Skip to comments.Rules, Small Returns Block New Refineries
Posted on 06/10/2004 8:18:31 AM PDT by ckilmer
Rules, Small Returns Block New Refineries Wednesday June 9, 7:00 pm ET Mike Angell
Sure, oil refiners are making a lot of money now. But there's no rush to build any more. Long term, oil refiners get a 5% return on investments, less than half that of a typical S&P 500 firm.
Add to that changing government policy, myriad environmental laws and public opposition and you can see why no refineries have been built in the U.S. since 1976.
Rising demand has sent gasoline prices soaring as crude prices hit new highs and refineries run all out to meet American drivers' thirst for fuel.
But experts don't expect new supply unless expanding or building refineries becomes more profitable and easier.
"The economics would never justify (building a new refinery)," said Bill Greehey, chief executive of Valero, the No. 1 U.S. refiner.
Some industry players, including OPEC giant Saudi Arabia, have said limited refining capacity has had a bigger impact on gasoline prices than crude oil supplies.
U.S. refineries can make 16.7 million barrels a day of gasoline and other refined products. In recent weeks, they've run nearly full out -- near 96% capacity.
They finally may be catching up with demand. The Energy Department said gasoline stockpiles rose 2.1 million barrels last week. The American Petroleum Institute said they jumped 4.7 million.
Recent inventory builds have helped cool gasoline futures and retail prices. But supply and demand will remain tight.
Back in 1981, refiners could make 18.6 million barrels a day, but used just two-thirds of that capacity. And spare foreign capacity meant cheap imports.
"Canada, Europe all had spare capacity," Greehey said.
Refiners then had little incentive to build refineries. Recent high prices have boosted returns to 6%. But the industry still makes plans that projects may only return 5%.
"This is a very capital intensive industry that requires long-term investments," said Bob Slaughter, president of the National Petrochemical and Refiners Association.
Before the '70s oil shocks, crude oil was cheap. So refiners planned to add capacity that eventually came on stream a decade later.
Government policy also brought on spare capacity. In the '70s, the U.S. subsidized small refiners' oil buys. But once the program ended, many refineries closed.
Another blow was the 1970 Clean Air Act. Last amended in 1990, the Act required refiners to upgrade plants to cut emissions and make cleaner burning gasoline. Greehey says 30 refineries shut since '90 because they could not afford to comply with the Act.
The U.S. now has 144 refineries compared to 315 in 1981.
Some investment went into making a low-pollution gasoline additive called MTBE. But states banned MTBE because it's a carcinogen and it seeps into the water supply. So refiners are stuck with useless MTBE facilities. That effectively took 500,000 barrels a day of gasoline off the market, Greehey says.
The Act also makes it harder to build new refineries. Building a refinery or even expanding a current refinery requires permits from federal, state and local agencies.
Refiners are most upset over one part of the Act called the New Source Review (NSR). It requires state approval on any upgrades or major maintenance to refineries.
During the late '90s, the U.S. interpreted the NSR much more strictly. Slaughter also says the NSR became retroactive. Older, already completed projects had to be reviewed by government agencies.
"It had a tremendous chilling effect on expansions," Slaughter said.
Any refinery expansion also faces local scrutiny. Not surprisingly, few locales want new industrial plants, especially refineries.
"There's an ever-increasing hostility to industry," said John Felmy, economist for the American Petroleum Institute. "You've got NIMBYs (not in my backyard), but also BANANAs (build absolutely nothing anywhere near anything), NOPEs (Not on planet earth), and NITMOs (not in my term of office.)"
The Bush administration is pushing NSR reforms to ease refinery expansions. But the courts are blocking the effort.
Greehey says what refiners really need are better returns.
Even if returns improved, it would be years before a refinery came on line. With today's regulations, it could cost $100 million and two to four years of engineering, regulatory review and approval before anything gets done.
"In that time, I haven't even poured any concrete or laid a yard of pipe," said Joel Maness, senior vice president of refining for Sunoco. A completely new refinery would take a decade or so to build.
Maness says supply is tight, but we don't face a crisis. Refineries get more efficient and are able to do smaller, less costly expansions. Along with imports, that'll ensure adequate gasoline supply, he says.
A new refinery would have some calming effect on prices, Maness believes. If nothing else, gasoline traders would have the perception that more supply was coming.
But Greehey notes crude makes up 45% of the price of gas. Taxes make up 20%, the same as refining costs. The way to cut gasoline costs, he says, is reducing crude prices and taxes on gas and ethanol.
It costs about $2.5 Billion to build a 200,000 bbl per day refinery in the US. That refinery would process about 70 million barrels of oil per year. The interest cost to borrow the money to build the refinery would be about $175 million per year, or about $2.50 per barrel.
Average refinery margins for have been about $2.35 per barrel over a five year period.
In other words, the profit margin on refineries is not high enough to even pay the interest on a loan to build a new one, much less return a profit to the owner.
That's why we don't have any new refineries.
Environmental issues are the secondary concern. If there were money in it, the oil companies would work hard on getting the permits.
Instead, they have sold off their existing refineries to independents for about $0.25 on the dollar. The oil companies get to deduct the loss from their income taxes, the independents get to work with a ridiculously low capital cost.
