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Aside from the weather, gas prices might just be the most popular point of conversation for Canadians these days. Everyone seems to be an armchair expert on the subject.
In this episode, we explore what’s behind those ever-changing numbers at the pump with the help of Jennifer Stevenson from the Scotia Global Asset Management Investment Team.
Key moments in this episode:
1:01 — The biggest factor when it comes to the cost at the pumps
1:53 — Why refineries are another large factor in gas prices
3:26 — Why there are so many unknowns in the process, from refinery to retail, that impact prices
5:01 — Gas stations often make more money from chocolate bars than gasoline
5:56 — Why there are fewer and fewer refineries
7:23 — How the war in Ukraine is affecting gas prices and why that may soon change
9:00 — A breakdown of why OPEC has reduced their supply recently
11:15 — Explaining Biden’s use of oil reserves
13:34 — Why a recession may be the only thing that slows energy prices
Transcript:
Stephen Meurice: There's a cliché that Canadians love talking about the weather, but a close second in terms of topics has to be the price of gas. Is it going up, down, cheaper across town? Downtown? Uptown? Out of Province? Everyone seems to be an armchair economist on the subject. So, this episode we're exploring what's behind those ever-shifting fuel prices. Jennifer Stevenson is our guest. She's Vice President and Portfolio Manager on the Scotia Global Asset Management Investment Team. Her focus is the global energy industry. She’ll demystify those mercurial numbers at the pump and break down some recent headlines you might have seen about the global oil market. I'm Stephen Meurice and this is Perspectives.
Jennifer, thanks so much for being on the show.
Jennifer Stevenson: Thanks so much for having me, Stephen.
SM: Okay, let's get right into it and talk about the price of gasoline, which seems to go up and down at a crazy rate, sometimes several times in the same week. How does that happen? Why does the cost of gasoline vary so widely from day to day or week to week?
JS: There's a few factors that play into that. The biggest one, not surprisingly, is the price of oil. And it's not the price of oil today as much as the price of oil when the refinery bought it to make us the gasoline that we need or the diesel that we need or the jet fuel that we need. So, the typical refinery cycle, they get the oil from the field, get it to the refinery, turn it into those products that we need. There's about 45 days. So, one of the reasons the gasoline price might go up today is that the oil price went up 45 days ago. So that's a bit tricky to keep in your head when you're looking at the price on the pump, when you're driving home and figuring out if you should fill up. The other issue is the refineries themselves, whether they're able to maintain a consistent level of throughput. Because we are in a situation where demand for the things that refineries produce, like gasoline, is really strong and the supply of oil is really tight. So, there are times when there can be little gaps in getting enough oil to the refinery. Or there can be little gaps in the refinery itself because it's a complex process. It's a big industrial site. And if something happens and we have any gap in that throughput, that can affect how much they're producing of things like gasoline and that can drive the price up. And that'll be short term, but that can certainly happen as well. And then there's things like governments which throw taxes on consumable products like gasoline. And governments can put those on and take them off. Like, I live in Alberta and the Alberta government took off the tax that it had on gasoline. But, you know, any day now, it could put it back on.
SM: Right. So just to step back for a second, you talked about that 45-day cycle. So, 45 days ago, they paid a certain price for the oil that they're refining into gasoline. But between them now, all kinds of things could have happened that would affect the price they can sell that gasoline for now.
JS: Yeah, that's a really good focus because they know 45 days ago the price of the oil that they bought that they're going to get to the refinery to make the gasoline. But what they don't know yet is anything that's going to happen at the refinery itself or even logistically. Because then we have to get the gasoline out to the gas station. And if we're short of trucks or if there's any hiccup there, that could affect pricing. And then anything like we talked about with governments can affect pricing. But they have knowledge of a big component of the input, which is the oil price, but they don't have knowledge of all of it until the gasoline is actually in that tank at the gas station.
SM: Right. They're just constantly adjusting to the factors that exist at any given time across that entire industry.
