Much has been written recently about the "oil crisis" in the United States. Actually, there is no shortage of crude oil at this time. There is a shortage of cheap crude oil.

Oil Crisis?
How About the Refinery Crisis?
by Charles R. Perry
Chairman of the Board
Perry Management, Inc.
copyright © 2000 Perry Management, Inc.

For presentation on the
CompuServe Personal Finance Channel
July 31, 2000

Much has been written recently about the "oil crisis" in the United States. Actually, there is no shortage of crude oil at this time. There is a shortage of cheap crude oil.

The Looming Crisis

There is a real, serious "refinery and distribution" crisis approaching rapidly. Refining is the process of converting crude oil into usable products such as gasoline, jet fuel, and heating oil. Distribution is the means of transporting those refined products from refineries to consumer marketplaces. The crisis will culminate in the 2006-2007 era, and it undoubtedly will result in shortages and higher prices for gasoline, diesel, and No. 2 heating oil.

It has taken a series of events to get the U.S. refining industry to this condition. To begin with, there have been no new grass roots refineries built in the U.S. for over 25 years. Instead, the number of refineries has decreased from 365 in 1945 to 155 today.

Existing refineries have expanded and increased efficiency so that today, the combined U.S. refining capacity is slightly more than 16 million barrels per day. U.S. consumption of petroleum products now averages about 17 million barrels per day--the difference is made up of product imports that for several years have equaled approximately 5 percent of the U.S. consumption. For more than a year, U.S. refineries have been running essentially "wide open," averaging in excess of 96 percent of capacity.

Many Products, Few Pipelines

In addition to the constraints on the refining capacity, there are limitations to the refinery products distribution system--mostly pipelines. This system was designed to handle six to eight different products when it was built in the 1960-1970 era. Today, due to the many blends of gasoline required in various cities, the system now has to cope with three dozen different products. This multitude of products makes the system much more complex and reduces its capacity.

Because excess refining capacity is not always in the location where it is needed, it is essential that products can be moved from one area to another . Naturally, if there are constraints in the distribution system due to the multiple products that must be handled, then there are times when the distribution system cannot move the proper products to where they are needed. Thus there are spot areas with shortages.

The multitude of gasoline blends are being dictated by the U.S. Environmental Protection Agency in its quest for cleaner air. Non-attainment areas require "reformulated gasoline," commonly called RFG in the industry. However, different cities require different blends for RFG, depending on the pollutants prevalent in the air of that city. About 87 percent of the RFG contains methyl tertiary butyl ether, referred to as MTBE in the industry. The other 13 percent of RFG contains ethyl alcohol.

However, MTBE has been discovered in some groundwater sources in the western part of the U.S. (believed to have leaked from underground gasoline storage tanks.) This has caused a movement to ban the use of MTBE and to use ethyl alcohol or other oxygen containing compounds in RFG. The elimination of MTBE will require extensive modifications in refineries and will reduce the capacity of some.

Even More Environmental Regulations

To complicate gasoline and diesel supplies more, on June 1, 2000, the EPA mandated a reduction of sulfur in gasoline to no more than 30 parts per million (ppm) by 2006 and is expected to mandate a maximum of 30 ppm in diesel also by 2006. The EPA may elect to reduce the standard for diesel to 15 ppm by 2006.

Meeting these standards will reduce the capacity of existing refineries, will require extensive modifications to accomplish this reduction in sulfur, and will require extensive refinery additions to replace the reduced capacity. (This does not include the normal growth in demand, which is expected to be an additional 2 million barrels per day by 2006.)

The Sheer Magnitude of Work to Get Us There

Refinery additions and modifications to meet these standards will cost in the range of $20 billion. Although average return on refinery investments over the last 20 years has only been 4 percent, there does not seem to be any reluctance on the part of refinery owners to make these investments.

However, the real constraints to meeting the standards will be availability of engineering contractors to perform these modifications, and the permitting process required by the EPA and state environmental agencies. Industry experts fear that the shear number of construction permits that will be required may swamp regulatory agencies, preventing timely processing permit applications.

It Can be Done, But…

Experts believe the refining industry can meet these new sulfur standards and replace MTBE in the RFG by the 2006 deadline, provided that construction permits are issued in a timely manner by regulatory agencies, that there will be adequate engineering and construction crews available, and that these required new specifications are phased in over the six year period.

However, one hiccup, one sneeze, or one bobble and the industry cannot meet these mandated specifications, thus creating shortages.

Once all the modifications are completed, it will add approximately $0.10 to the cost of a gallon of gasoline.

31 Jul 2000
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