Fire at an oil refinery in the Gulf will not be fixed for a month. What will this mean for the gasoline market? Which curve shifts - demand or supply (or both) - and in which direction? What happens to equilibrium price & quantity?
Basic macroeconomic theory would indicate that a fire at an oil refinery in Gulf Coast region of the United States would generate an increase in the price of gasoline and other petroleum-based products because of the drop in supplies such an event would entail. Little in life, however, is quite so simple, and the question of shifts in supply and demand of oil do not lend themselves to such simple naked calculations. There are two main reasons for this, specific to the United States. First, demand for oil in the United States is seasonal. Demand always increases considerably during warm winter months of summer, when Americans are driving to and from vacation destinations, and decrease in winter when families tend to stay put (excepting, of course, the large community of “snow birds,” mainly middle-class and upper retirees who spend winter in warm-weather climates like Florida and Arizona, and summer in their Northeast or upper-Midwest communities.) Consequently, the effects on supply and demand and on prices is dependent on the time of year the fire occurred. The effects would obviously be lower during winter than during summer.
The second main reason for the complexity of determining shifts in supply and demand and on prices of a fire at a Gulf Coast oil refinery has to do with the far more mercurial role of speculation. While estimates of the true impact on the price of a barrel of oil vary, there is no question that the impact can be considerable. A 2012 article in Forbes, for instance, suggested that impact of commodities speculation with respect to oil could be as much as $23.39 per barrel, which would translate to an increase of $.56 per gallon of gasoline at the pump. [See Robert Lenzner, “Speculation in Crude Oil adds 423.39 to the Price per Barrel,” Forbes, February 27, 2012, http://www.forbes.com/sites/robertlenzner/2012/02/27/speculation-in-crude-oil-adds-23-39-to-the-price-per-barrel/] This educator has had discussions with energy producers and providers in the United States and in the Kingdom of Saudi Arabia, the consensus position of which is that the oil speculators constitute the most important determinant of energy prices. Because speculation is, by definition, driven by emotions and estimates and is, consequently, fraught with uncertainty, ascertaining the effect of the hypothetical fire is equally fraught with uncertainty. What we do from history, however, is that Americans consume less fuel when prices reach certain, higher levels.
Beyond the above variables impacting oil prices and supply and demand, the issue remains just as prone to vast uncertainties. According to the U.S. Government Energy Information Administration, Gulf Coast refineries account for over 45 percent of total U.S. petroleum refining capacity. The actual data follows:
Total U.S. Gulf Coast Capacity
Total U.S. Capacity
U.S. Gulf Coast Share of U.S. Refinery Capacity
[See U.S. Energy Information Administration, URL link provided below]
That level of dependence on Gulf Coast refineries is sufficient high as to impact supply and prices across the country. We do know from experience that closures for a variety of reasons, including routine maintenance and fires, do impact prices. A recent report issued by the U.S. Congress, Joint Economic Committee, titled Gasoline Price Spikes and their Impact on the Economy (May 2014) noted on this point:
“In the Midwest in the spring of 2013, a number of oil refineries were shut down for planned maintenance at the same time, and delays and emergency shutdowns caused a gasoline supply shortage. Across the region, prices for a regular gallon of gasoline increased by 42 cents from April 15 to May 20. During the same period, the average regular gasoline price increased by 81 cents in Minnesota.”
Later in that report, the committee noted the following:
“West Coast price spikes in 2012: Domestic gasoline prices are generally highest on the West Coast because of slow arrival of supply from outside the region, the lack of pipeline capacity from the Gulf Coast, the unique blend of reformulated gasoline in California, and demand outpacing refining capacity. The prices spikes in May and October of 2012 were partly blamed on refinery fires.”
So, a fire at a Gulf Coast refinery can be expected to impact supplies and, consequently, prices – assuming no concurrent drop in demand. If the fire occurs during winter, the impact demand and prices will be less for the reasons mentioned above. If the fire occurs during the summer “driving months,” however, the impact would considerably higher.
