new california legislation misleading, chevron exec says

California Governor Gavin Newsom approved Assembly Bill (AB) X2-1 last month. The bill authorizes the California Energy Commission (CEC) to set regulations on the state’s refineries and energy infrastructure.

In a letter to state representatives, Andy Walz, Chevron’s president of Downstream, Midstream and Chemicals, outlined why he believes that the legislation is flawed.

• Claims made about the refining industry in support of the legislation are misleading. Multiple factors, including economic and market behavior, can force prices up when demand outstrips supply. High gasoline prices in California could impact consumers in Nevada and Arizona, which import gas from that state.
• Energy suppliers must go to great lengths to meet consumer demand. Operating a refinery and efficiently managing inventory is a complex process. In addition, creating artificial shortages through minimum inventory thresholds could cost Californians more at the pumps.
• The new policy could create more risk. This legislation could have a negative impact on California’s energy infrastructure, including supply shortages and higher gasoline prices. Labor unions also raised concerns that state regulations could risk worker safety. These new policies may cause refiners to rethink how capital is used, which could lead to California becoming “uninvestible.”

Chevron is concerned by the recent Committee and Assembly passages of ABX2-1 and seek to address some of the inaccurate and flawed arguments made by its proponents. As the Senate prepares to vote, it is crucial that it makes a fact-based decision. The political posturing that has characterized these proceedings must stop, including baseless and frankly ridiculous claims that the industry is engaging in price gouging. Let us have a balanced, fact-grounded conversation about the state of California’s fuels marketplace, a marketplace weakened by misguided policy decisions, driven by misleading rhetoric.

Across the three dozen states in which we work, the California government remains unique in its focus on marketplace interference with negative effects on consumers resulting in the highest U.S. gasoline prices. California has investigated the industry numerous times for price gouging and come up with no evidence or charges. Chevron has been a trusted partner to California consumers for 140 years. We value that trust as we strive to reliably provide ever-cleaner fuel to Californians and our neighbors.

Two propositions ostensibly justifying the emergency regulations are wrong. First, the claim that regulation is justified because “price spikes are profit spikes” is misleading. Second, the claim that “refiners did not adequately prepare for [planned maintenance events] by increasing inventories and imports,” while we do not speak for other refiners, we believe this to be uninformed and not how we operate.

Economic fundamentals force prices up when demand outstrips supply. This signals the need to bring in more expensive finished gasoline or blending components. These statements about price spikes also overlook that supply shortages are an outcome of California’s regulatory policy and fail to reflect the energy industry’s cyclical nature. While we do not purport to speak for the industry, quite apart from the unfounded allegation of price gouging, there are many instances where net refining margins are negative, causing refineries to operate at a loss¹.

The suggestion that refiners mishandle inventory prior to shutdowns is likewise an ill-informed generalization. We have contractual obligations to supply our customers and go to great lengths to meet them. It is common sense that refiners use the available tankage infrastructure to store as much product as they can, so that they have inventory on hand to meet California’s high demand, particularly during the summer driving season.

Ill-considered regulation on top of 20 years of bad policy is risky under normal order; to do so under the rush of special session is folly. California's policy choices have led to a gasoline shortage by driving suppliers away. We have a shortage of incentivizing policy for additional refiners and supply. California, stop making consumer conditions worse.

Now that we have addressed the rhetoric behind this action, let’s discuss the bill’s specific issues. The bill still shifts maintenance safety standards to bureaucrats who lack refining experience, taking it away from knowledgeable experts and regulatory agencies responsible for protecting refinery workers and our community. This undermines the decades of expertise our teams maintain for ensuring safety in refining operations.

Prior to the Assembly's vote, you asked industry to present a case to refute the alleged costs savings of billions of dollars for consumers - claimed by the policy advocates. We contend that enforcing a mandatory minimum inventory requirement will likely result in two negative outcomes: an increased frequency and duration of supply shortages, and a permanent rise in gasoline prices for consumers. Both risks extend beyond California, which should create the need for the legislature to proceed with caution, as policies that raise prices for the state could also affect neighbors in Arizona and Nevada.

