california regulations could cut supply, raise gasoline prices says chevron exec

Table 1.

Figure 1.

West vs. Gulf Crack Spreads ($ per barrel | 2011– 2023
Calculated with Publicly Available Information

The US Gulf Coast has grown its refining capacity by 27% since 2000⁵. Gulf Coast refiners have chosen to invest in additional capacity, making their markets less prone to supply and demand imbalances. If you look at West Coast and Gulf refining margins holistically, you start to learn why. While there are key differences between the West Coast and Gulf Coast in terms of supply and demand that would call into question the reliability of a comparison of prices between the two regions, it is worth noting that—as reflected in the Figure 1—over a 12-year period, there has almost never been a West Coast refiner margin premium, as measured by the 5-3-2 crack spread. The crack spread measures the difference between the purchase price of regionally available crude oil and the selling price of principle refined products. Crack spreads are a metric widely used by energy market experts to help monitor a refiner’s margin potential.⁶ The 5-3-2 crack spread measures the difference in prices for 5 barrels of crude oil to produce 3 barrels of gasoline and 2 barrels of heating oil. There was no West Coast margin premium during the initial 2022 gasoline price spike, and thus, no indication that refinery margins were the root cause of California price differentials when emergency legislation was drafted to blame refiners.⁷

The key to understanding what is happening with gasoline prices is understanding why so many refineries have exited the market. There’s no mystery. Instead of fostering innovation, state policies have actively sought to put refineries out of business. For decades, California has required refineries to make an especially expensive gasoline blend while restricting supply from in-state wells that refiners rely on for affordable crude oil—squeezing refiners at both ends.⁸ More recently, the state promulgated a rule that is set to phase out sales of new gasoline cars by 2035 in an attempt to limit gasoline demand.⁹ Add to these a host of other state and local regulations and taxes, and it is no surprise that there is less incentive to invest in California. As we have mentioned before, California’s policies have made it a difficult place to invest so we have rejected capital projects in the state. Capital flight reflects the state’s inadequate returns and adversarial business climate.

The effects of these policies have been far-reaching. For example, politicians and regulators have recently suggested refinery maintenance causes high gasoline prices by disrupting supply.¹⁰ But supply disruptions can only lead to high prices because California has effectively forbidden the opening of new refineries or the expansion of existing ones, and as such, there are very few refineries able to make up the shortfall when supply is disrupted. In any case, this maintenance is critical to ensuring the safety and reliability of the state’s refineries, and a refiner is not at liberty to forgo or postpone necessary maintenance.

These negative consequences of decades are exacerbated by geography—another factor no refiner can control. California is cut off from the rest of the United States by the Rocky Mountains, and as such oil and gasoline cannot arrive by pipeline. Meanwhile, fuel brought in from overseas takes weeks to get here and is expensive to import.¹¹ That means that when gasoline prices go up because of a supply disruption, it takes a long time to resupply the state with our uniquely formulated finished gasoline.¹² Regulators should design around these problems, rather than blame refineries for them.

In short, California’s policies and geography—and not supposed greed by refiners—are responsible for price spikes. Because refiner profits are not the problem, a penalty on profits will not help. It can only hurt.

On the one hand, the state can choose to continue implementing policies that restrict refineries’ ability to operate in California. That is what the maximum margin and penalty are—policies that make it harder to refine gasoline in California. If you regulate something, you typically get less of it. And that is where this path gets us: less gasoline, at higher prices for Californians.

These kinds of price controls have been tried many times, always with the same results. Many still remember the fuel shortages of the 1970s, which were caused in large part by misconceived price controls. More recently, Hawaii implemented a policy with goals similar to the one the CEC is proposing—and abandoned it after it turned out to be impossible to administer, bad for consumers, and detrimental to the state’s energy supplies.¹³ In fact, in 2003, Stillwater Associates told Hawaii not to pass the profit cap because it would backfire;¹⁴ the same firm told the CEC in April that its proposed penalty could raise average prices for Californians.¹⁵ That forecast was correct in 2003, and it is correct again today. In fact, even the CEC’s own economist has acknowledged that a penalty would “potentially increase price at the retail end of the market.”¹⁶

Californians should be especially concerned about this particular penalty, because it is poorly designed and fundamentally misunderstands, in several critical ways, the way refineries work.

