Gasoline Prices Part II: Long-Term Factors


In Part I, I discussed the short term factors that have resulted in the recent, rapid increase in the price of gasoline. But there are a number of underlying, long-term issues that have been major contributors. I will attempt to address them and answer a number of related questions, such as: Why have no new refineries been built in the past 30 years? Are U.S. refineries breaking down more than normal? Are oil companies purposely withholding supplies to keep prices high? Have environmental regulations played a role? Does the use of ethanol influence gasoline demand growth? The answers to some of these questions may surprise you.

Please note that my essays should not be confused with financial advice. Following Part I, I received a number of e-mails requesting financial advice. While there are often potential financial implications, I am not a financial planner. If you choose to make investment decisions based on what you read here, you are on your own.

Further note that it is not my contention that refiners are not benefiting from higher prices. They are. But my contention is that prices aren't higher because they have increased margins. Margins have increased because prices are higher.

U.S. Refinery Capacity

The problem, I have read on many occasions, is that we aren't building any new refineries, and that "limiting refinery capacity seems to make more money for oil companies than expanding it." Claims like the following from the Foundation for Consumer and Taxpayer Rights - are quite common:

America's big oil companies figured out long ago that they could make more money by making less gasoline. That's why the industry hasn't built a new refinery in 30 years. Since deregulation of the refinery business in 1982, oil consumption has increased 33% but oil companies have kept refining capacity near what it was 25 years ago. Why not? They know that the scarcer the product, the bigger the profit.

Even members of the Senate Committee on Energy and Natural Resources seem to believe this, with New Jersey Senator Robert Menendez recently commenting in a Senate hearing on gas prices:

Senator Menendez: Isn't there a reality that we are paying for some industry decisions that actually reduced refining capacity in this country? I mean there was a time that we had greater refining capacity, and the industry reduced that refining capacity, and as a result of making that decision, consumers today find themselves with exactly the consequences that you have described in your testimony before.

There are elements of fact and elements of fiction in the preceding statements. So, what's the scoop? Are oil companies cutting refinery capacity in order to boost profits?

In the past 10 years, refining capacity in the U.S. has increased by about 2 million barrels per day, which is equivalent to about 10 good-sized refineries. Capacity expansions equivalent to 8 more new refineries have been announced for the next 4 years (although some refiners have recently suggested that some expansions may be put on hold as a result of the stated goal of reducing gasoline consumption by 20% in 10 years - in order to avoid an oversupply situation). So while it is true that new refineries aren't being built, it is certainly not true that capacity is stagnant. There are several reasons for expanding existing refineries as opposed to building new ones.

First, it is less expensive per barrel to expand an existing refinery than to build a new one. The estimates I have seen suggest that existing refineries can be expanded at 60% of the per barrel cost of building a new refinery. Second, the permitting process for building a new refinery is onerous. A group in Arizona has been trying to build a new refinery, and it took them 7 years just to get the permit. If they proceed and build the refinery, it will have taken 13 years from the time they started the process. (Even as I was working on this essay, they have announced a further 1 year delay). Finally, while everyone seems to want more refining capacity, nobody seems to want a refinery in their community. This makes building a new refinery next to impossible. As Investor's Business Daily recently asked Senator Chuck Schumer: "Just where in New York state would you like a new refinery to be built...?"

However, the critics are correct on one point. Starting in the early 80's, U.S. refining capacity did drop significantly, before beginning to climb back up in the 90's. The reason for this is quite simple: There was far more refining capacity than was warranted by the demand. The result was that gasoline was $1.00 a gallon, and many oil companies were losing money. Many refineries shut down. Some oil companies went out of business. Property values in "oil towns" like Houston plummeted. Yet many view oil companies as if they are public utilities. But the majority are owned by shareholders, who expect a return on their investment. Billions of dollars of capital are risked in this business, and if the rewards are poor (or negative), the risks won't be taken.

No industry can be expected to maintain high production levels in the face of poor or even negative margins. If milk producers make too much milk, prices fall and some producers go out of business. When that happens, supply is reduced and prices go up. The same is true for any other business. Yet people don't accept this very well in the case of oil companies, because many have come to view cheap gas as an entitlement.

U.S. Senator Ron Wyden has spent quite a bit of time investigating these issues, and his view is probably typical with respect to the evolution of refining capacity:

The Oil Industry, Gas Supply and Refinery Capacity: More Than Meets the Eye

In this report, Senator Wyden presents a number of "smoking guns", such as this internal Texaco document from 1996:

“As observed over the last few years and as projected well into the future, the most critical factor facing the refining industry on the West Coast is the surplus refining capacity, and the surplus gasoline production capacity. The same situation exists for the entire U.S. refining industry. Supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline.”

Senator Wyden skipped right past the part about poor margins and poor financial results, and focused on the "smoking gun", that either supplies needed to be reduced or demand for gasoline increased. He then gives a list of the refineries that have closed since the mid-90's, apparently failing to connect these events with "poor refining margins." Here are the refineries he lists that closed in 1995:

Indian Refining Lawrenceville, IL
Cyril Petrochemical Corp. Cyril, OK
Powerine Oil Co. Sante Fe Springs, CA
Sunland Refining Corp. Bakersfield, CA
Caribbean Petroleum Corp. San Juan, Puerto Rico

Do you recognize any of those names? Probably not, because most of the companies that shut down did so because they went out of business. Margins were too poor to remain in business for some. For others, it was failure to comply with environmental regulations (some of the closed refineries are now Superfund sites). Yet Senator Wyden presents a picture in which it was a systematic and cooperative effort between oil companies to reduce refining capacity - and that refinery capacity should have been maintained at any cost (as long as oil company shareholders are the ones to bear those costs). Somehow "the industry" is culpable for the closure of a number of marginal producers - many of whom went completely out of business. But it was years of poor returns in this cyclical business that drove down refining capacity.

Even in the past 10 years, refinery margins have turned negative on numerous occasions. The problem is that many people take a snapshot of the current view and believe this is normal. See the data that the IEA has accumulated (XLS download warning). Shall we expect that those who are calling for measures to be taken to address the current refinery margin situation will be calling for the government to extend a helping hand the next time margins go negative? Somehow, I doubt it. (Incidentally, for those who think oil companies have boosted their margins by raising prices, how do you explain the incredible variability from month to month? How do you explain negative margins?)

Paul Sankey, an analyst with Deutsche Bank, testified on May 15th before the Senate Committee on Energy and Natural Resources. He pointed out the long-term factors that have resulted in the refinery capacity we have today:

The reason for the massive recent run up in prices can be traced back to the last significant period of high prices, in the late 1970s, which forced lower gasoline demand, then more efficient cars, which led to excess refining capacity, which led to years of poor returns in refining (and cheap gasoline prices), which disincentivised investment in refining and encouraged demand, and which has ultimately led to today’s intense market tightness.

The bottom line on the refinery capacity issue is that yes, refining capacity has been reduced at times. And there were perfectly valid reasons that this happened. It is also true that capacity is short at the moment - if the objective is to maintain sub-$3 gasoline prices. But, reduced investment in refining capacity is indeed a key factor behind the current gasoline price spike. If some want to level the charge that refiners failed to accurately anticipate demand growth, then that charge is accurate. But like the rest of us, refiners don't have crystal balls.