How does this bill potentially exacerbate shortage events long enough to form lines at gas stations?  We ask this because DPMO and CEC have not analyzed the existing capacity constraints available to refiners. The graph² that DPMO presented as their sole evidence of viable refiner inventory footprint ignores the potential capacity constraints related to fuel specification seasonality, available marine shipment capacity and blending tank working capacity³. These capacity constraints may reduce storage available during higher demand months. Furthermore, mandatory inventory thresholds remove significant supply from the market that refiners would otherwise sell, creating an economic fundamental of driving up wholesale prices. When refiners build and maintain inventories, it reduces the quantity available for immediate sale, thus restricting supply.⁴

How does this bill create permanent gasoline costs to consumers? There is significant cost involved in building and sustaining a mandatory inventory threshold that is not included in the proponents’ cost analysis. Costs to consumers can occur either by creating the shortage of supply which shifts the marketplace fundamentals as described in Appendix B or because refiners must secure additional storage. For example, just 20 cents per gallon in carrying costs leads to billions of dollars per year in extra expenses for Californians and our neighbors⁵. Costs to hold extra inventory would be on top of the prices paid during the price volatility seen when demand outstrips supply.

That ABX2-1 lacked additional amendments, despite extensive stakeholder feedback during the hearings, demonstrates that the Assembly chose to act based on politics— under the veil of a thinly studied basis fabricated by CEC and DPMO. Assemblymembers shared concerns regarding the bill’s language. They provided critical feedback and recommendations such as addressing safety concerns by removing the CEC’s authority to limit timing for planned maintenance; ensuring a robust process for drafting regulations; ensuring a shorter timeline for requirement sunset; and establishing an independent review panel to participate in regulatory decision-making. These suggestions and other opportunities for improvement were ignored. This bill makes bad policy worse—it suffers from the dearth of debate and informed analysis needed to address the complexity of the issue.

I leave you with final thoughts to consider. Without investment in the critical energy infrastructure that allows California consumers to live their daily lives, your body will ensure these products become more expensive and less reliable. The California gasoline marketplace is constrained, and government manipulation will only increase prices⁶. To boost supply and reduce consumer costs, we need to rethink the policies that limit supply. We urge consumers in California, Arizona and Nevada to contact their governments to ask about the cost of any new or amended energy policy. We will do our part to ensure California consumers are informed about your role in shaping policies making life even more unaffordable.

Responsible refiners make investment decisions every time equipment becomes closer to their end-of-life and requires routine maintenance to sustain safe and reliable production capacity, for example Chevron spends nearly $800 million dollars in annual capital to maintain our refining facilities. These policy decisions can cause the idling of units as refiners consider whether to reduce the on-going capital needed to maintain capacity infrastructure or pursue opportunities to expand production and capacity in other states. Voters will hear about how you’ve made the state “uninvestable” by reducing refiners’ incentive to invest the annual capital needed to maintain the fuel production capacity needed to keep California, Arizona and Nevada energy costs affordable, reliable and ever-cleaner.

Sincerely,
Andy Walz
President, Downstream, Midstream and Chemicals

¹ Chevron Response to RFI Maximum Gross Refining Margin and Penalty Docket 23-OIIP-01 March 3 2024; see “It ignores operating costs” for more information on Volume-Weighted Gasoline Refining Net Margin

² See Figure 1 in Appendix A; DPMO A Seller’s Market: Resupply and Minimum Inventory Requirements Presentation to ABX2-1 Assembly

³ See Figure 2 in Appendix A for more details on a typical mogas systems.

