Tight gas market aids refiners, punishes consumers

By Nicole Gaudiano
GANNETT NEWS SERVICE
The oil-refining industry may have helped create a gasoline market that’s so tight, 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 that they wanted to reduce refining capacity to boost profits. The industry dismisses those memos’ significance — and the notion that 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,” said Tyson Slocum, director of Public Citizen’s energy program. “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 today, 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 facilities 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 refin-eries closed, some in the industry worried about having too much refining capacity to turn a profit, according to “highly confidential” internal documents exposed in a 2001 investigation by Sen. Ron Wyden, D-Ore.An internal 1995 Chevron memo relays the warning 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 (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 past 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 using nearly 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 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,” said Godwin M. Agbara, who led the study.Refiners keep some gasoline on reserve at U.S. refineries or terminals to protect against price spikes in case of a disruption. But inventories have declined from 40 days of average U.S. consumption in the early 1980s to 23 days in 2004, a GAO report stated.Their move to a just-in-time delivery system mirrors other industries, and it may reduce gas prices because of lower storage fees. But it also can increase price volatility.On Aug. 26, just before Hurricane Katrina hit, U.S. inventories for gasoline were 194 million barrels, fewer than three days’ supply before hitting the minimum operating level, a Congressional Research Service study found.An Arizona attorney general’s report on post-Katrina gas prices argues that, while the practice may work under ideal conditions, every disruption caused by natural disaster, refinery outage or broken pipeline affects the tight supply-demand balance.“Petroleum markets quickly tighten and prices skyrocket,” the April 2006 report said. “Thus, consumers pay a high price for the oil companies’ profit maximization strategies.”Low inventories exacerbated refinery production problems and failures of pipelines serving the Midwest during the spring 2000 switch to reformulated gas. Midwest refiners, along with others across the nation, had allowed their inventories to dwindle as they waited for the price of crude to drop, the Federal Trade Commission found in an investigation.As the national average reached $1.67 a gallon, gas in Chicago soared to $2.13 and in Milwaukee to $2.02 that spring.On one hand, that price spike helps illustrate a complaint of refiners: boutique fuels. Chicago and Milwaukee relied exclusively on ethanol as a pollution-reducing additive, and refiners couldn’t easily import a substitute to ease the shortage, the FTC’s investigation found.“All these different fuels around the country — that’s effectively using up refining capacity,” Peter J. Robertson, Chevron Corp. vice chairman, said in an interview. “By having one flavor for Atlanta and one flavor for California and one flavor for Chicago means you can’t balance the system.”But the FTC also found that three companies, left unidentified in its report, had previously decided independently to maximize their profits by curtailing production. At least one other company had excess supply but withheld it from the market to keep prices high.“An executive of this company made clear that he would rather sell less gasoline and earn a higher margin on each gallon sold than sell more gasoline and earn a lower margin,” the report said.Despite such findings, the FTC determined the industry did nothing illegal and issued a warning that seemed targeted more toward consumers than refiners: “Unless gasoline demand abates or refining capacity grows, price spikes are likely to occur in the future in the Midwest and other areas of the country.”