Are Oil Companies Purposely Withholding Supplies?

This charge has been repeated quite a bit lately. Oil companies are either accused of withholding supplies ala OPEC, or they are accused of stretching out their maintenance in order to keep supplies low. Let's address that.

In a very tight market, events that take supply off of the market are likely to drive prices higher. In light of that, would it be a wise business practice if BP, for instance, purposely slowed down the maintenance at their Whiting, Indiana refinery that is partially closed due to a fire? Not a chance. When BP has supply off the market, it benefits everyone BUT BP. They are foregoing money every day they have that capacity offline. The refinery manager at Whiting will have part of his performance graded based on the financial returns of his refinery. The longer the supply is offline, the worse that grade will be.

Consider a couple of examples. Say that you operate a 200,000 barrel a day refinery. Margins are quite good right now - let's say in your area they are $20 a barrel. So, when the refinery is running normally, you are grossing $4 million a day. Would it make good business sense to cut your capacity in half - to 100,000 barrels a day? While such action would probably cause the overall price of gasoline to rise, it is going to have a disproportionate effect on your refinery. If margins go up to $30 a barrel (although there is no way taking 100,000 barrels off the market would impact margins to that degree), you are still $1 million a day worse of than you were. You have given up $365 million a year in order to reduce your capacity. You would have made an incredibly stupid business decision. In fact, you would be much better off if you could boost capacity by 100,000 barrels a day. Sure, prices might slightly drop, but your overall profits will be higher, especially in such a tight market.

Furthermore, you don't know if Shell down the street might be able to make up the production shortfall, pocketing the money that would have been made by your refinery. (Contrary to popular opinion, oil companies do not consult each other on such issues). You also don't know if exporters from Europe will respond. If they respond by boosting exports to the U.S., now they are pocketing the money that your refinery is losing. In summary, this is not a rational way to conduct business - unless your margins are negative. You would be making a decision that will certainly cut the returns at your refinery, while not knowing how your competitors will respond to the supply shortfall.

For another example that many can relate to, consider that you wish to put your house on the market. Housing prices in your area have been outstanding, and you want to capitalize. However, you are afraid that by putting your house on the market, you may boost the supply in your area and cause prices to fall. So, you decide to be a charitable neighbor and keep your house off of the market in order to maintain prices for everyone else. You will sell some other time, even though the market may not be as good. If your primary objective is to capitalize on the good housing market, have you made a rational business decision? Of course not. The same is true regarding the charge that oil companies are deliberately prolonging maintenance. It just wouldn't make good business sense in this market.

Are Refineries Breaking Down More Than Normal?

It certainly seems each week brings several new refinery outages. While refineries still have not reached pre-Hurricane Katrina production levels, most of the outages that you read about are the kinds of things that happen every year. Practically all refineries have one or more unplanned outages each year. Most years, when the market is amply supplied, these sorts of events don't make the news. But this year, as we have seen, is very different.

As the afore-mentioned Paul Sankey testified:

The poor returns of the 1980s and 1990s have indirectly caused some additional external events that have played into the problems. The years of losing money caused companies to neglect refining investment, culminating in BP’s Texas City disaster. Texas City has now rightly caused other refiners to operate more cautiously – and so less capacity is available.

A second impact of years of reduced investment has been a lack of qualified engineering, procurement and construction staff. One vital issue here is that the tightness of US refining capacity at this time is not because companies are unwilling to invest in more capacity, it is that they are unable.

Refineries are complex. Heat is being added to flammable materials, and the entire chain of events depends on a steady supply of raw materials, equipment, and qualified people to keep things running smoothly. Equipment is going to break down. A refinery is much more complex than your car. Yet you would not be surprised if your 30-year old car had annual maintenance problems.

While this year's outages may be somewhat above average, similar outages happen every year. The only difference is that most years there is enough spare capacity that the outages go unnoticed by the media.

The Impact of Environmental Regulations

Let me make it clear that I am in favor of the environmental regulations we have in place. They have made our air and water cleaner. But there is a price to be paid for those regulations, and consumers should understand that, as they are the ones who will ultimately bear those costs.

There are several things that can happen when a new regulation is implemented. First, new regulations may redirect capital that might have gone into expanding refining facilities. Second, they may increase the costs of producing the fuel. Third, additional processing, as in the case of ultra-low sulfur diesel (ULSD) and gasoline - can reduce the overall product yield. Fourth, and perhaps of greatest importance, additional equipment will increase the complexity of the refinery.

Those are the consequences. The more complex the refineries are, the more unreliable they are going to be. With each additional complexity that is added, there are more ways for them to break down. There is more danger as the inventory of hazardous materials increases. Politicians who are quick to point fingers should understand that they make their own contribution to supply shortages. If they are going to hold hearings on gas prices, they needn't ponder "Gosh, I wonder why prices are going up?" Stricter environmental regulations - necessary as they may be - are one more piece of the puzzle. They have helped crimp supplies and add to costs.

Investor's Business Daily recently touched on this:

Our refineries are doing more than ever, but their numbers are dwindling and no new ones are being built. The reason is not greed, but cost and regulations. From 1994 to 2003, the refining industry spent $47.4 billion, not to build new refineries, but to bring existing ones into compliance with ever new and stringent environmental rules. That's where those allegedly excessive profits go.

I think most people are willing to pay higher prices for a cleaner environment, but it is important that they understand that this is a component of fuel prices.

The Ethanol Factor

It is a fact that ethanol only contains about 65% of the energy content of gasoline on a volumetric basis. Therefore, to displace the gross energy content of 1 gallon of gasoline requires 1/0.65, or 1.5 gallons of ethanol. What this means is that as ethanol is put into the gasoline pool, demand will go up simply because the pool now contains less energy. Is this enough to explain why motor gasoline demand (which includes blended ethanol) is at a record high?

In March of 2007, ethanol contributed 539 million gallons to the gasoline pool, according to the Renewable Fuels Association (RFA). This is almost 50% greater than the 365 million gallon ethanol demand in March of 2006. Gasoline demand in March, according to the Energy Information Administration, averaged 9.266 million barrels per day (up from 9.076 a year earlier). Total gasoline demand in March was then 9.266 million * 31 days * 42 gallons/bbl, or 12.06 billion gallons. The breakdown would have then been 11.52 billion gallons of gasoline and 0.54 billion gallons of ethanol. (Ethanol imports have been omitted as their impact would have been pretty small).

The energy content, however, of the 12.1 billion gallons would have been equivalent to 11.52 gallons of gasoline plus 0.54 billion gallons of ethanol * 0.65 (factoring the lower energy content), or 11.87 billion gallons of gasoline equivalent fuel. Therefore, our perceived gasoline demand is 1.9% (12.06/11.87) higher than it would be without ethanol in the pool.

In other words, part of the record high gasoline demand we are currently experiencing is due to the fact that ethanol is scaling up rapidly, and it is being counted in the finished motor gasoline pool. Even if demand was constant on a BTU basis, increasing the fraction of ethanol in the pool will increase the volume demand.


