Big Squeeze by Big Oil

ARKANSAS CITY, Kan. ¡ª The dormant complex here at the edge of Kansas is a weathered still-life of a bygone era.

Remnants of rusty pipes and storage tanks hint at the oil refinery that once hummed here on the banks of the Arkansas River.

Property that could produce enough gasoline to satisfy half the state¡¯s thirst for the fuel is now overrun with prairie grass. Abandoned buildings sit with plywood-shuttered windows.

It¡¯s a fate few here thought possible. Even nine years after the refinery closed, some former employees still can¡¯t believe what happened to the economic lifeblood of the community since 1918. They still ponder how a deal to sell the refinery fell apart.

So does Malcolm Turner. He led a group that wanted to buy the refinery. They offered the owner, Total Petroleum Ltd., $37 million and thought they had a deal. But Turner said Total backed out at the last minute ¡ª offering scant explanation.

Seeking answers, Turner hopped on a flight from Dallas to Total¡¯s North American headquarters in Denver. Over a round of golf with Total executives, the discussion finally got to the question: Why would Total walk away from $37 million and prefer to sell a perfectly good refinery for scrap?

¡°They finally said by closing the refinery it would tighten up the market,¡± Turner recalls. ¡°They thought they would benefit.¡±

At the time, Total told employees the sale fell through and the company was closing the refinery for business reasons. The company has declined repeated requests for more comment on its decision-making process.

Turner, a decades-long veteran in the oil industry, was dumbfounded that the company shut the plant. But similar stories have been quietly playing out across the country ¡ª wiping out thousands of good-paying jobs, devastating communities and, ultimately, squeezing consumers at the gas pump.

Drawing from dozens of interviews and previously undisclosed government documents, The Kansas City Star has discovered a largely untold story of a rapidly consolidating industry that has clamped down on refining capacity to drive up profits. Now, as retail gas prices routinely surge to more than $2 a gallon, what started as a legitimate business concern about overcapacity has become a recurring theme that has limited refining capacity in the world¡¯s largest oil-consuming nation.

The Organization of Petroleum Exporting Countries, which itself has been under fire for high oil prices, has criticized the shortfall in U.S. refining capacity. In April, the foreign policy advisor to Saudi Arabia¡¯s Crown Prince Abdullah said additional supplies of crude oil to the U.S. would ¡°make no difference¡± because we lack the refining capacity to make it into gasoline.

Federal Reserve Chairman Alan Greenspan recently called our domestic refining capacity ¡°worrisome.¡±

President Bush proposes using former military bases as sites for new refineries. Others urge a streamlining of environmental regulations to make it quicker to gain the necessary permits to build refineries. Still others argue for fewer types of environmentally friendly reformulated gas to eliminate production bottlenecks.

But such proposals miss a central question: Does the oil industry even want to significantly increase refining capacity?

ExxonMobil Corp., the world¡¯s largest oil company, last year had a return on investment of about 25 percent on its refineries. Its 2004 earnings were $25.3 billion, a record for a public company. The company now has a cash horde of more than $20 billion. But while the company is using some of its extra cash to buy its own stock, it doesn¡¯t have plans to build another U.S. refinery.

¡°You won¡¯t see our investment spending swing with changes in near-term commodity prices,¡± Exxon CEO Lee Raymond recently told investors at the company¡¯s annual meeting.

Over the past 25 years, 176 refineries have closed in the United States ¡ª including refineries in Sugar Creek and Kansas City, Kan. A new U.S. refinery hasn¡¯t been built since 1976. Even with upgrades and expansions at the remaining refineries, domestic capacity is down 9 percent since 1981, while demand for gasoline has increased 38 percent

Today this country, which once had far more refining capacity than it needed, can no longer depend on its own refineries for all its fuel needs ¡ª even when they run virtually at full speed. Imported gasoline now accounts for 10 percent of supply, and that number is expected to grow.

