Gas supply kept tight

Any disruption could be problem
Cincinnati Enquirer
Jul. 29, 2006

WASHINGTON - The oil-refining industry might have helped create a gasoline market that's so tight that some industry experts and critics say any hurricane, pipeline break or other disruption is likely to cause price spikes.

During unprofitable times in the 1990s, some refiners' internal memos show they wanted to reduce refining capacity to boost profits. The industry dismisses those memos' significance - and the notion it tightly controls supply - but ultimately, its investments in refining capacity haven't kept pace with the growth in demand.

Today, there are fewer refineries and fewer, but more profitable, refining companies.

Refiners also reduced the amount of gas they keep in reserve to use as a cushion during disruptions, and some companies limited production in the Midwest in 2000 for the sole purpose of maximizing profits.

Those moves are legal and considered to be sound business practices. But they contribute to higher prices at the pump.

Some members of Congress and consumer advocates say the oil industry has taken such practices to anti-competitive extremes that ultimately hurt consumers.

"Gasoline is not Starbucks coffee," Tyson Slocum, director of Public Citizen's energy program, said. "It is a critical commodity that should not be subject to the whims of the supplier."

The price of crude oil is the largest determinant of the price of gasoline, accounting for about half of the cost of a gallon and most of oil-producing companies' profits.

But crude must be refined into gasoline, and disruptions in that process can lead to sharp price increases. That's especially the case now, as the demand for gas grows faster than U.S. refining capacity.

"It will not make a difference if Saudi Arabia ships an extra million or 2 million barrels of crude oil to the United States," Crown Prince Abdullah's foreign affairs adviser, Adel Al-Jubeir, said this spring. "If you cannot refine it, it will not turn into gasoline, and that will not turn into lower prices."

There were dozens more refineries in the 1990s, but they weren't as profitable. Environmental regulations on the products and refineries required expensive updates and some refining companies "didn't make the economic cut," said Bob Slaughter, president of the National Petrochemical and Refiners Association.

Even as smaller, inefficient refineries closed, some in the industry still worried about having too much refining capacity to turn a profit, according to highly confidential internal documents exposed in a 2001 investigation by U.S. Sen. Ron Wyden, D-Ore.

An internal 1995 Chevron memo relays the warning that an energy analyst made at an American Petroleum Institute convention: "If the U.S. petroleum industry doesn't reduce its refining capacity, it will never see any substantial increase in refining margins," which are earnings divided by operating revenue.

Similarly, a Texaco executive in 1996 complained of "surplus refining capacity" and wrote that "significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline."

API's chief economist John Felmy called the statements "purely musings" and said it's "utter nonsense to argue that we're tightly controlling supply."

"We've expanded capacity over the last 10 years, the equivalent of a new refinery every year," Felmy said. "But these radical groups will come up and say things that are fundamentally untrue."

Further, the industry projects capacity increases of 1.4 million to 2 million barrels a day in the next four years.

The Federal Trade Commission, in its investigation of post-Katrina gas prices, found no evidence suggesting that companies refused to sufficiently invest in new refineries to tighten supply and raise prices in the long run. Instead, the agency said the evidence suggested that further investment would have been unprofitable.

Indeed, refining capacity increased by 12 percent since 1987. But U.S. demand for gasoline increased by 28 percent. Refineries are now using almost all of their capacity, compared with 83 percent in 1987.

The U.S. refining companies that stayed in the business - 55 in 2006 compared with 188 in 1980 - are seeing the rewards.

ExxonMobil's refining and marketing segment ended last year with a 40 percent profit increase. The top independent refiners and marketers collectively scored a 92 percent increase.

"We have grown, and we've been in the right business at the right time," Rich Marcogliese, Valero's executive vice president of refining operations, said in an interview. "It is a great time to be in refining because the supply/demand balance for refined products is tight with good margins."

Valero led the independents, earning $3.6 billion in profits, a 99 percent increase over 2004. The company grew from one refinery in 1996 to 18 today, becoming one of the largest U.S. refining operations after acquiring Premcor Inc. last year.

Valero was just one part of the industry's consolidation. There were more than 2,600 mergers in the U.S. petroleum industry - about 13 percent in the refining and marketing sector - since the 1990s.

The industry's consolidation, mostly in the refining segment, has generally led to wholesale price increases averaging 1 to 2 cents a gallon, a 2004 Government Accountability Office study found. The FTC disputed the study, but the GAO has stood by its results.

"If you are observing higher wholesale prices, you probably can expect higher retail prices, all things being equal," Godwin M. Agbara, who led the study, said.












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