Table 2.

• The gross gasoline refining margin is the difference between wholesale gasoline price and acquisition costs plus certain regulatory costs. Missing from this picture is everything a refiner does to turn crude into gasoline, such as paying thousands of workers to maintain and run a refinery. The Legislature and the CEC understand this—that is why they implemented a net margin reporting figure that, although still flawed, at least accounts for operational costs. But the CEC has not explained how it will use the net margin data collected from refiners since June 2023. Instead, it continues to focus on the misleading gross margin metric. Furthermore, a maximum margin that ignores operational costs directly discourages investment, including in co-processing renewable fuels, which is precisely what California needs to fix longstanding supply issues. Even the data on the CEC website doesn’t support policy of this nature: it shows refiners posting a loss on gasoline sales since October of 2023.¹⁷ It is particularly concerning that this data was not presented in recent media interviews with the Department of Petroleum Market Oversight (DPMO) and in recent CEC workshops.

• Refineries do not turn one barrel of crude oil into one barrel of gasoline. They make a whole slate of products from oil, including diesel, heating oil, and jet fuel. Each of these products has its own market value and production costs, which contribute to a refiner’s overall margin. A gross margin for gasoline overlooks the multifaceted nature of refining operations and the market dynamics that impact actual refiner margins—namely, the fact that capping the price of one product will likely reduce the supply and increase the price of others.

• The maximum margin separates gasoline sales into simplistic categories that do not capture complex differences between refiners. For example, unlike other refiners, Chevron incurs enormous distribution costs to support and supply a large network of retailers—costs that this scheme simply ignores. To make matters worse, the margin on which refiners would be penalized assumes that all gasoline is sold for the “rack” price—that is, the price charged when gasoline is loaded onto trucks at terminals—even though refiners sell gasoline in a number of different ways, such as by pipeline or marine delivery. For these reasons, as one expert recently told the CEC, the penalty would result in an “unfair situation” for refiners by treating different barrels of gasoline as if they were the same.¹⁸

Given these problems with the proposed penalty, the CEC should not charge forward with complex regulations based on a flawed legislative framework that cannot be reconciled with hard facts and economics. After all, the law that tasked the CEC with evaluating this new policy says that it “shall not set a maximum gross gasoline refining margin or accompanying penalty…unless it finds the likely benefits to consumers outweigh the potential costs.”¹⁹ And the facts and economics do not support a finding that consumers could possibly benefit from this policy.

• Any maximum margin would further disincentivize investment in California. As a result, it would reduce investment in California’s refinery infrastructure, which in turn would lead to less supply and higherprices at the pump. Low-income and marginalized communities who spend a higher share of their income on gasoline would be the most impacted. Some have suggested that gasoline imports might moderate any rise in prices, but that is not the case. Out-of-state refiners with the know-how and desire to produce California-grade gasoline are few and far between, and the gas they refine must be shipped over oceans to get here, making it quite expensive. And even if imports were affordable, they still would not be a good answer to supply shocks (given the substantial shipping distances). Moreover, they would be worse for the environment, both because of the additional greenhouse gas impact from shipping and because imports would come from countries with less stringent environmental standards with less transparency in carbon accounting practices and accountability for following our standards.²⁰ These factors are all additional to the geopolitical risks in the Middle East and Eastern Europe that could increase the price of crude oil this summer.