The industry¡¯s refining margins, the difference between crude oil and wholesale gas prices, have doubled and tripled at times to nearly 60 cents per gallon. Refinery and marketing profits, according to the U.S. Department of Energy, were up 292 percent for the last quarter of 2004 when compared with the same period the previous year.

The refinery squeeze already has contributed to some of the most volatile gas prices in memory. Indeed, the gasoline market now is so tight, say industry executives, that any demand spike, refinery outage or pipeline shortage can easily cause prices to soar.

Refining margins were a big topic at an oil industry conference held last fall at a resort near Las Vegas.

¡°Any little thing that happens, prices shoot up,¡± Bill Greehey, chief executive officer of Valero Energy Corp., told the audience.

Greehey, in a remarkable moment of candor for an often tight-lipped industry, dubbed this the ¡°Golden Age of Refining,¡± saying ¡°the best is yet to come.¡±

Two 1970s oil crises orchestrated by OPEC left consumers with indelible images of long lines at gas stations and high prices at the pump. But they also marked a turning point for Big Oil that set a course for today¡¯s higher refinery profits.

A detailed portrayal of that turnabout is contained in a previously undisclosed 393-page document, assembled by Federal Trade Commission lawyers as part of an antitrust suit that was pending before an administrative law judge that was later dismissed.

As countries around the globe nationalized their oil industries, the domestic oil industry increasingly looked to refining for profits. In some instances, according to the FTC document, the oil companies cooperated among themselves to reduce refinery capacity.

¡°It¡¯s not happenstance that we¡¯re short of refining capacity,¡± said David Haberman, a retired former antitrust lawyer with the Federal Trade Commission and the U.S. Department of Justice. ¡°I really thought it could end up like it is today.¡±

Haberman was one of 19 lawyers who spent nearly a decade compiling a case which has been largely forgotten. The case, which was before an administrative law judge within the FTC, was dismissed in the early days of the Reagan administration. But it created a treasure trove of more than 500,000 pages of documents within the FTC archives that offer a rare glimpse inside the industry.

The FTC, replying to requests by The Kansas City Star, so far has refused to release most of those documents after initially saying they could not be located. The federal agency now says that it is required to get the approval of the oil companies that authored the memorandums and other documents before they can be released.

But the FTC¡¯s ¡°Complaint Counsel¡¯s First Statement of Issues, Factual Contentions and Proof¡± obtained by The Star offers some details of the government¡¯s investigation of eight major oil companies. The FTC has confirmed that the document, which is dated Oct. 31, 1980, and summarizes the FTC¡¯s case, is legitimate ¡ª even as it refuses to release other supporting documents covered under the newspaper¡¯s request.

The FTC¡¯s lawyers found that Big Oil was turned on its ear by the nationalization of Mideast oil. The industry had relied on the vast supplies of Mideast oil for much of its profits and plenty of refinery capacity was crucial in being able to process it all.

But the loss of control of Mideast oil, according to the FTC report, meant the end of the old system. The major oil companies increasingly viewed refineries as having a new role ¡ª a stand-alone business that needed to be profitable.

The FTC document said the industry turned its attention to making that happen, alleging:

¡ö In other instances, if an independent company was looking at land to build a refinery, the site was purchased to prevent it from being built. If there was still investment interest, oil companies would temporarily reduce wholesale gasoline prices in that territory to convince the would-be buyer that it would be unprofitable.

¡ö In addition, refining capacity among the companies was controlled by sharing information on gasoline production. One company¡¯s memorandum to another company that discussed plans to shut down a refinery included instructions to destroy the document after it was read.

At one point, according to the FTC report, the companies thought demand would increase significantly. But the companies ¡°contrary to their individual business interests, did not expand refining capacity or take other actions to meet anticipated demand¡± ¡ª delaying or canceling refinery projects.

¡ö The companies also sought to keep from dumping too much gasoline on the market by following the ¡°leading firm¡± in each market regarding how much gas to refine to sell to that market.

