On February 24, 2022, years of political tension, propaganda, annexation, rebellion, and the imperialism of Vladimir Putin’s Russia erupted into the mass invasion of a sovereign European country.[1] The likes of which had not been seen since the start of World War II over three-quarters of a century ago. The Russian Federation’s invasion of Ukraine sent shockwaves throughout Europe that reverberated across the globe. From local and national politics to Starbucks and McDonalds, few areas of geopolitics and global economics failed to suffer repercussions. This is no less true than for the global energy market.

Immediately following the invasion, global energy markets nosedived, oil prices skyrocketed, and the Russian energy market nearly crumbled.[2] President Biden and fellow global leaders prevented a complete collapse of global markets by announcing the United States and other nations were considering a combined release of oil from strategic reserves.[3] At the end of the day, however, European energy markets remained the hardest hit, primarily due to their reliance on Russian energy imports.

While the global energy market staved off impacts as harsh as the regional EU market, it continues to suffer impacts of the invasion and subsequent US and EU sanctions. Russia is the world’s second largest exporter of crude oil, behind Saudi Arabia.[4] Following their invasion of Ukraine, crude oil prices exploded to over $100 per barrel, prices not seen since the Great Recession.[5] The geopolitical risk related to Russia’s invasion of Ukraine, in addition to stronger petroleum demand following the easement of the COVID-19 pandemic, has contributed to higher and more volatile crude oil prices.[6]

[7]

As a result, gas prices in the U.S. shot up to an average of $4.07 per gallon, over a $1.00 increase from a week before the invasion.[8] In response, on March 1, the U.S. Department of Energy committed to releasing 30 million barrels of crude oil from the U.S. Strategic Petroleum Reserve (SPR) in conjunction with other members of the International Energy Agency (IEA).[9] The other IEA members collectively committed to matching the U.S.’ release, bringing the total release of emergency crude oil barrels into the global market to 60 million barrels.[10] The hope was that the release of the SPR would ensure an adequate supply of petroleum in the market to counteract the effects of Russia’s invasion of Ukraine.[11]

However, gas prices have not fallen to pre-invasion levels and in fact, the Energy Information Administration (EIA) predicts that gas prices will remain above $4.00 per gallon throughout the summer.[12] Naturally, the question that remains is why has the release of SPR from the IEA not brought down gas prices? The American Petroleum Institute contends it is a simple answer: the market forces of supply and demand.[13] On its face, this solution seems shaky because we should expect the influx of crude oil from the SPR to have solved the issue. According to the White House, the U.S. imported nearly 700,000 barrels per day of crude oil from Russia[14] while the total U.S. SPR release this year in conjunction with the 30 million emergency barrels, will roughly equal one million barrels of oil a day.[15] Despite this influx, our gas prices remain stubbornly high.

[16]

The true answer is a bit more complex and technical: the oil crack spread. Crack spread is a term used in the oil industry for the differential between the price of crude oil and the wholesale petroleum product produced by that oil.[17] Crude oil is made up of long-chain hydrocarbons that must be “cracked” at an oil refinery into useful shorter-chain petroleum products.[18] The crack spread approximates this profit margin. The larger the crack spread, the more profit for oil refiners.

One major factor which impacts the spread is the particular blend of crude oil feedstock, or the quality of a given barrel of oil, being processed by an individual refinery and the specific product the refinery was designed to create.[19] For example, heavy crude oil, like that which comes out of Russia, is composed of longer carbon chains which are more difficult to refine into lighter products such as gasoline while easier to refine into certain niche products like chemicals or lubricants.[20] The refining process for heavy oil differs significantly from the process for lighter oils.[21] In order to widen the crack spread and maximize their profits, oil companies have optimized their refineries for a specific quality of crude oil.[22] Consequently, changing a refinery’s infrastructure to be more optimized for oil of a different quality requires substantial investment and time.[23] Therefore, when a refinery receives oil it is less optimized to refine its crack spread, and the companies’ profits will narrow dramatically.

