Refiners’ profits spur scrutiny from special legislative session

Several major firms that refine crude oil into gas in California have been doing well lately, a contrast to consumers facing gas price hikes.

The net income of the Valero Energy’s Western region profits from the company’s California refineries only topped 60 cents per gallon in the third quarter of 2022 after reporting second quarter profits of 83 cents per gallon. “Valero’s California profits were once again higher than any of its other regions in the country and the world,” according to a Consumer Watch analysis.

Meanwhile, PBF Energy Inc., the third-biggest oil refiner in the Golden State, reported that its profits tripled to 78 cents per gallon in third-quarter 2022.  “PBF’s profits per gallon were 48 cents on the Gulf Coast, 49 cents per gallon on the East Coast, 55 cents per gallon in the Midwest – an average of 50 cents across the rest of America,” according to Consumer Watch.

“These (refiners’) profits may be a result of a free market, but it is not a competitive market.” — Jeffrey Michael

The consumer group also noted that Chevron posted refining profits of $2.5 billion dollars in the third quarter, almost double the same quarter the year before. Half that amount came solely from US refining operations, according to the company’s financials.

“But consumers will only learn how much of Chevron’s profit specifically came from California when a new state refiner transparency law kicks in,” Consumer Watchdog said in an Oct 28 written statement.

Against this backdrop, Gov. Newsom has called for a special legislative session in December focused on capping windfall profits (like PBF and Valero’s recently) and a price-gouging rebate for consumers. That return of refiners’ profits to consumers’ pockets would help them to buy gas despite its rising price.

A major oil industry executive counseled caution, and noted the market’s volatility.

“There are hard times, as we saw just two years ago where we had enormous losses,” Chevron Chief Executive Officer Mike Wirth said on Bloomberg TV. “You move into another part of the cycle and you have strong earnings. Good times don’t last just like the difficult times don’t last. We have to invest through those cycles.”

Wirth rejected the idea that current profits are a windfall and warned politicians against enacting any “short-sighted” policies that would restrain investment.

One approach to the above economics and politics is to unpack how the free market connects with government oversight. We turn to Jeffrey Michael, a professor of public policy at McGeorge School of Law in Sacramento.

“These (refiners’) profits may be a result of a free market,” says Prof. Michael, “but it is not a competitive market. When a market is served by a few firms and price changes are disconnected from costs, government oversight is warranted.”

In other words, the refiners’ profits do not result from rising costs of production but from their strength as monopolies that dominate an industry. Controlling the supply of gas allows monopoly firms such as PBF and Valero to set prices above what it costs to bring their product to consumers, an anti-competitive practice.

In terms of governance to combat an anti-competitive industry, Prof. Michael offers the following advice.

“Now, with high demand for refined products domestically (e.g., after Russia’s invasion of Ukraine), there is not enough capacity to meet demand.” — David Rapson

“The need for thoughtful government oversight may grow in importance as California moves away from gasoline vehicles and the gasoline market contracts over time. Getting the details of a windfall gasoline profits tax correct is tricky. My concern is that legislators will be more focused on distributing rebates than understanding the current and future market and the best way to structure any special tax or regulatory policies.”

David Rapson is the Chancellor’s Leadership Professor in the UC Davis Economics Department. According to him, the main issue to address is underinvestment, or too little capital allocated, in refinery capacity. What led to that?

“Years of low profitability and a highly uncertain regulatory environment for owners of refineries in the future (environmental, social and governance (ESG) and climate policy) have reduced investment,” Rapson says. “ESG “scores” increase as firms divest or close dirty assets like refineries, and this is one (but not the only) reason why the U.S. had a 5% decline in refining capacity over the pandemic.

“There are hard times, as we saw just two years ago where we had enormous losses. You move into another part of the cycle and you have strong earnings.” — Mike Wirth

“Now, with high demand for refined products domestically (e.g., after Russia’s invasion of Ukraine), there is not enough capacity to meet demand. The outcome is that the existing refining capacity is scarce. High prices are sending a signal that more investment is needed, but investors are hesitant.”

Catherine Wolfram is deputy assistant secretary for climate and energy economics at the U.S. Treasury, and an economics professor at UC Berkeley. In her view, California’s December legislative session on refiners’ business practices is necessary.

“I think California refiners’ margins deserve some scrutiny,” she says, “as the governor has proposed. While it’s true that crack spreads (the difference between the price that a refinery sells a barrel of refined product for and the price for a barrel of crude oil) have been high globally for a number of reasons since the beginning of 2022, there’s something particularly out of whack with California gas prices.”

Professor Rapson also counsels caution, warning Californians and their elected officials to be careful of what they want.

“Policy proposals like a windfall profits tax,” he says, “a refined product export ban, or nationalizing refineries will further decrease the incentive for investment dollars to flow towards building and maintaining refineries.  While environmentalists would likely cheer, this will have several predictable effects—higher profits for existing/remaining refineries, higher and more volatile prices for consumers, and eventual need to import product from abroad (or export less).”

In such a scenario, one policy choice is to increase government investment. We will see if the December legislative session considers state government’s power to tax as a way to raise investment capital.
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Editor’s Note: Seth Sandronsky reports regularly for Capitol Weekly. Contact him at [email protected].