Capacity Crunch

Refining squeeze limits prospects of price relief at the pump

NEW YORK -- Even if high oil prices ease, prospects for cheaper gasoline, diesel and jet fuel are likely to be limited for at least several years by a severe crunch in refining capacity, reported The Wall Street Journal.

And growing demand for oil from China, India and others is aggravating the shortfall in refining and threatening to keep prices elevated for years, it said. Global demand is expected to grow by nearly two million barrels per day this yearfrom 82.5 million bpd last yearbut the world's capacity to refine and process crude oil is expected [image-nocss] to grow by less than half that.

The recent move by the Organization of Petroleum Exporting Countries (OPEC) to crank up production of crude oil to nearly its limit is not likely to translate into major price cuts for consumers any time soon, said the report. There is a bottleneck in refining worldwide, Saudi oil minister Ali Naimi told the newspaper. He suggested that until the bottleneck is eliminated, demand for refined products will keep pressuring oil prices.

Last week, Federal Reserve Chairman Alan Greenspan warned in a speech that besides feared shortfalls in crude-oil capacity, the status of world refining capacity has become worrisome as well.

Oil prices began a long climb in early 2004 amid fears of a supply shortage and instability in the Middle East. They have trended downward since then, but remain volatile. Some of the recent drop in crude-oil prices has translated to the pump, the report claimed. Since April 11, the U.S. price of a gallon of regular unleaded gasoline has fallen about 6%, to $2.13 this week, though it remains up six cents from a year ago. And the rise in crude-oil prices has hit other types of refined products even more severely.

A slowdown in the world economy could reduce demand for gasoline and other refined products, the Journal said. But the economy continues to grow despite soaring energy prices, and demand for oil remains on the rise. Many industry analysts are forecasting a second peak in crude-oil prices later this year, to more than $60 for a barrel of U.S. benchmark crude, because of tightening refining capacity.

We don't know if they [refiners] can meet demand for the right products in the fourth quarter, Roger Diwan, an analyst at Washington, D.C.-based PFC Energy, told the paper.

Industry analysts say the refining shortage hits the United States especially hard. U.S. refiners have not built a new plant since 1976, and remain reluctant to do so for a variety of reasons, including public resistance, expected returns on investment and environmental regulations.

In February, the most recent month for which figures are available, the U.S. imported about 12.5% of its gasolinenearly three times as much as a decade ago. Much of it comes from Europe, where motorists have been shifting to diesel-powered autos. In coming years, India and China are likely to consume more imported gasoline and diesel.

Though Saudi Arabia and other countries are adding refineries, it can take years to expand existing facilities and longer to build new ones, said the report. Industry analysts and OPEC officials expect the refining crunch to keep product prices high at least until 2008. Global demand for oil products is once again expected to outpace refinery capacity growth next year.

The first year that the situation could change is 2007, Lawrence Goldstein, president of New York City-based Petroleum Industry Research Foundation, told the paper. He estimates that demand for oil products grew by 4.6 million bpd in 2003 and 2004, while refinery capacity grew by only 700,000 bpd.

Contributing to the pressure, countries have been tightening emissions standards for diesel and gasoline. Many refineries, especially in developing nations, are not equipped to meet the standards. In part, that is because refining was long an industry stepchild, said the report, earning modest profits at best because of the worldwide glut in capacity. Until the recent crunch, many oil companies were reluctant to invest in refining. Some even shed such operations over the years, directing investment dollars to the much more profitable exploration and production business.

Today, the squeeze is proving to be a bonanza for refiners, the report said. Valero Energy Corp. expects its financial results for the second quarter, historically a weak period for refiners, to be the best for the period in its history. The refiners' advantage shows up best in the refining margin. Since 2003, refining margins have been rising for all kinds of oil products, most sharply for diesel fuel, jet fuel and heating oil. Margins for diesel fuel are high, especially abroad.

Philip K. Verleger, a senior fellow at the Washington-based Institute for International economists, told the Journal that U.S. truck drivers may see diesel prices rise to $3 a gallon this winter, and to $4 a gallon in winter 2006.

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