Werner's Blog — Opinion, Analysis, Commentary
Refining margins in BC and across Canada

Last week (at the end of April 2019) gasoline prices reached unprecedented heights in the Lower Mainland of British Columbia. $1.70 per liter made many motorists ask: why are these prices so high? Some political pundits were quick to blame price gouging by oil companies and pointed to the refining margins in BC, which tend to be higher than in other parts of Canada. How large are these differences, and what explains them? Does something need to be done about high refining margins?

To begin with, what exactly is the refining margin? It is the difference between the wholesale gasoline price charged by the refiner (also known as the rack price) and the crude oil price (including transportation costs). Crude oil is, of course, the main input in gasoline. The marketing margin is also important, and it refers to the difference between the retail price of gasoline (before taxes) and the wholesale rack price.

Refining Margin, Vancouver, 2016-2019

click on image for high-resolution PDF version

The chart above shows the refining margin for Vancouver since July 2016 (as provided by Natural Resources Canada). The margin normally hovers around 40 cents per liter, but can shoot up when there are capacity problems. In October 2018 the Enbridge natural gas pipeline ruptured, and as a result refineries were cutting down output as they rely on natural gas for a (cheap) source of energy for their operations. This generated a local shortage in supply, and refining margins spiked to 70 cents per liter. As inventories were replenished in January, the margin dropped back to under 30 cents. Since March 2019, the margin has been rising quickly again and reached 55 cents per liter by the end of April. Is "price gouging" to blame, or are there a different explanations?

It is true that there is very little local competition, because BC is a relatively peripheral market. Fuel production is concentrated among few firms, and this lack of competition does increase prices somewhat. However, there is a limit to that because refineries can ship their product to markets where prices are higher, and this arbitrage keeps a lid on the differences that can emerge.

More important is how each refinery secures supply. The refinery in Burnaby (owned by Parkland Fuel, and previously by Chevron) with a capacity of 55,000 barrels (8,700 cubic meters) per day relies on supplies from the Trans Mountain pipeline. It competes for capacity on this pipeline as it is also used to transport fuel to international markets. A price spread between international crude prices and landlocked (Canadian) crude prices reduces the capacity available for importing fuel into British Columbia, which in turn raises refining margins. The refinery can also source more crude by relying on rail, but this is more expensive as a means of transportation and also adds to the refining margin.

So what is making refining margins spike again in March? While the Enbridge accident last year provided a clear and simple explanation, the rise in March indicates a local shortage of supply. This appears to be a temporary spike and is likely to subside and return to the long-term average soon. The current 15 ¢/L excess margin will very likely disappear in the next weeks. It is also useful to look at trends in refining margins elsewhere in Canada. The refining margin in Edmonton has increased as well, but not as much as in Vancouver. The high refining margin is a regional phenomenon driven largely by international prices, and spreads between different types of crude oil. There is no reason to expect that significant price deviations will persist once markets adjust.

‘The Trans Mountain pipeline expansion would bring, at best, only little relief for gasoline prices in BC.’

What is perfectly clear is that the current price spike has nothing to do with the proposed expansion of the Trans Mountain pipeline—as Alberta's new premier Jason Kenney has asserted. The spike in gas prices is clearly not the fault of the BC government, nor is it the fault of the federal government. Even if and when an expansion of the Trans Mountain pipeline is built, it may not necessarily bring much price relief to BC. The expansion will provide more capacity to ship refined product, but it will still compete with crude oi going to export markets. This means that refining margins have to be sufficiently high to make this more profitable than using the pipeline capacity for exporting bitumen to foreign markets. At the margin, BC will benefit from increased capacity and increased supply. However, by the time the pipeline expansion would come online, BC will have a larger population and yet more demand for gasoline—unless technological change (or higher fuel taxes) improve fuel efficiency faster than population growth. It is therefore unlikely that a completed Trans Montain pipeline will bring much price relief to BC; at best a little, but probably not much.