While the immediate cause of skyrocketing gas prices is a combination of record demand and low gasoline inventories in the U.S., several longer-term factors have contributed. Following years of poor returns and expensive new environmental regulations, investments into expanding existing refineries dried up. Many refineries closed their doors permanently, as a number of smaller producers went completely out of business in the 80's and 90's. The cumulative effect was that refining capacity fell starting in the early 80's, but has recently been climbing back as margins have improved. Just as we were in an oversupply situation in the 80's, we are now in an undersupply situation if the goal is to keep gasoline below $3.00/gallon. However, refining capacity has increased significantly in the past 10 years, and looks to continue this trend in the foreseeable future. But demand growth has remained robust in the face of higher prices, so an oversupply situation in which gasoline returns to $2/gal does not appear likely in the foreseeable future.

Good points Robert, but reminds me of a comment my father used to quote. " Don't confuse me with facts, my mind is made up!" Good luck with the agenda driven Congress and the clueless motoring public.

Hey everyone, don't forget Reddit and Digg!

During the OPEC oil embargo, there were all sorts of claims about oil companies holding tankers off the US Coasts and oil storage tanks practically overflowing.

As a young engineer, I took this with a grain of salt, but it also served to show that anything that directly affects lifestyle where it is the lifestyle that causes large demands on supply margins are things that Americans may not readily wish to accept.

I worked for a engineering firm that was big into 'gasohol' in the early 1980's, but many of my coworkers took off for Texas (and other locations) to work for the oil companies. A few years later, the were back doing something else. In my own company, we were fortuante to have bought ourselves away from the parent engineering firm because 5 months after that sale was complete, that parent engineering firm filed bankruptcy and went out of business.

Just as it has taken a long time (and many tortuous paths) to get to where we are today, it will take informed choices to develop the silver BBs we need now and in the future. As one person in the federal government asked me, "what will it take to get people to understand?"

"A terrible shock," I replied, "with attention getting properties of the Anna Nicole Smith death or Paris Hilton going to jail, that will shake us to our cores." As some of the Congressional investigations seem to imply, people want a cheap simple fix so that they can go on with what's really important in their lives.

The Whiting refinery is down, there was the Imperial refinery fire in Canada, and other problems as well.

With Iran stating it wanted to build five refineries in Asia in addition to other refinery projects planned for Asia it seems the higher consumption rate of some non-OECD countries will divert new crude supplies away from the US. Numerous currencies were strengthening compared to the dollar, thus oil was becoming more affordable for them. The preemptive war is taking its toll on America.

I have read rumors on the board that the refineries cannot get the type of crude they want. If this is true, you get builds in heavy sour and draw downs in light sweet. I cannot prove it.

Worldwide car sales seem to be outpacing supply thus we have $3.00 + gasoline in the shoulder season without a hurricane and no major build in supplies ahead of hurricane season and the winter.

Here is a good question for everyone!

World gdp=45 trillion

us gdp maybe >3 trillion?

North American GDP maybe 4 trillion max.

now do you sell oil to 4 trillion worth of people, or 40?

I'd sell to 40 after fleecing the 4. (this ignores that canada and mexico are USA's #1,#2 oil suppliers)

You're only off a few trillion.

IMF figures:

World GDP: 48.1 trillion
North American GDP: 15.3 trillion

That's 1/3rd of the world, not 1/10th


i guess i was thinking about the US federal government tax, and not the country as a whole. My mistake!

please continue selling oil to 1/3rd of the worlds gpd.

If you want a good visual of GDP, check out the first map on this link.

Best regards from Western Canada,

Mose in Midland

I think the ethanol has a double impact for raising summer prices:

1. The lower BTU impact you talk about.
2. Required adjustments to the gasoline base (RBOB) to which it is added which tend to reduce the amount of gasoline produced in the summer months.

The relatively lower amount of gasoline produced from a barrel of crude also has an adverse impact on prices. Since ethanol is now used primarily in the summer months, this is basically a summer-months issue, and helps to drive up prices in the summer. This issue may actually help gasoline supplies (and prices!) in the winter, if the fractions that must be removed when ethanol is added can be added back in outside of the summer months.

I tried to explain this a little more here.

Speaking of the ethanol impact, I have noticed in my neck of the woods that the higher grades which use ethanol are now higher than in the past. Used to see them stay at ten cents higher for each grade, 87 89 91. now they are 12 or sometimes 15 cents higher per grade.

I can only quess its because of the ethanol costs, but maybe not.

Quid Clarius Astris
Ubi Bene ibi patria

In Minnesota E-85 sells at forty cents per gallon less than 87 octane regular. We are, of course, a pro-ethanol state.

I'm curious if you know if it sells at that price differential. Assuming gas is selling for $3/gal in Minnesota, that would make the BTU content equal to about $2.10/gal for E85. At 2.60, I wouldn't think anyone would buy it. I've been told by a rural Nebraska supplier that he stopped carrying E85, because even in the middle of the corn growers, they wouldn't buy it because it wasn't economical for their big pickups and Suburbans, etc. (Don't know what the price differential was at the time.) A vehicle that gets 17mpg on regular, gets 12mpg on E85. Of course, I think our state vehicles are mandated to use it. Maybe your state has additional mandated vehicles running on it. One way they can "cheat", is that E85 can contain between 15-30% gasoline. Since it doesn't work well in cold, this is the time of year Minnesota sales of it should be high if they are going to use it at all!
Thanks for the article, RR.

The costs at the pump and these numbers make me wonder. why the cost of the extra octane at the pump is 20 cents or more a gallon higher that regular.

How much ethanol is needed (whats the octane of the Ethanol
rating in Minn at at the pump.

Seems to me if you are running a high octane vehicle it would be worth your while to drop in a gallon of ethanol or so (you could figure it out to be close) with 19 gallons of reg. and save some decent money.

Quid Clarius Astris
Ubi Bene ibi patria

My reliable sources tell me that for driving a flexfuel Ford Taurus that there is no difference in cost between driving on E-85 and regular 87 octane. I think that is because the engine has been optimized for driving at higher octane than 87, and of course, ethanol boosts octane rating.

Were any mtbe needed to boost the gasoline to 87, or is ethanol added to the blend of all grades, is ethanol in 87. Robert seemed to be surprised that 87 was the standard octane in many states. I have never seen 85, except maybe in Denver, I don't think I saw it in LA.

What is the octane rating from the refined "gasoline" and where do they start adding ethanol to up the octane.

Quid Clarius Astris
Ubi Bene ibi patria

In Minnesota ethanol at 10% is added to all grades of gasoline with few exceptions. You can get pure gasoline with no ethanol in it, but in the seven county Metro area you have to pay hyper premium prices to get it at very very few gas stations.

Great key post, Robert! I enjoy your writing-its concise, easily understood and very balanced. One suggestion, when the trolls show up, and you are their favorite target, don't respond immediately. Allow them any response and they are gratified. I know its contrary to the Aggie way, but its the best response. Immediate attention only fuels their refinery fire.

Regarding quality of the keypost, agree 100%. Very good stuff Robert.