JS: Yeah, that's true. And it's also a competitive industry at the gas station level. And not every oil company owns gas stations. So, they will sell the gasoline from their refinery to a company that owns a gas station. And then it's up to that company what they sell the gasoline at. So, when we all see the prices go up, right conveniently before a long weekend. Right? That is the retail level. Somebody has jacked the price up and others will follow or not. And then you've got gas on gas competition and where do you fill up? Do you fill up at the Petro Can on one side of the road or at the Esso on the other side of the road? And pretty soon they're the same price.
SM: Right. So, I also want to ask you about profit margins at gas stations. I was surprised to read recently that they are actually pretty low and I found that interesting.
JS: Yeah, gasoline is a really, really low margin product. I mean, your average gasoline margin is like two or three cents. And companies make money from selling gasoline by the other stuff at the gas station, like chocolate bars and coffee and car washes. So, the profitability is not in the selling of the gasoline. Right now there is profitability in refining because we've got really strong demand for things like gasoline and diesel. We've got tight supply of crude. And we also are short of refining capacity. That's because in North America, we have shut down some refineries. In Europe, they shut down a lot of refineries. Because they get old and to put in the billions of dollars required to update them in a situation where, as an oil company, as a refining company, as a steward of your shareholders’ capital, you look out in this ENG environment and you say, okay, well, we're making a 50-year investment. Is it really profitable and prudent to do that in this situation with ESG concerns and with, at some point in the next 20 or 30 years, we could see a decrease in the utilization of these types of fossil fuels? So, we haven't seen expansions of refining capacity. We've seen shutdowns of older plants when they're not worth reinvesting in. And we've also seen some conversions of refineries. So instead of making products from hydrocarbons, they make things like diesel from renewable sources. So, they make it from things like animal fat or from plants.
SM: Okay. Can you talk about some of those factors in a little bit more detail that drive those prices? I mean you talked about refining capacity a little bit. What else goes into it? I assume geopolitics must play a significant role. What are the big factors driving the global price of oil?
JS: Yeah, big things going into the global price of oil. Geopolitics, certainly. I mean, the war in Ukraine has had a big impact on the price of oil. And the risk is it could have a bigger impact in the next month. Because if we just look at that issue to begin with, Russia invaded Ukraine and the immediate concern was with sanctions being put on anything that Russia was producing, including oil, there would be less oil in the world. But we were concerned at that point that there would be 3 million barrels a day less, which is a big problem because it's really tight out there and we're using everything we can. So, what really happened was that the sanctions were put in place, so that had an initial impact. The transportation costs went up because now Europe's oil is coming from different places. It's all coming by ocean. There's not any coming on a pipeline. But the bigger issue going forward is on December 5th, there's another level of sanctions being put in place from the E.U., the European Union, and that will affect oil that is coming to Europe and using anything from the West like shipping, like insurance or like dollar settlement services. So, the risk on December 5th is that there is actually a physical reduction in the amount of oil that's getting to Europe. So that's a concern. Geopolitics is a big issue right now with the war, but geopolitics is always an issue in determining global oil prices. Because oil prices are global.
SM: Okay, so refinery capacity, sanctions, what else is there?
JS: Yeah, other things that affect oil prices are what OPEC is doing, because they are a big supplier of oil to the global market. So, we just recently saw OPEC actually reduce their supply. And the reason they did that was twofold. One is they understand how tight oil is because demand is strong and supply is weaker. So, we're using up inventories to fill the gap. So, OPEC sees that, understands what that should mean for the price of an actual physical barrel of oil that we can touch. And yet the financial price of oil was going down and down and down because central banks were hiking rates. The world is concerned about inflation and the world is concerned about recession and concerned about maybe there being a reduction in oil demand. And the financial price, the speculative price, was going down. So, what OPEC wanted to do was re-sync the price of what a physical barrel should trade for, with the financial price. So, by cutting production, that financial price went up.
SM: Right.
JS: So that was more in line with where they viewed the physical price. So that made sense. But the other reason they cut production was there is basically no spare capacity. So, if something bad were to happen and that's usually, it's either a geopolitical event like a war or someone drops a bomb on some oil installation or something else, there is no way to pick up that slack and demand is still so strong. So, it also gave them the million barrels of actual production that they cut, that they could bring it back on if it's needed. Because as much as the press likes to, you know, put negative headlines out on OPEC, their focus is to try and maintain certainty and consistency of oil prices and oil supply.