During and after the FTC¡¯s investigation, the oil companies denied the allegations that they worked together to restrict capacity. Some argued that the government was merely looking to blame the industry for high energy prices. They contended that business decisions were individual responses to the pressures of a competitive free market, not an organized effort to use their market power to thwart competition.

Shortly after Ronald Reagan became president, in September 1981, the FTC withdrew its case, saying further proceedings were ¡°not in the public interest.¡± At the time, the commission noted that the decision to dismiss did not represent a decision on the merits of the case, and it left open the option of addressing competition in the industry at a later date. The case, which alleged some specific examples of ¡°collusive¡± actions, was the largest ever brought by the FTC.

A generation later, the oil industry sees the dismissal as exoneration of the antitrust allegations.

¡°There have been numerous claims but there has never been a finding of collusion,¡± said Edward Murphy, group director of refining and marketing for the American Petroleum Institute, which represents the oil companies. ¡°The fact is this has been and continues to be a very competitive industry.¡±

To be sure, Big Oil has at times had a legitimate reason to be concerned about overcapacity.

Even as the industry sought to reduce capacity, an unprecedented slump in demand during the recession-ridden early 1980s meant that U.S. refineries could make far more gasoline than needed.

But that didn¡¯t last. U.S. refinery capacity dropped from 18.6 million barrels of oil per day in 1981, to 15.7 million barrels a day in 1998, as demand soared.

The domestic refining industry, which used as little as 70 percent of capacity as recently as the early 1980s, in recent years has reached as much as 97 percent of capacity ¡ª effectively operating at full steam because some capacity is always down for maintenance or retooling. And that lack of spare capacity makes prices more volatile.

Edward Galante, a senior vice president for ExxonMobil, speaking at an energy conference in Houston in February, said a ¡°dramatic¡± spike in global demand for gasoline in 2004 made the market tight.

But Galante said it was unlikely that any company would invest the billions that it takes to build more refineries in the United States. He argued that there is still the possibility that demand could decline and refinery margins would follow. Building more capacity, he said, could contribute to another surplus, returning the industry to the darker days of the early 1980s.

¡°Some say we have entered a ¡®Golden Age of Refining.¡¯ ¡± Galante said. ¡°Of those I ask: How long is an age?¡±

Clearly, free-market adjustments explain some of the decline in capacity. Inefficient small refineries, for example, were among those closed. But other forces, say some critics, were also afoot.

¡°This is an industry rigged for profits,¡± said Jamie Court, president of The Foundation for Taxpayer and Consumer Rights.

¡°People think it is OPEC that¡¯s the reason for high gas prices, and it just isn¡¯t so.¡±

The concern about surplus refining capacity remained a recurring theme in the industry, even as use pushed past 90 percent.

In a 1995 internal memo obtained by U.S. Sen. Ron Wyden of Oregon, whose office has investigated the industry in recent years, Chevron discussed an industry meeting at which an analyst warned that if capacity wasn¡¯t reduced further, there would be no substantial increase in refining margins.

In a 1996 internal memo, Mobil officials called for a ¡°full court press¡± to stop an independent company from restarting a refinery in California that might reduce gas prices by 3 cents per gallon. The effort was successful.

Company officials say such efforts reflect legitimate business strategies. ¡°There have been various investigations that have concluded there has been no wrongdoing by the oil companies and the industry in general,¡± said Carolin Keith, a spokeswoman for ExxonMobil.

And a Texaco memorandum, also in 1996, stated too much capacity was hurting refinery profits.

¡°Significant events need to occur to assist in reducing supplies and/or increasing demand for gasoline,¡± according to the document.

A spokesman for Chevron, which later acquired Texaco, said the company has continuously upgraded and expanded existing refineries. He referred to a recent speech by a Chevron executive for the company¡¯s position on building new refineries.