Lets see we go from how hard it is to raise new capacity, because of course REGULATION, to we've actually added 2 millions barrels of new capacity, but no distinction as to what type of capacity gasoline vrs everything else. And while FCTR is taken to task for saying no new capacity, Investor Business Daily is quoted later in piece and agreed by the author with saying the same thing, because why, it's regulation not the oil industries.

But best,

It is a fact that ethanol only contains about 65% of the energy content of gasoline on a volumetric basis. Therefore, to displace the gross energy content of 1 gallon of gasoline requires 1/0.65, or 1.5 gallons of ethanol. What this means is that as ethanol is put into the gasoline pool, demand will go up simply because the pool now contains less energy.

Which as the new oil industry mantra goes, less ethanol equals higher gasoline prices, more ethanol means higher gasoline prices, and again this is an equation from the top of the industry which doesn't include any recognition of peak.

Bend over the and grab your ankles, the oil industry is driving.

Really good post, very informative.

Even if demand was constant on a BTU basis, increasing the fraction of ethanol in the pool will increase the volume demand.

IMO, it's a very important observation. we don't consume barrels but BTU (i.e. energy). The share of low energy density fuels (NGPL, ethanol, etc.) has increased greatly on a volume basis since 2010 but strong growth in volume does not imply necessarily that the demand growth for BTUs has been satisfied.

I'm not sure that I understand ". . . does not imply necessarily that the demand growth for BTUs has been satisfied." As Robert has stated on numerous occasions, whenever an oil or refinery company wants to buy some crude, it can (although at a high price).

In my opinion, this evidence that Robert has presented (and to the best of my knowledge nobody has questioned) is very persuasive on the side of the debate which says that we probably have not reached peak liquids yet in terms of BTUs.

As Robert has stated on numerous occasions, whenever an oil or refinery company wants to buy some crude, it can (although at a high price).

I can buy a Rolls Royce at any time I want to (although at a high price), but why isn't everyone driving a Rolls Royce?

The question is, what about the refineries that can't afford to buy crude oil at these prices? Regarding adequate OECD crude oil inventories, check out a map of the areas of the world not covered by these statistics:

Based on EIA (crude + condensate) data, the cumulative shortfall between what the world would have produced at the 5/05 rate and what we actually produced worldwide is on the order of 500 mb.

The average monthly Brent crude oil price in the 20 months prior to 5/05 was $38. The average monthly Brent crude oil price since 5/05 has been about $62, within a range of $54 to $74, and we are currently in the upper end of that range.

When we are at a geological peak, I would expect cases of refineries offering very high prices ($100+ per barrel) and being told that they amount they want to buy cannot be supplied from anywhere.

Granted, Robert's evidence is not conclusive, but I still find it highly persuasive.

I'm not sure that Robert is claiming that proximity to peak production has nothing to do with high gasoline prices...he explicitly stated that he was attempting to explain the "recent, rapid increase" only.
And while his evidence is persuasive, there are surely more factors responsible than those he lists here. For instance, while I agree that actual collusion is almost certainly not occurring, surely a case can be made that a reduction in the number of competitors, both at the refinery and retail level, must have some (upward) affect on prices.

The initial Lower 48 decline was quite gradual (less than 1% per year for the first two years), and we didn't have the benefit of nonconventional crude oil sources.

Worldwide, crude oil prices have traded in the highest sustained nominal trading range in history, and we saw a decline in crude oil production, in the most likely year for a decline, as predicted by Deffeyes.


Could this actually reflect how worthless the dollar is becoming?

Your ELM should be mainstream in the next couple of years.

Good point!

Much of the increase in U.S. gasoline prices has actually been due to the decline of the dollar vs. foreign currencies.

this article in finacialsense on < href=""> the dow would seem to indicate that yes, it is not the dow that is up, but the American dollar that is down.

I wonder what a graph of how much gold 1 barrel of oil would get you would look like.

(graphs how much much gold and oil 1 'dow' would get you)

we probably have not reached peak liquids yet in terms of BTUs

Actually the picture looks worst when fuels are added on a BTU basis:

So NGPL and other liquids provide only 8.8% of total BTU's, but make up 13.3% of the total volume. Sort of like those potato chip bags that shrink once you open them...

Wow, I had no idea that NGPL had only 2/3 the BTU/barrel of crude oil. All those charts that show an impressive increase in NGPL volumes need to be discounted by 1/3 to show the true amount of energy provided. That's actually quite shocking to me! Just one more piece of data on top of all the others that show we have a problem brewing in fossil fuels.

But like the rest of us, refiners don't have crystal balls.

What kind of balls do they have?

Putting the aside the NIMBY issue with location, and the fact they will be initially competing with their existing capacity and therefore reducing current margins.

Could it be they just do not have the crystals to invest billion(s) in new capacity to increase their reliance on imported crude, with no real idea that the demand for the quantities of products produced will be there at the prices they will need to achieve to make the investment worth while.

Additional problems with refiners is that they have been conditioned to handling light sweet crude. As more and more of world production turns sour, especially KSA which is growing more sour by the day, refiners will have more and more problems.

Refineries are running full speed just to fight a losing battle against wear and tear on their components- The crude is too sour, and not enough refining capacity can handle sour crude. Refinery accidents/shutdowns will become more and more common, and as a result more public outcry will be heard against the oil companies.

Without the sour crude problem, which is a massive problem in and of itself, the fundamentals point to massive price rises in gasoline in the next few years. When you factor in the sour crude problem, and then the oil export problem there is just no way you can say nothing will happen. It will get 10 times worse, before it gets even a little bit better. We aint seen nothin' yet boys.

Wait until MTBE comes back, Then another oil exporter gets invaded, Then the hurricanes, then the failures to deliver from exporters, then the trade wars.

How can you ignore the coming landslide? Please, make youself useful if you don't believe in Hubbert or PO 'the fringe' movement and stand under the landslide. More for the rest of us when you're burried. Just to let you know its not personal though once you're burried, we would love to dig you out. If only we had the gas.

A Marathon refinery expansion approved (180,000 bod throughput):

Here is a planned Motiva Port Arthur expansion (325,000 bod throughput):

Chevron files for permit to expand refinery:

Reuters published a table of additional refinery expansion plans:

Refineries were being built all around the world.

The Venezuela revolutionaries seized foreign owned drilling rigs in Venezuela, upgraders & oil & gas field infrastructure. They made partial payment on some oilfield interests they seized.

I wouldnt over play the sweet sour issue... refineries are built to run heavy sour crudes...its all a question of economics.......

could you explain this statement fletch. How come such stock plays as Valero then are touted because that is what they based their operations on, the refining of heavier crudes. this gave them an edge. Seems they would have to be set for one or the other. If they switch to heavier then the output goes down. This means more refineries would be needed to make up the difference.

How long and what is needed to switch between the grades of crude. cliff notes, no one has explained much how they work. I've been on site, and knew it wasn't a place I wanted to come to work each day if I had a choice. You gotta trust your co workers very much and the company. Lots of pipes, hissing, valves, tanks, pressure, flames, whooo hooo, watch your head, watch your step, run this way when the horn sounds.