That the existence of a fire at a refinery would not necessarily be determinative of shifts in supply and demand, and of prices, is suggested by recent history as discussed in an August 2014 article in The Wall Street Journal, which reported that “[a] fire at a small Kansas refinery is having an outsize impact on oil prices in the U.S., with investors and analysts tying the blaze to a steep slide in the cost of crude over the past week.” The article went on to state the following:
“The Coffeyville, Kan., refinery processes just 115,000 barrels a day of oil—too small to crack even the 50 largest refineries in the U.S., according to the Energy Information Administration. But since it was shut by a fire on July 29, oil prices have dropped 2.7%, hovering near six-month lows, on the New York Mercantile Exchange—overshadowing the impact of violence in Iraq, Libya and other hot spots, investors say. Oil had started sliding a few days earlier as concerns about those threats started to ease in the market, and is down 3.7% since late July.” [“Refinery Fire Spurs Oil-Price Slide,” URL link provided below]
While the refinery discussed in the article was not on the Gulf Coast, the fact of a slide in oil prices being linked to a fire at any U.S.-based refinery is instructive – or it represent a statistical aberration, quite possibly the latter. The Gulf Coast is the main transit point for oil imports entering the United States, accounting for as much as 57 percent, and any disruptions to the supply chain through that region can reverberate throughout the U.S. economy. As the Gulf Coast sits squarely within a major hurricane path – and Hurricane Katrina, which struck the Gulf Coast in August 2005, had a very noticeable impact on domestic fuel prices (according to the Energy Information Agency, “refinery shutdowns in the Gulf of Mexico region totaled 367,000 barrels per day (bbl/d) as of December 15, 2005”) – it has been well-established that supply disruptions impact prices. Oil prices spiked in the immediate aftermath of the hurricane before stabilizing due mainly to yet another, so far neglected, variable: then-President Bush’s decision to inject oil into the national supply from the government’s Strategic Petroleum Reserve (SPR), a series of massive petroleum storage facilities in salt mines in Louisiana and Texas that contain for emergency purposes hundreds of millions of barrels of crude oil. The presence of the SPR alone can influence supply and price issues, although an isolate fire at a single refinery probably wouldn’t trigger such a response.
In general, prices increase when demand exceeds supply. How much prices increase can be a factor of thenature of the supply disruption. Wars in the Middle East, especially the Iran-Iraq war during the 1980s, during which Iran repeatedly threatened and even attacked oil shipments through the Persian Gulf, and the invasion of oil-rich Kuwait by Iraq in 1990, can cause massive turbulence in world oil markets. In fact, just the threat of supply disruptions – the aforementioned problem/issue of commodities speculation – can be sufficient to cause major increases in the price of fuel even if no actual supply disruption occurs. The impact of a fire on a single refinery in the Gulf Coast region, however, would not be that dramatic. In fact, depending upon precisely which refinery was involved, it might not be felt at all. For example, a Shell Oil refinery in St. Rose, Louisiana, refines 45,000 barrels a day. An ExxonMobile refinery in Baton Rouge refines over half-a-million barrels per day. Obviously, a fire at the former would have far less impact on domestic supply and price than would a fire at one of ExxonMobile’s massive refineries along the Gulf Coast. [See U.S. Energy Information Agency, “Gulf Coast Factsheet,” http://www.eia.gov/special/gulf_of_mexico/data.cfm#gulf_coast_refinery].
In conclusion, a fire at a Gulf Coast oil refinery would impact supplies. How much would be dependent upon precisely which refinery was involved. Also, if the fire occurred during periods of peak domestic demand, such as during the summer vacation season, the supply disruption would be felt more greatly at the gas pump. A fire at a small refinery during winter wouldn’t be appreciated by consumers, but its actual impact on supply and on prices would be minimal.
The previous answer is an excellent and detailed answer about the real-world impact of a fire in a refinery in the Gulf. However, I wonder if you need a shorter answer that is directed at an Econ 101 level understanding of the question. I will provide a shorter, less detailed answer that is more likely to be right for your assignment but less likely to be right in the real world.
The fire in the refinery should cause the supply of gas to go down. It should not affect the demand. Supply goes down because the fire makes it impossible for the refinery to produce as much gas as it previously could. Demand does not change (all other things being equal) because a fire at a refinery does not change how much gas consumers want to buy at a given price.
When supply goes down, the equilibrium quantity goes down and the equilibrium price goes up. Therefore, your answer would be that this fire will cause the supply curve to move to the left, thus causing a decrease in quantity and an increase in price.
Thank you to pohnpei397 and kipling2448!
I somehow thinks my instructor wants a brief answer based on just the basic scenario he described. I did several hours research on the topic, wrote about different events and how the market changed in each instance, and he did not like the paper. I guess I will just stick to the question asked.