Shale oil boom and the profitability of US petroleum refiners

• Date: 01 December 2016
• DOI: http://doi.org/10.1111/opec.12089
• Author: W. D. Walls,Xiaoli Zheng
• Published date: 01 December 2016

Shale oil boom and the profitability of US

petroleum refiners

W. D. Walls* and Xiaoli Zheng**

*Professor Department of Economics, University of Calgary, Calgary, Alberta T2N-1N4, Canada. Email:

wdwalls@ucalgary.ca

**Doctoral candidate. Department of Economics, University of Calgary, Calgary, Alberta T2N-1N4, Canada.

Abstract

This article provides a quantitative analysis of how the recent boom in US oil production—largely

a result of shale oil production—has impacted the domestic petroleum refining industry. We

quantify how domestic crude prices are related to refiners’financial performance. The estimates

suggest that since 2011 independent refiners’profitability rose by 3 per cent for a domestic crude

oil price decrease of 1 per cent, while they were not associated with domestic crude prices before

2011. The relation between refinery profitability and domestic oil prices is consistent with the

results of pass-through of relative domestic crude prices to relative refined product prices in the

United States before and since the dramatic rise in shale oil production.

1. Introduction

Increased shale oil production since 2011 has had several important effects on refinery

markets in North America. Firstly, due to the US crude oil export ban and pipeline

constraints, increased production from shale oil in the Midwest resulted in excess supply at

the Midwest and Mid-Continent market locations. Beginning in 2011, the domestic

oversupply resulted in the WTI price—the North American benchmark price which is tied

to light sweet crude oil—being depressed relative to Brent Blend, the international

benchmark crude oil price (see Fig. 1 below). The increasing abundance in domestic

supply has rekindled policymaker interest in whether or not the United States should lift the

ban on crude oil exports.

1

Some stakeholders are strongly against lifting ban, with refiners

claiming that lifting the ban on crude oil exports would increase domestic crude oil prices,

thereby leading to more costly gasoline and diesel fuel (U.S. GAO, 2014). According to

this argument, the reduced incentives to refine may result in rising finished product prices.

Rising domestic oil supplies—largely the result of increased shale oil production

—stimulated much interest about the potential effects of removing the US ban on

crude oil exports.

2

Brown et al. (2014) argue that lifting the ban on crude oil exports

may lower domestic gasoline prices because foreign refiners are better suited to refine

©2016 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

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337

light sweet crude oil than are US refiners. Borenstein and Kellogg (2014) found that

depressed crude oil prices in the Midwest did not affect gasoline and diesel prices in

the region during the period 2006–2011. These studies suggest that as the United

States does permit exports of refined products—and because refiners will charge the

same fuel price in domestic as in world markets adjusted for transportation costs—

rents from lower crude prices in the Midwest would have accrued mainly to refiners

in those areas. US gasoline and diesel fuel markets have remained integrated with

global markets, even if the global market for crude oil has fragmented (Kilian, 2014;

Zavaleta et al., 2015). In some ways, the removal of the Alaska North Slope (ANS)

oil export ban in 1995 offers lessons for the potential effects of removing the oil

export ban nationally: the effect of removing the ban on ANS exports in 1995 led to

an increase in ANS crude oil prices relative to other comparable crude prices;

however, gasoline and diesel prices in West Coast markets did not increase

correspondingly (Bausell et al., 2001).

Has domestic refinery profitability been impacted by domestic crude prices as a

result of the boom in shale oil production? Have lower domestic crude prices (relativ e to

international crude oil prices) passed through to domestic refined product prices? In this

article, we provide answers to these questions through an analysis of regional- and

firm-level data. We confirm that US gasoline and diesel fuel prices are determined by

international rather than domestic crude prices and that there is almost no pass-through

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Figure 1 Brent and WTI prices.

Data source: EIA.

OPEC Energy Review December 2016 ©2016 Organization of the Petroleum Exporting Countries

338 W. D. Walls and Xiaoli Zheng