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California’s gasoline market is a world all its own. Gas prices there are consistently higher than anywhere else in the U.S. — and with the global oil industry currently experiencing its greatest physical supply shock since at least the 1970s, that difference has gotten especially painful.
Since Iran effectively closed the Strait of Hormuz to tanker traffic in response to U.S.- and Israel-led attacks, blocking around 10% of global oil production from reaching the world market, the average gasoline price in California has risen to $5.62 per gallon, according to AAA, up from $4.59 a month ago. Compare that to the national average $3.88 per gallon, up from $2.93 in February, and you’ll begin to feel Californians’ pain. The longer the strait remains closed and the higher oil prices continue to rise, the more dramatic those price increases are likely to be.
But where does that difference come from in the first place? In part it’s due to deliberate policy choices, including California’s unusually high taxes on gasoline, environmental regulations that require a unique blend of fuel, and the state’s cap and invest program. Then there’s what University of California Berkeley energy economist Severin Borenstein calls the “mystery gasoline surcharge,” which emerged after a 2015 refinery fire in Torrance that drove up prices beyond what the obvious tax and regulatory factors could explain. (Borenstein thinks it may be in part due to lack of competition between gas stations, but he admits it’s still an open question.)
California is also unusually dependent on other states — and even other countries — for its crude oil and even gasoline itself. The state is essentially cut off from the U.S. oil pipeline network due to its geographic isolation, strict environmental regulations (again), and the uncertainty of investing in fossil fuel infrastructure for a state that is actively and aggressively trying to decarbonize.
Not only that, California’s local refining capacity has been shrinking at a precipitous rate. The Phillips 66 refinery in Los Angeles shut down last year, and the Valero refinery in Benicia is due to shut down later this year, taking out some 17% of the state’s refinery capacity.
This makes California reliant on maritime imports, and thanks to the Jones Act — which requires that sea-based trade within the U.S. use American-made, owned, and crewed ships, of which there are just 55 in operation — those ships essentially have to come from overseas.
Since the Torrance refinery fire, the state’s gas price has fluctuated largely based on the price of imports of finished gasoline or components used to blend California’s unique fuel, Ryan Cummings, the chief of staff at the Stanford Institute for Economic Policy Research, told me.
“In California, the marginal barrel, which is what sets the price — the most expensive barrel to bring to market — is imported and has been that way since 2015,” he said.
While some of the feedstock for California’s gasoline does come from the U.S. (but arrives by way of the Bahamas to skirt Jones Act restrictions), far more comes from India and South Korea, which are at the heart of the current energy shock. Along with other states in the western U.S. that rely on imports, Cummings told me, California is “disproportionately” affected by the physical price of oil in the Middle East “because that’s where a lot of the imports come from.”
One curious feature of the unfolding energy crisis is that the benchmarks typically used as stand-ins for the price of oil — West Texas Intermediate and Brent — have diverged substantially from the physical price of oil being bought by refineries in Asia, which rely on Persian Gulf supplies. Asian refineries have been paying around $155 per barrel, according to JPMorgan chief commodities strategist Natasha Kaneva. The WTI, which is based on oil to be delivered in Oklahoma, sits at $96, and Brent, in the North Sea, is $110.
“The immediate physical shortfall is concentrated in Asian markets, where reliance on Gulf barrels is greatest,” Kaneva wrote in a note to clients. “Early signs of demand destruction are emerging in Asia as product prices surge and spot barrels become prohibitively expensive.”
California, on the other hand, will likely just continue to grit its teeth and buy. Cummings has advocated that the Benicia refinery, which is due to shut down by the end of April, be converted into an import terminal for petroleum products to ensure that California maintains adequate supplies of imported gasoline and components. That would help insulate it from shortages that cause spikes beyond high global prices.
If the strait remains closed through March and production shut-ins increase as storage fills up, “it’s totally reasonable to think oil is going to be $150 a barrel, if not more,” Cummings told me. “And if that’s the case, we’ll see higher than $7 a gallon average gasoline price in California.”
At least so far, however, “gasoline prices are doing about what you’d expect them to do,” Borenstein, the Berkeley professor, told me, rising in line with the rest of the country.But the state “really needs to make sure that we are out ahead of this by making sure there are no frictions that are created in expanding port capacity, pipeline capacity and storage,” he added. The ability to store and move gasoline around is particularly important, Borenstein explained, because of the lack of refining capacity in the state.
The real test for California’s petroleum system will be when “one of the remaining refineries has an unexpected shutdown,” Borenstein told me. “It always happens, and so at that point I hope we will have made sure there’s enough inventory to handle that and enough capacity to keep bringing product in.”