SM: Okay. And on top of the things you mentioned, there's also governments that can influence prices or at least try to. We're a Canadian show, but I think people might have read headlines about Biden using oil from federal reserves of some sort. Can you explain that a bit? And has that influenced prices?
JS: So, the U.S. administration, they keep a supply of crude oil called a Strategic Petroleum Reserve and they keep it for emergencies. So, an emergency might be when there's some massive storm and they need to take those reserves out — they’re in storage — and they can take it out and they can take it to where it’s needed. So, the emergency in the last year and a half has been gasoline prices. Whenever gasoline prices get over $4 American for an American gallon of gasoline, it's the end of the world. The headlines go crazy. Right?
SM: [laughs]
JS: I mean, I do the math here. What am I paying? Maybe six Canadian bucks for a Canadian gallon, but. And nobody's I mean, yeah, it's expensive, but there's not headlines about it. The world's not going to end, so that's okay.
SM: Right.
JS: So, we had the Biden administration do a huge withdrawal from the Strategic Petroleum Reserve, and we call that the SPR just because then we don't have to say so many words. So, he's taking a million barrels a day out of the SPR for six months. And that's going to wrap up basically in December. And even though they've been doing that, inventories in the U.S. have continued to fall because even with that supply, demand is still strong enough that we're drawing down inventories. And gasoline prices did go down, but not as much as you would think. Because, again, we get back to that, we're short refining capacity. You can take the oil out of the SPR in the U.S. and then when you can't refine it in the U.S., you actually export it and get it refined somewhere else. Someone else will turn it into the products that we need, like gasoline and diesel.
SM: Okay, let's just look ahead to the next six months or so or at least through the winter. What do you see coming? What should consumers expect at the gas pump and maybe on their heating bills?
JS: Oh, I'm not going to be Susie Sunshine on this one. Oh, Stephen.
SM: [Laughs]
JS: Going forward, unless there's a big recession, which means that economies and demand for everything retrench. So that's a demand driver. That's not any driver on the supply side. That's going to ease the prices we're paying for energy. So, wishing for a recession sounds really quite horrifying, but that would be the demand way to have lower energy prices. There is not a supply way to have lower energy prices if we continue with demand the way it is today. Because oil companies are very focused on managing the resources they have and making sure that those resources in the ground are developed in such a way that their shareholders make returns on them. The oil companies pay tremendous amounts of royalties, property taxes and cash income taxes to the government. I mean, there was one big Canadian oil company that had its investor call from their third quarter. And year to date, they have paid $11 billion in those taxes. So, because they're managing shareholder returns, managing the balance sheet, making sure their debt is prudent and paying it down, making sure their shareholders are getting dividends — because that's part of the shareholder value equation. They're not spending large amounts of capital to grow their production in an extremely quick way. Because, again, when you're developing oil and gas reserves, you're putting the money in today and you're getting your returns out over 10, 20, 30 years, depending on the nature of the resource. Though, in an environment where we're very focused on reducing carbon footprint and the longevity of hydrocarbon demand, they're spending their money on things that are reducing their carbon footprint as opposed to increasing it by adding large amounts of oil and gas production. They're still growing their production, but it's more like single-digit percentage. So that isn't adding enough supply to reduce price and demand is still strong. Going forward without a recession, we've got the same situation for natural gas with many of the same drivers.
SM: So those factors might be causing some rethinking of how we invest in fossil fuels.
JS: Well certainly, I think there's a rethink in the duration of the energy transition. Because earlier on, I do think many governments and perhaps consumers too, thought that the energy transition was more of a light switch. We'll just change, no problem. But it cannot be done that quickly. It is a multi-decade process.
SM: Jennifer, thanks again for joining us. Really appreciate it.
JS: Thanks so much for having me, Stephen.
SM: I've been speaking with Jennifer Stevenson, Vice President and portfolio manager, focused on the global energy industry. She's part of the Scotia Global Asset Management Investment Team.