Patricia Woertz, executive vice president of Chevron¡¯s downstream operations, said expansion of the nation¡¯s refining infrastructure would seem an obvious solution. But Woertz said any company would be hard pressed to find a community that would welcome a new refinery.

¡°Even if you believe the investment economics have become more favorable, other discouragements remain,¡± she said at an industry conference in San Francisco.

Employees at the Arkansas City refinery first realized their futures might be in jeopardy in 1996.

Total¡¯s parent company, based in Paris, France, said it no longer wanted the 56,000-barrel-per-day refinery in Arkansas City. But the company said it hoped to find a new owner.

The refinery had been upgraded over the years and employees had been told by management that it was profitable. So the workers were optimistic that an industry that had been in Arkansas City for nearly a century would continue to be a fixture.

¡°Many thought it was a done deal,¡± said Jerry Walker, who was one of the refinery¡¯s supervisors.

Recently sitting in his white-frame house just blocks from where the refinery stood, Walker remembered a trip in 1994 that suggested what was good business for the company wasn¡¯t always good for the workers.

Total executives had asked him to accompany them to a refinery in Wynnewood, Okla., that was for sale. After the inspections, the executives and Walker gathered to discuss the day. Walker recalls that one of the executives said Total should buy the refinery, explaining that if it didn¡¯t work out they could still close it and take it off the market.

Still, the future of the Arkansas City refinery seemed secure. Gary Jones, president of Total Petroleum¡¯s North American business, visited the refinery in July 1996 and told the employees that a sale was likely.

But on Aug. 12, 1996 ¡ª known as Black Monday in Arkansas City ¡ª the company gathered the refinery¡¯s nearly 200 employees and told them the refinery would be closed. A company spokeswoman told the local newspapers that the sale had fallen through.

¡°We empathize with the employees who will be laid off as a result of our decision to discontinue crude oil processing at the Arkansas City refinery,¡± Jones said in a prepared statement released when the closure was announced. ¡°This action will, however, make Total Petroleum a stronger company by allowing us to focus our capital and human resources on other areas of the company with a higher profit potential.¡±

Turner, considered one of the country¡¯s top refinery experts, was in his Dallas office the day the Arkansas City employees were told that the refinery would close. He said he got a call from a Total executive telling him that the company no longer wanted to sell and the deal was off. Turner said the sales contract was on his desk when the call came in.

The Arkansas City Traveler newspaper called the refinery¡¯s closing ¡°disastrous.¡± Over the years, the community watched as the refinery was dismantled and its parts sold. Today the site is home for a small asphalt and loading business.

Ten months after the Arkansas City refinery closed, Total reported financial results for its North American unit for the quarter ending June 30, 1997. The company singled out strong operations in the Midwest as a reason for a 61 percent increase in operating income for its refineries.

Eventually, Total sold most of its remaining U.S. refineries. Another unit, Total Petrochemical, continues to have an interest in a Port Arthur, Texas, refinery.

Jones took another job with Total overseas. Total executives declined to discuss the Arkansas City closure, or allow Jones to comment.

For many of the refinery¡¯s employees, the closing was financially disastrous. Employees who were not at least 55 years old received only a fraction of the projected value of their pensions.

Donald Bruce was 53 and had a full pension estimated to be worth $207,000. He received $70,000. Another employee was just weeks away from reaching 55 when the refinery closed. Other employees offered to donate vacation time so he would qualify for his full pension. The company refused.

A few years after the refinery closed, Greg Kent was still sorting through its remnants.

Kent, the appraiser for Cowley County where the refinery was located, has been in a dispute over the amount of property taxes that should be paid after it was closed. The proceedings have included subpoenas for some of Total¡¯s records.

One day Kent was thumbing through records when he was stopped cold by one of the documents. The document revealed that there had been three serious bids for the refinery. Kent said he was ¡°beside himself¡± as he absorbed what he read.