The Trans Mountain pipeline is actually quite unique: it is the only pipeline in North america that carries both refined products and cruide oil in "batches". Batching means that on any given day, product is moved sequentially from heavy crude to light crude to distillates to gasoline and back to light crude and heavy crude. The pipeline splits at the Sumas Pump Station and diverts some of the product to the Puget Sound pipeline that carries product to referineries in Washington State. The pipeline's capacity of 300,000 barrels per day is allocated 19% to the Burnaby refinery, 26% to marine exports, and about 55% to Washington State. There are five refineries in the Puget Sound area, and some of the crude processed there makes its way back into BC. The capacity of these five refineries (at 647,000 bbl/d) is about eleven times larger than the capacity of the Burnaby refinery.

The table below shows the refining margins and marketing margins across Canada, averaged over the 2-year period from April 2017 to March 2019. The table is sorted in ascending order of the mean refining margin. The table also shows the 5th percentile and the 95th percentile of the distribution of margins, which provides a sense of the typical range. Vancouver's refining margin averages about 40 cents, and most of the time (actually, 90 percent of the time) falls between 31 and 59 cents.

City Refining Margin Marketing Margin
5th Pct.
95th Pct.
5th Pct.
95th Pct.
Fredericton 9.8   1.0   15.0   9.1   5.2   13.9  
Halifax 9.9   1.5   14.9   8.4   4.4   12.7  
St. John's 10.4   1.8   15.7   9.5   4.9   15.5  
Charlottetown 11.1   2.2   16.1   10.5   6.7   14.0  
Montreal 14.6   6.4   19.7   7.4   2.2   12.7  
Quebec 14.6   6.4   19.7   4.9   0.3   9.9  
Ottawa 26.9   12.0   37.6   8.4   2.1   12.5  
Edmonton 27.0   16.9   45.6   5.9   -0.3   12.4  
Yellowknife 27.0   16.9   45.6   31.9   22.5   44.8  
Toronto 27.4   12.1   38.2   10.9   8.5   13.2  
Saskatoon 29.0   18.9   47.6   7.6   2.8   14.6  
Calgary 29.4   19.3   48.0   6.5   0.3   12.6  
Winnipeg 29.7   19.5   48.3   5.5   -2.1   12.0  
Vancouver 40.4   30.5   58.8   12.0   9.7   14.5  
Whitehorse 40.4   30.5   58.8   23.5   10.4   35.3  
Victoria 42.0   32.1   60.4   9.6   3.3   15.4  

The table shows that the West Coast has some of the highest refining margins, and Atlantic Canada (which imports oil mostly from European, African, and Middle-East markets) has some of the lowest refining margins. The differences largely reflect market conditions and geography. BC has the distinct disadvantage of limitations in refining capacity and transportation capacity. This means that fluctuations in demand make prices (and espeically refining margins) more volatile than in other parts of the country.

A quick look at the marketing margins also shows large differences across Canada. The highest margins exist in Whitehorse and Yellowknife, where fuel products face high transportation costs. Marketing margins are highly influenced by the cost of operating a gas station, and thus the cost of land in urban areas. Vancouver, with sky-high real estate prices, has a 12 ¢/L marketing margin on average, about a cent higher than in Toronto, but nearly 5 ¢/L higher than in Montreal. There is some variation in marketing margins, which in Vancouver amounts to a range of about 5 ¢/L. Variation reflects local market conditions as well as intra-week pricing strategies.

‘At 55¢/L, the refining margin is about 15¢/L above its long-term average, and this premium can be expected to subside in the next weeks.’

What is the outlook on gasoline prices in Vancouver? Refining margins are unusually high, but there is every reason to believe that markets will adjust to changed circumstances and refining margins will return to long-term averages around 40 ¢/L in Vancouver. As a result, gasoline prices are probably about 15 ¢/L higher than they would be under normal conditions. It is reasonable to expect that prices will fall a bit in the next weeks.