Quid Clarius Astris
Ubi Bene ibi patria

If your refinery is designed for a heavy sour feed, giving it a bunch of light sweet may not increase transportation fules yields all that much if at all. The extra equipment is specifically designed to bust up all those heavy molecules. It cant be used to process non existent heavy molecules in a lt sweet.

Also remember the front end device, a crude unit, distills raw crude. If it is hydraulically limited on trans fuels coming out the top part of the column(and they all are at some rate), you simply cannot get more through the plant. Then, with no heavy products coming out the bottom to feed your cokers, resid hydrocrackers or resid FCCs which make trans fuels from the crap that used to be ashphalt or heavy fuel oil, you end up behind.

OK, let me play devil's advocate for a moment. I suspect that part of the problem is that the "big-oil is gouging" folks are saying "no new refining capacity" when what they really mean is that refining capacity isn't keeping up with demand. From their perspective, while the refining industry can't predict the future, anyone can plainly see that prices are high, light trucks have been an increasing part of the motor vehicle mix for three decades now, and the country continues to sprawl out. It should be fairly obvious that the second and third points should raise expectations for increasing gasoline consumption, and the first confirms that.

So, from the "gouging camp" perspective, it should be painfully obvious that there is money to be made in refining and investments should have flowed there sufficiently to increase production to match expected consumption. I suspect they would say "Show us the plans and current expansion construction that demonstrates production is rising to meet demand now and in the future." Are there enough plans and construction in the works for production to match consumption?

Taking off my devil's horns for a second, I think the industry's response that the country is planning for less consumption is a stroke of genius. Why build it if you're planning to not use it? That dumps the whole situation back in the politicians'/environmentalists' laps. As an environmentalist, I'm not necessarily happy about it, but it is a smart move on the industry's part. And frankly, I think the industry knows that oil products will be expensive enough in the future to destroy some demand, so again, why build lots of additional capacity?

If the refiners take the heavier crudes they get more coke production and less gasoline production. They needed coker drums to get the heavy carbon asphaltenes out of the oil. They had to put hydrogen back in to get lighter molecules.

They like the Bonny light crude because they can get more gasoline per barrel out of it.

Early on the oil producers drilled and discovered numerous fields. They brought out their light sweet crude first as it was the best. Later they had the heavier and sour grades for sale.

The lower Tertiary trend in the GOM is the site of 12 ndw field discoveries. They have to keep drilling till they find the one(s) they want to develop first. There is some turbidite down there, it is not the most porous of all reservoirs and it has been reported that most of the fields contain oil that is not light.

One of the last giant Saudi fields to be developed is Manifa. Not too sweet. 10 billion barrels of sulfurous crude. Some refineries cannot handle it. They already have their allotments of sour crude. Billions have been spent on drilling, refinery upgrades and expansions and still the price of gasoline was rising. It is not enough. Too many drivers not enough energy producers.

ConocoPhillips has begun to develop a little known 6 billion barrel heavy oil on the North Slope of Alaska. Early excitement about the Orinoco River heavy oil deposits was stolen away. The day is coming when oil will peak and there will be too many refineries ... stupid oil companies.

Are there enough plans and construction in the works for production to match consumption?

Gasoline consumption is projected to rise 5.8Mb/d between 2005 and 2030, or about 1.45Mb/d by 2011.

RR points out that refinery capacity has grown by 2Mb/d in the last 10 years, which is "10 good-sized refineries", and that expansions equivalent to 8 more - 1.6Mb/d - are planned. If those expansions are done by 2011 - as the one in his linked article is slated for - then the amount of planned capacity addition times a reasonable utilization factor of 90% is almost exactly the projected rise in consumption.

Moreover, increased production of biofuels will occupy a portion of that 1.45Mb/d, leading to the addition of spare capacity if the full 1.6Mb/d goes in.

In other words, evidence points to "yes".

Yes, so that is one of the arguments the industry should be making. They could shut a lot of people up by showing that they are increasing capacity fast enough to meet projected demand. I think people would understand that it takes time to build additional capacity.


Thank you for this post. It's informative and
easily understood.

Well I really wanted to be the first to comment on this travesty when it was posted but I was too busy tramping around a pine forest in East Texas overseeing a harvest to see this. However, now that I am home and can read this let me start with the first bogus misrepresentation which I addressed in Part I.

No industry can be expected to maintain high production levels in the face of poor or even negative margins.

Totally false and nonsense. Go look at WMT's margins, they are 3.2% net on each store and as for the ratio of assets to liabilities, they have a ratio less than one. In other words, they GROW AT ALL COSTS. Of course they are in an EXTREMELY COMPETITIVE INDUSTRY as exhibited by their motto of ALWAYS LOW PRICES. Wonder why the refiners don't play the same game if they are so competitive?

My problem with Robert is that he is an employee with no ownership in anything other than his diploma which sits on his wall and makes him feel smart along with the many emails he receives (these people are undoubtedly even more ignorant of real business than he is since they solicit investment advice from him). Otherwise, Mr. Rapier has never involved himself in a business deal where his money was at stake, set a price for a product that is sold in a competitive environment or made a payroll. Yet Mr. Rapier constantly harps on what an energy expert he is and then tells us how businesses work without any business background whatsoever. Mr. Rapier wouldn't know a cartel if it hit him in the face with a two by four. Of course we can forgive him if he really seems no different than any of the other clueless idiots that do nothing more than write for a living.

I took the inventory data from the EIA and plotted it against price for the last 5 years and guess what I found. Mr. Rapiers little plot for the last 18 months (on which he bases his erroneous conclusion that inventory is the driver of price) that is not very correlated anyway is completely uncorrelated between the two variables prior to the last 18 months. So kick that one out the window.

Now let me tell you about consolidation and timber (a resource industry I know quite a lot about). I own a lot of timber in east texas and what is going on there is a consolidation of mills. Well since now that GP owns most of the old IP and Champion mills, we only have LP and GP and a couple of independent mills left to buy timber off the stump. Anyone want to guess what prices have been doing? Anyone, Buehler? Well let me just tell you that on the property we are currently harvesting, we are getting only about $280/MBF vs the $425/MBF we got back in 1995 the last time we harvested this property. But what's going on? Didn't we have a big housing boom lately? You bet but stumpage prices here in Texas have been dropping since 1995 even though inflation has been unchecked. We sold a lot of timber back in 2002 for $330/MBF and that was when the building boom was really going big guns. It still is but prices are the lowest in two decades. Wonder how that happened? Can you say cartel?

No Mr. Rapier isn't schooled enough in business to know what lack of competition means vis-a-vis prices but I do and I'm calling bullshit on him. Besides I have three degrees from a decidedly superior institution in Austin up the road from his alma-mater in College Station (which by the way Im forced to drive through every time I visit my timber in Walker County)....................

Please note that my essays should not be confused with financial advice.

Or any other kind of advice because all they are is badly misinformed opinions.


Remember the advice from before and upstream...
borrow Staniford's filter.

Remember the advice from before and upstream...
borrow Staniford's filter.

Right, ignore what you cannot refute.............

