Joe Biden, the US President, asked the Congress yesterday to suspend federal gas tax for three months and also called on individual states to follow suit by putting the collection of state fuel taxes on hold to tackle rising retail gas prices. Such a move requires congressional approval and given the bi-partisan resistance of tax suspension the proposal could be voted down. Nonetheless, it is a useful exercise to have a look at how the temporary suspension of US fuel tax would impact supply and demand.
To begin with, the federal tax in the United States is 18.4 cents/gallon on gasoline and 24.4 cents/gallon on diesel fuel. It has not been raised for almost 30 years and is not linked to inflation, which has risen 93% since 1993. According to the EIA as of January 2022 the average of total state taxes was 31.02 cents/gallon for gasoline and 32.66 cents/gallon for diesel, bringing the total to 49.42 cents/gallon and 57.06 cents/gallon respectively.
Retail gasoline and diesel prices are influenced by a myriad of factors, such as regional supply and demand, geographical proximity to refineries and as such transportation costs and population density. For the week ending June 13 the average US regular gasoline price was $5.006/gallon. Drivers on the West Coast had to fork out $5.868/gallon when filling up their cars whilst on the East Coast it “only” cost $4.849/gallon. On-highway diesel fuel prices for the same period and same areas would have been $6.423/gallon and $5.718/gallon. In case both federal and state tax holidays were introduced these retail prices would be lowered meaningfully – by around 10%. The cost is estimated to be around $10 billion and the Highway Trust Fund, whose major source of revenue is fuel tax would be replenished by increases in other revenues.
The market’s knee-jerk reaction in the early hours of yesterday morning was one of a massive sell-off. Presumably it was mainly the liquidation of length in an illiquid market coupled with automated trading systems triggering sell signals when words like “gasoline”, “tax” or suspension” appeared in headlines. Perhaps not so surprisingly, the market recovered impressively from the day’s lows, products more than crude oil, and now the real question is whether any kind of tax holiday would considerably destroy demand and/or increase supply.
Yesterday’s proposal of the White House was a clear indication that previous measures implemented in the past months have not achieved the desired effect. The most significant one is probably the co-ordinated release of crude oil from IEA emergency stockpiles, the brunt of which is borne by the US. This ongoing process has, so far, seen US SPR stocks dwindle by more than 100 million bbls or 16% in the space of eight months. It would be stretching the truth to conclude that this effort has failed because the increase in crude oil price has come to halt; WTI has gone nowhere near to the peak seen in March, but retail product prices kept marching to record highs without hindrance.
Although the latest proposal has led to a tidal wave of selling yesterday its ultimate impact should be muted – if introduced. The bottom line is that the recent price strength has been the function of fears of supply shortage and these fears have not been mitigated and a tax holiday would not result in additional supply. Consequently, prolonged price relief would only be attained by demand destruction but artificially lowering retail product prices might achieve the exact opposite. Pent-up demand built up during the pandemic should last until after the summer making sure that travellers will do everything to enjoy their first free summer in three years – regardless of price. US gasoline demand is above 9 mbpd and is expected to stay resilient in coming months – 9.14 mbpd for 3Q, to be precise, as estimated by the EIA.
Lower pump prices will not lead to increased product supply from refiners either. The EIA estimated that US refinery capacity fell by 126,000 bpd in 2021 and this year’s running average of refinery throughput is still 1 mbpd below the pre-pandemic level. Current utilization rates in the US are around 94% jumping as high as 99% in PADD 1, the biggest consuming region of the US. Persistent product shortage, apart from demand destruction, could only be alleviated by reviving idle refining capacity, a time-consuming process, which would not help the Democrats in the upcoming mid-term elections.
The proposed measure of suspending tax on fuel sales, even if it gets the greenlight from the Congress, is unlikely to bring relief at the pump and this much is acknowledged by the administration. A fact sheet from the White House concedes the main reason for run-away prices is the Ukrainian conflict and the consequent sanctions on Russia. It also admits that the suspension of fuel tax will not tame rising prices. Its medium to long-term impact is questionable, to put it mildly.
Although yesterday’s early weakness was a gut reaction to the White House proposal, the recovery from the lows was telling. Products finished the day higher but crude oil ended in the red, another indication that the proposed measure would likely be ineffective. It is the destruction of demand that will bring relief to the pump and this relief might come after the summer. Fears of recession are clearly growing and the Fed’s chair yesterday refused to rule out an even bigger rate hike than the last one.
Until then however, support is to come from the product side. It was reflected in yesterday’s API data, which showed a 5.6 million bbls build in crude oil inventories. Gasoline stocks also rose but only by 1.2 million bbls whilst distillate stockpiles declined by 1.7 million bbls. Add to that that Russia is more than capable of finding willing buyers for its crude oil and one might conclude that there is no shortage of crude oil. This should indicate limited upside potential in outright prices, although the tightness in physical product markets should put a floor not far below current prices. Crude oil structure might struggle to strengthen but product backwardations are to remain at elevated levels helping refinery margins stay healthy. With or without tax holidays consumption should be resilient in coming months before fragile economy growth and inflationary pressure will start destroying demand towards the end of 3Q.
Please note that the EIA will not publish its Weekly Petroleum Status Report today as planned due to “systems issues”. No time of release has been provided but it will not be this week.