Most U.S. crude oil produced in the last six years is light crude while domestic refining capacity remains mixed in order to most efficiently produce different products.[24] Certain refineries in the U.S. rely on heavier oil not produced domestically to more efficiently produce certain niche petroleum products, keeping its crack spread high.[25] Therefore, while imports of Russian crude oil only comprised approximately 8% of total U.S. imports in 2021, their percentage share of heavy crude oil was much higher.[26]

On March 8, 2022, the Biden Administration banned the importation of Russian oil and gas.[27] As the supply of heavy crude oil fell, oil companies’ crack spreads tightened despite the IEA’s release of millions of SPR barrels which were intended to cover the loss. To maintain their profit margins, oil companies compensated by raising prices for petroleum products, like our gas, but perhaps they went too far. It appears that the oil industries’ profits for the first quarter of 2022 will break records.[28] Many have called into question the ethics of earning record profits as a result of a global crisis and while the masses face pain at the pumps. Calls have already been made to implement a windfall tax on energy companies posting record profits.[29] With just a few days out until official quarterly reports are released, we will have to wait and see how lawmakers in the U.S. and EU will react.

 

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[1] Shashank Bengali & Marc Santora, Russia Attacks Ukraine, The New York Times (Feb. 24, 2022), https://www.nytimes.com/live/2022/02/24/world/russia-attacks-ukraine.

[2] Jeff Sommer & Kevin Granville, Stocks and Energy Markets Whipsaw After Russian Attack on Ukraine, The New York Times (Feb. 24, 2022), https://www.nytimes.com/2022/02/24/business/economy/stock-market-today.html.

[3] Id.

[4] Hilary Hooper, Justine Barden, & Tejasvi Raghuveer, Europe is a key destination for Russia’s energy exports, U.S. Energy Info. Admin. (Mar. 14, 2022), https://www.eia.gov/todayinenergy/detail.php?id=51618.

[5] Kevin Hack & Jimmy Troderman, Crude oil prices rise above $100 per barrel after Russia’s further invasion into Ukraine, U.S. Energy Info. Admin. (Mar. 4, 2022), https://www.eia.gov/todayinenergy/detail.php?id=51498.

[6] Id.

[7] West Texas Intermediate (WTI) crude Oil price and NYMEX confidence intervals, U.S. Energy Info. Admin. (Apr. 2022), https://www.eia.gov/outlooks/steo/images/fig1.png.

[8] SHORT-TERM ENERGY OUTLOOK, U.S. Energy Info. Admin. (Apr. 12, 2022), https://www.eia.gov/outlooks/steo/.

[9] Kimberly Peterson, U.S. to release 30 million barrels of crude oil from its Strategic Petroleum Reserve, U.S. Energy Info. Admin. (Mar. 8, 2022), https://www.eia.gov/todayinenergy/detail.php?id=51538.

[10] Id.

[11] Id.

[12] U.S. Energy Info. Admin., supra note 8.

[13] Gas Prices Explained, Am. Petrol. Inst. , https://www.api.org/oil-and-natural-gas/energy-primers/gas-prices-explained (last visited Apr. 25, 2022).

[14] FACT SHEET: United States Bans Imports of Russian Oil, Liquefied Natural Gas, and Coal, The White House (Mar. 8, 2022) https://www.whitehouse.gov/briefing-room/statements-releases/2022/03/08/fact-sheet-united-states-bans-imports-of-russian-oil-liquefied-natural-gas-and-coal/.

[15] Zeke Miller & Josh Boak, Biden orders release of 1 million barrels oil a day from strategic reserve to hit brakes on gas prices, PBS News Hour (Mar. 31, 2022), https://www.pbs.org/newshour/politics/biden-orders-release-of-1-million-barrels-oil-a-day-from-strategic-reserve-to-hit-brakes-on-gas-prices.

[16] World liquid fuels production and consumption balance, U.S. Energy Info. Admin. (Apr. 2022), https://www.eia.gov/outlooks/steo/images/Fig6b.png.

[17] An introduction to crack spreads, U.S. Energy Info. Admin. (June 02, 2011), https://www.eia.gov/todayinenergy/detail.php?id=1630.

[18] Id.

[19] Id.

[20] Dean Foreman, Why the U.S. Must Import and Export Oil, Am. Petrol. Inst. (June 14, 2018) https://www.api.org/news-policy-and-issues/blog/2018/06/14/why-the-us-must-import-and-export-oil.

[21] Id.

[22] Id.

[23] Id.

[24] Id.

[25] Id.

[26] Oil and petroleum products explained, U.S. Energy Info. Admin. (Apr. 21, 2022), https://www.eia.gov/energyexplained/oil-and-petroleum-products/imports-and-exports.php.

[27] The White House, supra note 14.

[28] Sabrina Valle, Exxon Signals Record Quarterly Profit From Oil and Gas Prices, Reuters (Apr. 04, 2022), https://www.reuters.com/business/energy/exxon-signals-record-quarterly-profit-oil-gas-prices-2022-04-04/.

[29] Id.