There is about 12 million barrels of spare refining capacity in the world, mostly outside of the US. That spare capacity is equal to 3/4 of the total US refining capacity.
The US has been increasingly importing finished products from this spare capacity. However, environmental restrictions requiring doubled-walled tankers, among other things, have tightened the supply of tankers available for this service, which is why freight rates have soared recently.
The high freight rates have pushed up costs for refined products, including gasoline.
New tankers are being built, which will eventually reduce this problem, but because of the Exxon Valdez oil spill, major oil companies are not willing to own tankers. Third party shippers, who are less financially capable, are the one building the tankers. If the oil companies were not so worried about an oil spill, more tankers would be built sooner.
In the mean time, the high price you're paying for gasoline is the result.
Of course, supply and demand for crude oil, the value of the US dollar, and the world wide geopolitical situation, all contribute to the underlying cost of crude oil. That sets the base value of refined products.
But US refining capacity is not really a major factor. It is just one part of the distribution system that turns crude oil into refined products and delivers them, at the appropriate specifications, to the local markets.
"Balkanization" of US gasoline specifications (Lots of individual specifications for relatively small localities) is probably more important than the amount of US refining capacity. Balkanization makes the supply chain more tortuous, no matter where the refinery is located.
I believe environmental issues are the primary concern. They push the economics to make it unprofitable.
"Sure, oil refiners are making a lot of money now. But there's no rush to build any more. Long term, oil refiners get a 5% return on investments, less than half that of a typical S&P 500 firm."
The auther seems to think a 5% return is "a lot"? I must question his knowledge of general business. There is no reason for any Oil Companies to invest in capitol when they could do much better investing in Bonds.
I hate it when my NIMTOs turn into NITMOs.
By the term "environmental issues," I meant the process of obtaining permits to build a new refinery. If the economics for a new refinery looked more favorable, then oil companies would work harder on obtaining the needed permits, which they are not doing.
As for the cost of environmental facilities required as a part of a new refinery design, that is an interesting question. One may argue that about 25% of the investment cost of a new refinery is associated with facilities required strictly for environmental compliance. Taking that assumption, then the cost of a new refinery without environment facilities might be $1.875 Billion.
Interest charges would be about $131 Million per year, or about $1.88 per barrel. At an average refinery margin of $2.35 per barrel, after paying the yearly interest charges to borrow the money to build it, it would take 57 years to recover the capital. Then the refinery owner could start pocketing a profit. Not a very attractive proposal.
The real problem with refinery profits in the US is the amount of spare refinery capacity built in places like Korea and the middle east, as a strategic investment for those countries. That government subsidized spare capacity competes directly with new grass roots capacity which might otherwise be built in the US. The only economic protection for the US capacity is the current high tanker rates for transporting refined products into the country.
One might argue that refineries built somewhere else in the world do not require so much environmental investment, but that "savings" is largely offset with the higher general construction costs.
Print the IBD article and reply #4 out for your significant other.
Oh, for heaven's sake, not the Peak Oil myth again. It's the Internet's newest and shiniest urban legend.
But environmental issues even dictate foolish additional cost in operations. When so many different requirements about the gasoline used in different areas are incompatible with each other, it greatly increases the cost. Either you have to make many different types of gasoline, or you greatly limit your market.
No, the self-filling oil reservoirs hold that current distinction.
They are building a liquid natural gas plant just over the border south of San Diego to receive gas from South America before piping it north into the US. Such a plant could never be built in California, despite the great need they have to diversify their gas sources.
California's blackouts of recent years were caused as much as anything by natural gas shortages. The criticism of energy brokers such as Enron masks the fact that brokers can't play you unless there is a shortage to begin with. The solution to being held up at gunpoint is to find new sources of fuel, but California's legal climate makes it all but impossible to build anything. Thus I expect to see in future not merely LPG plants being built on the border, but finished gasoline being piped up from Mexico as well.
The rest of the US is almost as restrictive as California, or quickly becoming so, which guarantees energy shortages, guarantees that sharp traders will make hay on it, and guarantees that future industrial development will happen outside the US whenever possible.
Well, newbie, you don't know what you are talking about. I worked in the oil industry for years and we are nowhere near you magic "peak oil." Many old fields are slowly refilling plus areas with hugh reserves have been declared off-limits by the enironmental wackos (both inside and out of government agencies.)
Your "peal oil" won't be seen for well beyond our lifetimes.
Add to that the cost of building alternative kinds of oil factories or refineries. Depolymerization plants might take over some of the slack in oil supply, but at a price. Would it be worth investing in depolymerization? or wind/solar for that matter.
But the initial investment I would not assume to be slight. Also, and I think (without any backup) that the many different "recipes" prevent the free market from working efficiently. When a shortage (due to whatever) occurs in a an area, it is difficult to supply the need from other shortages. Also it reduces competition if refineries specialize.
Your "peak oil" won't be seen for well beyond our lifetimes. Add to that - if ever!
You are exactly right. What we need is standardization to prevent the "localized" fuel options. That plus fuel tax reductions and some regulatory relief would reduce pump prices fairly quickly.