Wrs: Your educational and business credentials are very impressive. You obviously feel the main reason for higher gas prices is collusion/lack of competition. State your argument and then present some relevant evidence from the oil refining business, without wasting everyone's time with your tall tales about East Texas timber. Thanks.

Read part I in which I refuted Robert fairly exhaustively. He only scored one minor point and that didn't even deal with the issue I raised. It would be a distraction to this thread to review the first one but you can easily pull it up to review my position.

As to other relevant oil industry experience. I grew up in the shadow of Goose Creek and Pelly. My parent's summer home is one half mile from Glenn McCarthy's summer home, one mile from the Sterling Mansion and about one and a half miles from the Miller home. The Bludworth's lived next to the Miller's. All of these people were in the oil bidness in Houston (the Bludworths built boats), my parents are native Houstonians born in 1919 and 1920. I worked in the Exxon Refinery at Baytown for two summers and the next summer I did a turnaround on the big lannate unit at the DuPont plant acros the channel. I was a bricklayer's helper on that project and nothing but a laborer who worked with the wetbacks doing backfilling on the Exxon project. I know how dangerous a refinery is but I also know that they can be built PDQ if there is some money in it, which there was back in the 70s...............

Today there is money in not building them. I have a friend who I went to high school with and who graduated from that place in College Station who builds refineries all over the world except in the US. He told me that three years is plenty of time to put up a 200kbd refinery. So the only issue in the US is permitting, you really think the big oil guys couldn't get that fixed with Bushco in office if they wanted it done?

Read part I in which I refuted Robert fairly exhaustively.

"Exhaustively" and "successfully" are not always the same thing.

Go look at WMT's margins, they are 3.2% net

Refinery margins are effectively gross profit margins (i.e., sales revenue - cost of product sold) and not net profit margins. So let's compare:

Walmart's gross profit margin is about 24%.

The average refinery margin over the past 5 years was $2.50/bbl. On an average price of about $50/bbl, that's a 5% margin.

That's not only much lower than Walmart's margin, it's lower than the net profit margins of major companies like Toyota.

In other words, refineries really aren't making enormous margins, on average, and anyone who tells you otherwise hasn't checked the data. (Or has checked it and is ignoring it.)

Walmart's gross profit margin is about 24%.

The average refinery margin over the past 5 years was $2.50/bbl. On an average price of about $50/bbl, that's a 5% margin.

The average price of oil over the last 5 years is not $50 and I doubt that the average gross margin per barrel is $2.50 either. You should provide a reference for that statistic.

Currently refinery margins are running at 40%, you can read that right here.

They have exceeded $20 a barrel now for the last two years.

In making the comparison to Walmart, make sure to engage in relevant comparisons. Walmart's margins have been consistent over the last 5 years. The margins in the oil refining business have spiked in the last two years and that is where this claim of gouging is coming from. If you want to talk about averages you are simply admitting that you have no reasonable answer for the current high prices because you are trying to mitigate them with the more normal returns of past years using averages.

The average price of oil over the last 5 years is not $50

That was an estimate; computed value is $43, leading to a 5.8% margin. Which is still 1/4th of Walmart's margin, and still below Toyota's net profit margin.

I doubt that the average gross margin per barrel is $2.50 either. You should provide a reference for that statistic.

You should click on the link I provided, which goes to the IEA table of refinery margins, and check the numbers for yourself.

They have exceeded $20 a barrel now for the last two years.

Evidence? 'cuz the IEA says you're wrong.

(Note that they're listing monthly margins, which makes it harder for you to cherry-pick a particularly high data point.)

Walmart's margins have been consistent over the last 5 years. The margins in the oil refining business have spiked in the last two years

And that volatility leads to increased risk, which leads to a demand for higher margins from a rational investor.

Instead, refinery margins have averaged 75% lower.

Prices in the resource sector are volatile; I don't see why it's a surprise that that's also true of oil. For example, lumber prices doubled between the start of 2003 and mid-2004, and now are almost back down to their 2003 level.

If you want to talk about averages you are simply admitting that you have no reasonable answer for the current high prices because you are trying to mitigate them with the more normal returns of past years using averages.


I'm talking about averages because those are what determine whether a refining company can afford to stay in business. Since average margins have been so low, there's been little incentive for investors to spend their money building new refining capacity.

Am I "admitting" I have no explanation for the current high prices? Of course not - all I'm doing is correcting your laughably-false claims about refinery margins. I haven't even tried to explain why current margins are high.

The short answer, of course, is "supply and demand". At $2.50/bbl margin, there's (currently) a higher demand for refining capacity than there is supply, so the price rises until supply and demand equalize.

Guys, I am about to climb on a plane and head back home, so I will truly be on hiatus after this post. And for those who are aware, I did have a jagged kidney stone removed yesterday. I have been dealing with this since April 1. That, plus being away from my family for 5 months, has made this the most difficult period of my life. But it ends today, as I will see my family before the end of this (very long) day.

I just want to say that I enjoyed the bitch-slapping of wrs. Normally, I don't get so much pleasure out of these things, but anyone who actually measures his worth in terms of "I have three degrees from a decidedly superior institution" is begging for it. Maybe the fact that the rebuttals came from someone other than me (with my decidely inferior education at a Top 20 engineering school, which is high school relative to wrs' education at the Harvard of Texas) might cause the point to penetrate a little further.

It has been clear from his first post to me that wrs has greatly overestimated his competency in these matters - and underestimated mine. For some reason, when I was debating Creation/evolution, the absolute worst Creationists were those who happened to be electrical engineers or those involved in the computer industry; they always overrated their understanding of the issues. For 3 shining examples of this, look up electrical engineers Walter ReMine, Fred Williams, or computer scientist David Plaisted and you will see an incredible combination of arrogance and incompetence. So, I have had a bit of exerience with over-confident electrical engineers like wrs.

Cheers to all. I shall return. (But not for a while).

pleasure. but I'm afraid the man convinced against his will is of the same opinion still. Clearly a nice fat profit ffor mr. forester (probably with a big assed gov't subsidy to grow timber) and nosebleed margins on software are good since the money flows toward wrs. Margins for refiners after 20 years in the wilderness are bad since the money flows away. Classic "conservative" thinking (sic).

Matching the market on software is fine. Matching the marking price for gasoline is gouging.

And as we said back at another land grant engineering school.

Double the voltage, double the flux, double E double E doulbel E sucks.

Not that WRS needs any help, and I find it fascinating that people are jumping in to give Robert advice.

so here's mine for you.

In Carl Sagans rules for logic and The scientific method this rule exists.

absence of evidence is not evidence of absence.

using a personal example and the question is can big business collude and if so is there any reason to exclude oil companies from that possibility. I don't see one. And as I am sure you are aware of, asking to prove collusion is a very tough thing, and so I wonder why you take such a stance. Sounds personal.

Quid Clarius Astris
Ubi Bene ibi patria

Prisoner: Yes, businesses try to maximize profit. So you and WR feel that refineries which are not being built should be built as soon as possible. However, if gasoline consumption has peaked in the USA this would not be a logical business move, as any timber baron could tell you. Has gasoline consumption peaked in the USA? Maybe not, but we probably agree that it is not going very much higher from this point. Who needs more refineries with these realities? Karl Marx might say build them anyway, but he wasn't exactly the hero of the Houston private school set.