⁴ See Appendix B for more details on the economic fundamentals

⁵ Assumes annual gasoline consumption of 13.3 billion gallons in 2024-25

⁶ See Appendix B for more information on the economic fundamentals and the bill risks to supply and price

⁷ Western States Petroleum Association Comments – Preliminary WSPA Margin Cap Framework Workshop Comments

⁸ Turner Mason & Company Comments – Transportation Energy Supply Chain Infrastructure and Investment Study (TESCII) – Turner, Mason & Company – June 15, 2024; at https://efiling.energy.ca.gov/Lists/DocketLog.aspx?docketnumber=23-OIIP-01 and https://efiling.energy.ca.gov/Lists/DocketLog.aspx?docketnumber=23-SB-02

Appendix A – Refinery Mogas System Constraints⁷

Figure 1

From DPMO A Seller’s Market: Resupply and Minimum Inventory Requirements Presentation to ABX2-1 Assembly, DPMO and CEC point to the graph above showing gasoline stocks higher in winter and early summer. This graph intends to show available inventory footprint but lacks consideration of the liquidity constraints in refiners blending systems & marine shipment.

refiners store more in the winter and early summer, less in late summer and early fall

monthly average refinery stocks of refined gasoline and blending components, thousands of barrels

Figure 2

sample refinery mogas system*

Structurally, component tanks are always kept well below full capacity for operational reasons:

Full component tanks force process unit cuts (less gasoline production)

Empty components tanks cause product blending disruptions (less gasoline production)

1. When the DPMO reference winter inventory they do not account for the differences needed for seasonal fuel specifications that change between winter and summer months. In addition, there are bottlenecks in marine importing and mogas refining blending processes that will change between low and higher demand months. The DPMO graph does not account for these bottlenecks. We attempt to describe those in the sections below.
2. When the DPMO or CEC refers to “days of supply,” of the average refinery stocks as shown in the graph above, they fail to recognize or communicate that half of the typical refinery inventory on hand is in the form of gasoline components (the ingredients needed for gasoline blending). If one of these key components runs short, it can make all other ingredients “unblendable.” This would be like trying to make a cake without having sugar.
3. The component tanks are continuous production tanks for the raw ingredients being produced by several processing units across a refinery. A refinery will almost always see these tanks well below 100% capacity because there is an inherent safety risk if one was overfilled. As such, avoiding this risk involves turning down operations at processing units, resulting in less gasoline components production (i.e., less gasoline).
4. It is not possible to run at 100% capacity in finished product tanks. You can see in the sample illustration below that you will always have one tank that has been blended and certified, while there are other tanks that are being blended or being emptied (by definition, you will typically see these at well below 100% total capacity).
5. Low refinery tank utilization across a system like this is very realistic. This is not a function of artificially low inventory, but rather that reality of the complexity that makes up blending CARBOB gasoline. There simply are not enough tanks today to hold additional finished blends for storage.
6. When a refinery experiences a single unit upset (e.g., a Fluid Catalytic Cracking unit), it does not lose finished gasoline – the refinery loses production of key components to produce finished gasoline. This can quickly limit the refinery’s ability to produce CARBOB blends within just a few days’ time.
7. Marine traffic and capacity face significant limitations currently and will encounter even more in the future. due to Jones Act Tonnage available. Policy that reduces in-state crude production will impact refiners marine capacity. Regulations that constrain emissions At-Berth will create additional constraints. It appears WSPA has begun to investigate this to help policymakers understand this further through their TESCII Report.⁸

Appendix B – Economic Fundamentals

Although CEC and DPMO assert that refiners have sufficient capacity, they overlook the limitations imposed on refiners during periods of high summer demand. These constraints arise from restricted marine shipment capacities and operational constraints with mogas blending systems within refineries. We are deeply concerned that if CEC and DPMO continue to assume refiners have unutilized capacity then they will unintentionally shift the “equilibrium market price”. Below are diagrams describing how ABX2-1 restrict supply in the wholesale market.

• Equilibrium: Without ABX2-1, the wholesale market is in equilibrium at the “Equilibrium Market Price” and “Equilibrium Market Quantity,” where quantity demanded equals quantity supplied.

ABX2-1 restricts supply:

• ABX2-1 restricts supply as refiners build to mandatory inventories (taking supply out of the market that refiners would otherwise sell) and, as a result, wholesale prices increase
• ABX2-1 will also restrict supply and increase prices when refiners would otherwise sell some of their mandatory inventory during, say, mild price spikes in the middle of summer

Deadweight Loss: This inefficiency will adversely impact the downstream market: the supply reduction in the wholesale market will cause an equivalent supply reduction in the retail market, increasing retail prices.