In the long term, population growth in the Lower Mainland adds more demand, and unless there is a significant switch to electric vehicles or improved fuel efficiency, this higher demand will translate into higher prices. Motorists who buy a new vehicle should take this into account and conduct a "stress test" in the same we it is now common for mortgages. Can I afford my (new) car if fuel prices rise by 20-40% in the next few years? For practical purposes: can I still afford my car if gasoline prices reached $2.00/L permanently? If the answer is no, motorists should look for more fuel efficient options, including hybrid-electric and battery-electric options, as well as alternative modes of transportation.

What are the implications for public policy?

The last two weeks have seen a lot of commentary from public figures about the high gasoline prices in Metro Vancouver. There is even a sense of panic that "something has to be done about it." Some suggested price caps or lowering fuel taxes. Both suggestions are entirely misguided and counterproductive approaches. Price caps would be ineffective, and additional price spikes (from increases in crude oil prices) would lead to rationing and line-ups at gas stations. Some governments tried this in 1973 after the first oil price shock. It didn't work then and it doesn't work today. Some governments around the world subsidize fuel prices, at great detriment to their societies. Most notorious is Venezuela, which boasts gasoline prices of 2 cents per liter.

Lowering fuel taxes would simply blow a big hole in the provincial budget. Most of the 10-¢/L provincial component goes to a dedicated fund for road infrastructure and public transit, and only 1.75 ¢/L is general revenue. The carbon tax currently amounts to 8.89 ¢/L, but it is in place to reduce emissions, not encourage increased driving. Even if taxes were reduced, this would not be enough to lower prices significantly. Recall that refining margins have moved between 30 and 70 ¢/L—that is a range of 40 ¢/L. Lowering fuel taxes would never be enough to keep a cap on gasoline prices (except if fuel taxes are at a level as in Germany at $1/L, which might provide enough room to buffer market price fluctuations). Those who suggest lowering fuel taxes should make it clear first how they would make up the budget shortfall. Which other taxes would they raise, or which government programs would they cut, to make up for the difference?

Yet others suggested regulating prices through the BC Utilities Commission. But unlike electricity and natural gas, there is no natural monopoly here that needs to be regulated. The market for gasoline is imperfectly competitive, but there is no monopoly. The lack of competition is a local phenomenon, not a global phenomenon (beyond the six or seven oil majors there are dozens of smaller companies). At best, price regulation could dampen some of the fluctuations. At worst, retail price regulation would run into crisis when input prices spiked unexpectedly, leading to critical shortages as prices would be unable to match supply with demand. Involving the BC Utilities Commission is not going to solve the problem of high prices.

‘British Columbians actually enjoy one of the lowest gas prices in the western world; all OECD countries except the United States have much higher fuel taxes and gasoline prices.’

So what is left to do then? There is simply no short-term fix. The market needs to do its magic to match supply and demand through flexible prices—and prices may spike and sometimes will set a new record. Perhaps a change of perspective will help alleviate "fuel cost anxiety." British Columbians should celebrate their good fortunes even at $1.70/L. The web site GlobalPetrolPrices.com tracks gasoline prices around the world each day. On April 29, 2019, Canada's average was $1.52/L. In Germany it was $2.20/L; in Sweden: $2.40/L; in Norway $2.66/L; and in Hong Kong $2.97/L. Among OECD countries only the United States was cheaper, at $1.12/L. In short: British Columbians actually enjoy one of the lowest gas prices in the western world; all OECD countries except the United States have much higher fuel taxes and gasoline prices.

In the long term, the only solution to high gas prices is lower demand through significantly improved fuel efficiency or through electrification of the transportation sector. High gas prices may be a blessing in disguise: they may accelerate the inevitable transition. Rather than complain about high gas prices, motorists should look to the future and plan for fuel prices that sooner or later will top $2/L.

Further readings and sources:

Posted on Wednesday, May 1, 2019 at 19:55 — #Economics | #BC | #Energy
© 2024  Prof. Werner Antweiler, University of British Columbia.
[Sauder School of Business] [The University of British Columbia]