You should go read my comments on Part I. I never said this

Yes, businesses try to maximize profit. So you and WR feel that refineries which are not being built should be built as soon as possible.

I simply said that the oil companies have recognized the structural issues and taken advantage of them. That has resulted in exorbitant prices at the pump and it's called collusion. There are five factors that lead to collusion. The govt can lessen the impact of those factors but it has failed to address any of them since Bush has been in office.

Not that I am a fan of govt regulations, as a small business owner I look for my own opportunities to maximize profit and it happens in the absence of competition. The laws of economics do not work as they claim in textbooks. I discovered that to my own benefit a good while back so while I don't like the situation with timber in East Texas, I am not unsympathetic to the mills. I have looked into starting a plywood mill but it's beyond me. The good thing about timber is that it's always growing back while with oil, it's just being emptied out.................

Now with my software, there isn't any competition and I am making very good margins on that product.

Many people acting in a rational manner (not investing in refining capacity when margins sucked) is hardly collusion.

Think maybe lumber prices are down because the new home building starts are collapsing? You know, supply vs. demand? I've no doubt that with just 2 major mill owners they choose not to enter into cut throat competition. C'est la vie. Build a co-op mill or get used to it. It's not illegal to choose to bid low. Only if you meet with your competition and set up pre agreed prices.

And why is it you are gouging on your software? Can't you sell it cheaper by reducing your margin?

Think maybe lumber prices are down because the new home building starts are collapsing?

Lumber prices are down because of dumping by Canada as well as countries from South America shipping plantation lumber here as well. It's also due to the consolidation of mills in the East Texas area. The latest housing slump just makes it worse but the structural issues have been leading prices down for the last five years.

And why is it you are gouging on your software?

My software margins are consistent with others in the industry. It turns out that software is a high-margin business, check it out for yourself. That is why I switched from selling software development services to selling software about 8 years ago. Software is a declining cost of goods sold type of business whereby the more you sell the greater your margins.

well guess what Einstein. Refining is now a high margin business too. As it was in the 70's.

Are you software developers colluding? sure looks like it to me. Selling the same work over and over again for big money. when you could sell the marginal copies for pennies. Shame on you you eeeeevul exploiter. We need to regulate your kind

/conspiracy theorist horsepucky.

PS -- I did read your mess in thread one. If you think you won that debate, GWB is a genius.

I wonder why you take such a stance

Let's look at the stance he's taken:

You obviously feel the main reason for higher gas prices is collusion/lack of competition. State your argument and then present some relevant evidence from the oil refining business

His stance is that he wants a straightforward argument with relevant evidence backing it up.

For someone who talks about "the rules of logic" and "the scientific method", it should be fairly clear why BrianT wants to see evidence supporting a clear argument.

i.e., if you were suggesting that he's taken a "there is no collusion" stance in that post, you have misread it.

"Go look at WMT's margins, they are 3.2% net on each store and as for the ratio of assets to liabilities, they have a ratio less than one."

Try again. A ratio of assets to liabilities of less than one means that the business has a negative owner's equity. Definitiely not true of Walmart which has been consistently profitable. [Assets = Liabilities + Owner's Equity]

should have said current assets to current liabilities...

From their 10-K

Working Capital

Current liabilities exceeded current assets at January 31, 2007, by $5.2 billion, an increase of $166 million from January 31, 2006. Our ratio of current assets to current liabilities was 0.9 to 1 at January 31, 2007 and 2006. At January 31, 2007, we had total assets of $151.2 billion, compared with total assets of $138.2 billion at January 31, 2006. We generally have a working capital deficit due to our efficient use of cash in funding operations and in providing returns to shareholders in the form of stock repurchases and payment of dividends.

A monopsomy [or something approaching a monopsomy] can give the relatively small number of buyers the upper hand in a market with a large number of sellers. You might be getting a bad price for your timber as a result. We are agreed on this point.

Moving on, there a number of things currently out of wack in the oil markets. Spot Brent higher than Spot WTI. The East Coast under supplied with gasoline versus the rest of the U.S. Tanks in Cushing bulging with light sweet crude. Tanks elsewhere in the U.S. bulging with heavy sour versus light sweet [or at least so goes the commentary at The Oil Drum.] Logistics is the most probable explaination for these circumstances.

Pure logistics might also explaing the state of the cracking spead.

Is the current cracking spread the result of the number of refiners or the result of previous under investment due to poor cracking spreads in earlier years? Or is it a function of refiners not wanting to get stuck with a refinery that in the future they suspect they won't be able to obtain enough crude to run at capacity in the intermediate term?

Even within the cracking spread the prices of gasoline seems high. Could that be due to processing crudes with a higher yield of diesel, asphalt or whatever. Seems plausible doesn't it? Or maybe it is just that the demand for gasoline is higher in relative terms than diesel.

BTW, have you considered building a regular sawmill for dimensional lumber [edited -- you mentioned a plywood mill]? The barrier to entry in that business are nowhere near as high as opening a refinery.

Refiners have invested very heavily in heavy sour processing over the last 2+decades. WTI's relative weakness may well be a measure of how little the USGC refiners need sweet relative to production.

This weird brent/WTI inversion is probably due more to shortfalls of Nigerian production that anything else. Nigerian is the gasoline grade of choice to US East/Gulf refiners for their sweet feed. Ditto many refiners in Europe. Losing capacity there is putting pressure on North Sea Substitutes. If you could easily get WTI to the water, it would jump up.

As for gasoline margins. As long as demand continues to rise regardless of price, we'll have huge margins. Refiners did not invest aggressively in new capacity while margins were poor. Many of their financial analysts have multiple degrees. Even more have common sense. Why throw good money after bad?

BTW, have you considered building a regular sawmill for dimensional lumber [edited -- you mentioned a plywood mill]? The barrier to entry in that business are nowhere near as high as opening a refinery.

The dimension lumber is what comes from South America and there is already one established dimension lumber mill in the area (Steely). The plywood mill is the easiest to do because there are still some old plywood mill sites that could be purchased and refitted. The cost though is still out of my league and it's not really my business area.

wrs - your head is so far up your behind that you are seeing daylight again.

Comparing the refining industry to Walmart is just plain dumb. Even a refiner would have jumped at a NET margin of 3% of sales from 1985 to 1998. The problem was there were periods that for the smaller, less complex refiners, there wasn't even a positive margin considering variable costs alone. They lost their labor cost and returned NOTHING on the capital employed. WMT has a big cheap box, goods bought on credit and a relatively unskilled, non union workforce. Refiners have billion dollar machines that can't be turned on and off at a moment's notice, with expensive skilled workers etc. Got any more apples to mud pies comparisons?

I watched my peers leave oil after the early 80's oil crunch hiring boom one by one. No projects, other than environmental, for 5-8 years. No career advancement etc.
The refining industry was on its rear. I could rent refinery capacity in fairly complex Italian export refineries for maybe $1.25/bbl where the same space might fetch $20+ today. At $1.25 they were barely covering fixed costs. They just did it to keep from shutting down. I watched an affiliate refinery in Canada (200 MBD) shut dwon for 6 months at a time. Laid off everyone but the engineers who they used as gate guards to keep them on salary.

