Avgas Prices

The price of automotive gasoline jumped about four cents a litre last night across most of the country and, of course avgas prices will soon rise along with that.

As the price of one fuel goes up the other follows, because they all come from the same feedstock and the same factors, like refining and transportation affect the prices of both. Avgas remains higher in price, mostly because it is more expensive to make with the special handling required due to its tetraethyl lead content.

Today, 4 April 2012, in Ottawa auto fuel is at $1.324 per litre. The Smith's Falls Flying Club is good enough to post their avgas price on their website and keep it up to date and they are selling 100LL for $1.816.

Of course the comments on CBC articles about this story are full of the usual whining and conspiracy theories about why gas prices are so high.

One CBC commenter said "Crude shortage not the problem. No... the problem is greed."

Others take the "government should do something about this" approach. Another CBC commenter said "People are hurting. Yet what does the government do to relieve the pressure on strapped Canadian families? Nothing. Absolutely nothing."

In a free market, and our current federal government very much believes in the free market, the government has no role to play in supply and demand. The market will sort prices and supply out on its own. In 2008 our current PM was asked to lower taxes on gas and he refused, pointing out he would have to raise other taxes to make up the loss.

The truth about what is going on with prices lies not in a lack of government action or even in oil company gouging, but elsewhere. As John Quarterman explained in his talk to Flight 8 in March 2010 these higher prices have been long expected and fairly accurately predicted as well. Marion King Hubbert told us this was coming early in the 21st century, back in 1956 and here we are.

We know that world oil production has been flat since the end of 2005. We also know that world demand for oil overall is up. The OECD countries' demand is generally down, including the USA which has reduced demand by about 5% over last year, mostly through high and persistent unemployment, but demand in India and China is way up, more than compensating.

We also know that the cheap and easy to find oil was burned long ago. Oil today comes from very deep wells in places like the deep water off shore. Production of this oil is expensive.

The growing threat of war in the Middle East is also a factor. The Iranian government has predicted that oil will go to $440 a barrel if anyone attacks them and that they will take military action in the Straits of Hormuz. Every day 25% of the world's oil passes through the straits, so $440 a barrel might turn out to be an understatement. Hopefully we will find a diplomatic solution and then we won't find out if they are right or not.

There are more reasons for price increases and closer to home, though.

Roger McKnight with Oshawa-based En-Pro International Inc is quoted in that same CBC article and he has hit one of the major reasons why prices are going up and are likely to stay up. The reason is refinery capacity.

Many years ago oil companies were very "vertically-integrated", meaning that they owned the whole supply chain. They did exploration for oil, drilled wells, produced the oil, transported it, refined it and retailed it. Then the oil company economists looked at what they were doing and discovered that some parts of the operation were making money and other parts weren't. Retailing and refining were money-losers and were mostly were sold off.

Today anyone running a gas station will tell you that they make almost zero money selling gas. They make their money selling milk and lottery tickets to people who stop for gas. At least they have a model that works for them. Most refiners don't.

Refiners buy crude oil, refine it and then sell the product to the retailers. Their costs are very high, a new refinery can cost $10 billion to build and their margins are so low that they are mostly losing money here in North America. With US gasoline consumption down it doesn't make sense to build new refineries or even to fix old ones. The money losing ones are being closed and refining consolidated. So far, of the five existing US east coast refineries four have been closed and the last one is on the chopping block, up for sale with no one lining up to buy it. If it isn't bought it will be closed this summer.

ASPO says: "The loss of refining capacity in the Northeastern US continues to pressure prices. The EIA says the operating refinery capacity in the region is down to 1.2 million b/d from 1.6 last summer. There is still no word on the sale of the Philadelphia area Sunoco refinery which may be closed in July sending the region’s gasoline situation into crisis."

"That region" is us.

With Montreal's refineries long closed, the Ottawa area has been supplied by those closed (and closing) east coast refineries. So where will we get our avgas and car gas from in the future? From the US Gulf of Mexico coast refineries. Yes, they will truck gas all the way here from Louisiana.

Even a few years ago Ottawa had gas storage tanks on West Hunt Club, but those are mostly gone now. Nobody stores gasoline anymore, if they can avoid it, as it is too expensive to do that. Imagine the insurance costs alone on an urban tank farm. No, instead we do "just-in-time delivery" now, meaning a steady stream of tank trucks driving from Louisiana to Ottawa to keep our gas station and airport retail tanks full, all arriving just as the tanks empty. The transportation costs will be high and so gas prices have to rise to pay for it, but not as far as if new refineries had to be built.

The greater danger, especially with a long supply chain like that is disruptions, like a refinery fire, a hurricane (the gulf coast gets those), highway closures or tanker trucks breaking down, will occur. Any one of those could mean local fuel supply shortages in Ottawa. That long supply route will mean higher gas prices this summer, but it also might add up to a period of time where we have no gas at all - not for planes and not for cars, either.

The inability of refiners to make money refining over the last ten years has manifest itself in this long and very fragile just-in-time delivery system, that will be subject to disruptions. If we had accepted higher retail prices a few years ago to give refiners a better cut we wouldn't be in this situation, but we are here now.

Of course the general population will keep whining that it is all an oil company conspiracy and that the government should do something about it, but whining won't accomplish anything. The free market sets the prices and consumers of avgas and auto fuel will individually have to decide for themselves whether they are "in" or "out" of that market. When enough people drop out then demand will stabilize and so will prices.

These sorts of situations always have a silver lining, though. High fuel prices will result in fewer people driving and flying, so the roads and airports will be less busy. There will be less airline flying as ticket prices rise to account for the price of fuel, too.

The price of used aircraft will fall, too meaning this will be a good time to buy an airplane, as long as you can afford the gas!

Will this prove to be a price spike or a new permanent price for fuel? Probably both. Prices will probably spike this summer and then settle down to a new normal, that, with the long transportation chain will be higher than the old normal price. We'll have to see how it shakes out.

What will happen if we do have a period with no fuel available here, due to, say, a gulf coast hurricane? Well a bicycle would be a good idea. Just don't ask the government to do something about it.