• Refineries in California supply transportation fuels to Arizona, Nevada, and other western states. By supplying these states, Chevron is able to optimize operations for a broader slate of products, which improves supply reliability for Californians—a win-win solution for Californians and these neighboring states. But the penalty scheme assumes that refiners turn one barrel of crude oil into one barrel of California gasoline, thus preventing refiners from allocating their costs in a way that fully reflects this reality. The result is a burdensome policy based on flawed assumptions that will impactallthe products that refiners make—meaning higher gasoline prices across western states. A maximum margin would not just hurt Californians—it would also make us a bad neighbor to other states that rely on us.

• Gasoline will not be the only fuel impacted, since the same refining process that makes gasoline also creates other products like diesel and jet fuel. Air travel prices would be impacted if jet fuel becomes more expensive due to new supply constraints, with follow-on effects on trade, tourism, and jobs. Reduced diesel supplies would impact the cost of shipping, agriculture, and construction. Even national security could be impacted by supply imbalances in a state that is home to critical military infrastructure.

First and foremost, we need to tackle the root causesbehind gasoline price spikes. In fact, the CEC itself has acknowledged that “refinery greed” is not the cause of high gas price. In September 2022—a time of especially high prices at the pump— the CEC found that, of the then-average gallon price of $5.06, $1.19 came from taxes and regulatory costs as opposed to just $0.64 from refinery costs and profit.²¹ If the CEC wants to take a chunk out of gasoline prices, refinery profits are hardly the right place to look.

Instead, CEC should focus on easing decades of regulations that have driven refineries out of business to choke back supply. It should also help prevent new policies that will make supply issues worse. Every agency in California should assess the expenses related to revised policies.

We previously informed you that CEC data for 2022 indicated a cost of $0.49 per gallon for "environmental fees" which is a mix of Oil Price Information Service (OPIS) Low Carbon Fuel Standard (LCFS) and Cap-and-Trade costs ²². Unfortunately, the worst is yet to come. The California Air Resources Board (CARB) is currently proposing to increase the LCFS reduction target from 20% to 30% by 2030, and to increase the Cap-and-Trade GHG reduction target from 40% to 48% below 1990 levels by 2030. Policymakers are progressing these stringent policies, which are expected to add at least $0.88 per gallon of gasoline by 2026 and $1.01 by 2031, see Table 3. If the Cap-and-Trade Price Allowances hit the cost containment ceiling, this would add $1.46 to each gallon of gasoline.²³ Compare that cost to the negative profit refiners are making, -$0.02 per gallon of gasoline sold, when averaging the CEC’s monthly refiners net margin from June 2023 to February 2024. We urge CEC to take these costs into account when making recommendations to manage gasoline prices.

Table 3. Past, Current and Proposed LCFS and Cap-and-Trade (C&T) Amendments Costs

On top of the LCFS and Cap-and-Trade costs, CARB has implemented the Ocean-Going Vessels At Berth Regulation, also known as the At-Berth rule. The proposed technologies have not been demonstrated on tankers, present a safety risk to tanker and terminal operations, and are not cost-effective. Unlike other vessels, tankers have unique safety hazards and measures, which may be affected by these control technologies. Assuming the control options were feasible, safe, and cost-effective today, compliance with the January 1, 2025, deadline has potential to further bottleneck supply.

Californians will also bear the costs of the fast-approaching ban on new gasoline cars that force consumers to build new infrastructure and abandon the prevailing liquid fuel infrastructure.³⁰Electric vehicles should be part of the solution, but so should lower-carbon fuels, such as renewable gasoline, ethanol, renewable diesel, biodiesel, and renewable natural gas. These lower-carbon fuel options can be used in vehicles on the road today to help achieve the state’s greenhouse gas and air-quality targets while diversifying energy risks and keeping costs down³¹. In light of the concerns regarding gasoline fuel supply, it is crucial to note that the CEC’s analysis may not have fully accounted for the complexities of jet fuel market dynamics. The potential oversight in evaluating the impact of margin caps on jet fuel supply could lead to unintended consequences, disrupting not only the aviation industry but also the broader energy market.