Also ask yourself why did Exxon sell the Bayway refinery in the early 90's to Tosco? Well Bueller, it's because Exxon did see any profit in the place and didn't wish to throw more investment into it to make the new USLD and clean gasoline. Return on capital was horrid. Tosco saw it differently and made a billionaire or two.

You might want to rent "Bowling for Columbine". You seem to have a heavy dose of the monster-under-the-bed paranoia.

And BTW, 3 degrees doesn't mean much per se. The difference between 20 years of experience and one year of experience 20 times is an obvious comparison.

Comparing the refining industry to Walmart is just plain dumb.

No it isn't. I am comparing margins in what are supposed to be competitive industries. You and others here claim that the refining business is competitive and Im using a quantitative indicator of competitiveness to counter that claim. Competitive industries are characterized by low margins. If the refining business is competitive it's margins would be lower.

Refiners have billion dollar machines that can't be turned on and off at a moment's notice, with expensive skilled workers etc.

You mean all the dumbasses that could barely graduate from LaPorte High School that I grew up with in the 60s and went to work on the ship channel were skilled? Expensive yes because of the OCAW but skilled? Nope. That was part of the problem with the refining business but it has been rectified by more automation in refineries as it should have been. Cry me a river on the late 80s for the oil business, that was 20 years ago. Refining margins were fine in the 90s, they were low but positive because the business was competitive. The lack of competition started in the late 90s with the mergers and buyouts.

No it isn't.

It may not be, but comparing net margins to gross margins fits the bill much better.

And that is what you tried doing.


not to mention, one company has small fixed assets with the capability to swing the products that flow through a distribution system to find what is selling. The other has enormous fixed costs and capital employed in manufacturing gear that really can do only one thing -- make transportation fuels.

The stupidity of "my friend told me you can build a refineryin 3 years so they are screwing us" is laughable.

Sure, with all permits in hand, design work done, contracts let and equipment ordered, you can pour the concrete and sling pipe into place pretty quickly. But those other phases can take 3-5 years. Design work alone for a major refinery project can be 2 years. Been there, done that.

Couple that with oilco management that got their start int he 70's/80's (my peers are now in their 50's). They watch their management a generation ago go hog wild adding capacity. Then watched as that capacity made poor to no return on capital employed for 15 years. So when margins turned up in 2002, they were cautious. And if some bright spark makes an electric car with a battery good for 500 miles with 20 min re-charge, the refining industry will be toast again.

But hey, offering other people suggestions on how to invest billions with none of your own skin in the game is pretty easy. Especially since my friend the welder told be all about it.....


I don't exactly disagree with much in your post, but in a post about long term factors in gas prices, you are spending a lot of time on the mice while ignoring the elephant: OPEC either can't or won't raise oil production in line with what demand would be at lower prices. The great question of the day is whether it's "can't" or "won't". All the other factors you detail are basically chickenfeed next to that.


There is no need to worry, you see, because Saudi Arabia's reserves "rose to 264.3 billion barrels from 264.2 billion"!,0,6619089.stor...

How absurd is that?

I wonder how they account for adding .1 billion barrels? You should ask them--and when they tell you, let me know because it has really been boggling my mind...

I'm starting to think I'm about the only one who has spent time in refineries and got to see the spectrum of competitors since we were a third party contractor. We did high level electrical testing and troubleshooting. This was 20 years ago and I don't think much has changed, and I can tell you that these refinery companies are competitive. Production is King.

You want to see some nervous unit supervisors or electrical foremen, just go into the main substation control room of a refinery. You'd think you were going into Fort Knox. There were only two people allowed into the main substation of Imperial Oil and I was one of them, and only because I was with my boss. They wouldn't even let their own electricians into that building. Because the processes are sequential, the first Oops! cost them $2 million, and $1 million per hour thereafter. That is a liability suit we didn't want on our hands. If the product sits too long in the pipelines, dynamite is required to free up the hardened substances.

Or, I've seen a refinery bring in a crane that sat on the site at $1 million per week with $1 million mobilization fees because their main cracker was down. (300 ton crane with 300 ft. reach). You want to see maintenance, contractors, and cranes scramble. While I was making the typical post university pittance, the electricians were making so much overtime they were calling their stock brokers from the unit substations. No kidding. The point is, refineries do not shut down for fun and games. It's a serious business.

RR summed up the big picture well enough. But before we judge the motivations of the "oil business", (and they are not without due suspicion), spend a day or a week in a refinery. They are playing it out just as they should in a sunset industry.

Bingo -- the refiners bust their balls to make a margin and run as hard as they can. In the 80's that was to their detriment as the harder they ran the more they cut each other's throats. Since the last bbls effectively run with no incremental labor cost, they were, at times, the only ones with a profit. The base supply to the marketing operation didn't make squat.

There's no question the top levels decided to minimize investment in refining capacity to what they were sure they would need. This was an obvious and smart decision given that the giant capacity increases of the 70's based on wild optimism led to the margin debacle of the 80's and 90's. This lead to demand finally exceeding nominal capacity.

Of course, consumers could collude and dump their SUVs such that 1 MMBD of gasoline demand disappears. Margins would collapse in a heartbeat. But stump farmers will continue blaming collusion and bad faith in the face of a far more rational explanation.

One factor not considered is the effect of changing crude supplies (towards heavier and sourer) and gasoline yields.

There is little doubt that Light Sweet Crude has peaked (focus on North Sea) and declined due to depletion by over 1 million b/day. In addition, Nigerian supplies are periodically disrupted.

Yields of gasoline and diesel are higher for light oil than for heavy oil (even with additional refining steps that can make heavy oil usable). Part of this is due to simple carbon hydrogen ratios (although additional hydrogen derived from natural gas can be, and is, added to fuel molecules).

Heavy crude is high carbon ratio, gasoline is the highest hydrogen ratio product, next is diesel.

My question is just how much the changing crude mix is driving low gasoline yields ? Inventories of other products are generally close to normal.

How much of this shortfall is a yield change ? How long a change in demand mix ?



I would have thought it has to be a factor. Im not a refining engineer and I dont know what advances have been made in the last 10-15 years to increase yields but i would have thought a heavier sourer slate would yield less gasoline. However increases in refinery capacity has meant we actually have been producing more gasoline yr on yr, just not as much as we would if the slate had been light sweet. When increasing demand is factored in then it should result in lower stocks. However that is a little simplistic since level of stocks will also depend other issues such as arbitrage and shape of the curve.

When planning refinery investment I am pretty sure that the oil comapnies are assessing the availablity of the crude slate and asking themselves the question, 'What will be available for the next 25 yrs heavy sour Venezuelan, Mexican, Canadian, or Bonny Light, Qua Iboe or Brent?'
Maybe they know the answer to that question and hence their desire to upgrade to run sour.

as a footnote...the narrowing diffs between sweet and sour (particularly due the current WTI weakness) must be hard for them to swallow but making sweet priced off WTI even more attractive. Whilst the decline Mexican production might also have hit them from left field.