¡°Why didn¡¯t they take the $37 million and run?¡± Kent asked. ¡°This was a catastrophe that shouldn¡¯t have happened.¡±

In a 1996 internal memo, Mobil officials called for a full court press to stop an independent company from restarting a refinery in California that might reduce gas prices by 3 cents per gallon. The effort was successful.

That effort could not have succeeded without the active and willing complicity of the California state government, could it?

"Over the past 25 years, 176 refineries have closed in the United States ¡ª including refineries in Sugar Creek and Kansas City, Kan. A new U.S. refinery hasn¡¯t been built since 1976. Even with upgrades and expansions at the remaining refineries, domestic capacity is down 9 percent since 1981, while demand for gasoline has increased 38 percent "

I'm shocked I tell you, just shocked! And of course, our politicians are scrambling to find ways to have refineries re-opened. They're working feverishly to give relief to their constituents. Any day now, they will solve this "squeeze." Any day now. I promise. Just you watch and see. Soon. Honest!

Malcom Turner should go to the City Council of Arkansas, KS and have them "acquire" the refinery for fair market value as per the recent Supreme Court decision, then re-open it and use it to "benefit" the community by providing jobs and tax revenue.
Total (pronounced "Toh-tahl") is a French company anyway, and we all know what that means:

Beat me to it. I was wondering the same thing...

I was thinking how hard it would be to build minirefineries like backyard stills. Instead of buying the refined product with all the taxes added on find a guy with a well willing to sell you maybe a barrel or two of crude a month, then brew your own gasoline. The cost per production would not be as good as the big time refinerys but other costs would be less.

It's something Red Green would try to do if he had enough duct tape.

I think refining is a complex and environmentally nasty process. Each of us having our own in the backyard sounds too much like Mao's "great leap forward" with all kinds of mini iron & steel mills in backyards.

Perhaps with some coordination we could each stock up a half month's supply of gas and diesel (30 gal in my case) and then for a month get with neighbors and coworkers to carpool to cut useage in half. That way we'd buy NO (more likely, little) gas and diesel for a month which would send a pretty good supply glut shock into the market.

Long term if gas prices stay high, I thnk you'll see a switch to hybrids that minimize gasoline use by allowing the batteries to be recharged at home. With that scenario 100 mpg isn't unreasonable. The oil companies are doing us a favor. As long as hybrid demand keeps increasing, the Japanese are going to make money by supplying it.

If GM gets its head out of its ass and jumps on the hybrid bandwagon, the competition should drop prices and fuel demand. So far we're not talking about millions of hybrids available each year. GM could change that. High mileage cars killed the growth in gasoline demand in the early seventies. Hybrids can do the same or more in the next few years.

The oil companies may have fu*ked themselves by getting greedy. You can collude all you want when you control an industry but when another industry can dramatically affect the demand for your product you can go from hoser to hosee in a matter of years especially if the American consumer understands they can destroy the linkage between gasoline demand and supply by buying a vehicle that allows them to delay demand.

Once the demand goes from relatively inelastic to somewhat elastic, the Exxons and Shells are screwed. No more pricing control for them.

Someone in Vicksburg MS tried that years ago. In the beginning they wanted to make whiskey. When they got finished they had a refinery to make high grade kerosene. The problem then is getting the big boys to allow you to buy crude. That's doable but you have to pay market.

Stockpiling diesel is doable. I'm running five year old diesel I bought when the price was $1.20/gal. Normally you can count on diesel dropping to the lowest price point after the summer drive exodus has died and before the winter home heating oil pice increases take off.

The refiners have to start stocking heating oil which is the same as diesel before the cold weather sets in. People might bitch and moan about high gasoline proices but you haven't heard screaming and seen politicians covering their asses until the little people start freezing in their homes and the pipes start bursting because there's no heating oil to be had. For obvious reasons that won't happen. You have about a month each year to buy relatively low priced diesel. I've been doing that for years.

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