other global crude producers have tankers waiting in the Gulf of Mexico for the ports to reopen.
Many of us have been warning for years now that the U.S. is in dire need of improved and expanded refinery and pipeline infrastructure. Refineries exist across the U.S., in the Northeast, the Midwest and the West Coast, but so much volume is now concentrated in the Gulf Coast region. Moreover, the U.S. does not have spare capacity to be able to ramp up refining in other regions in times of necessity (like now and after recovery from the storm). Nor does the U.S. have sufficient refined product pipelines to divert product from a refinery in one region to a different market in need of an influx. The market would likely build these capabilities if the permitting process were simplified.
In the current situation, given the extreme and unexpected disruptions created by Hurricane Harvey and given the downstream refining infrastructure limitations in the U.S., we must hope for a quick return to normal operations. Otherwise, the price of products like gasoline will rise while the price of crude drops, a nightmare scenario for the U.S. economy.