Refiners pull back on capacity additions, EIA chief says

Nick Snow
Washington Correspondent

WASHINGTON, DC, May 15 -- US refiners apparently have scaled back plans for additional capacity from levels of a year ago, the head of the US Energy Information Administration told a Senate committee on May 15.

Unexpectedly higher costs for the additions and uncertainty created by growing discussions of alternative energy sources are the primary reasons, EIA Administrator Guy Caruso told the US Senate Energy and Natural Resources Committee.

Caruso said a member of his staff noticed the difference after informally surveying refiners at the National Petrochemical & Refiners Association's 2006 and 2007 annual meetings.

The staff member, senior analyst Joanne Shore, told reporters following the hearing that EIA also monitors refiners' financial results and their statements to financial analysts. "We saw some projects pulled back or delayed due to sharp increases in costs and uncertainties due to alternative fuels," she said.

Shore said one of the biggest reductions in plans to add capacity came from Valero Energy Corp., the nation's largest independent refiner and marketer. "It had very aggressive plans in 2006," Shore said.

Via phone from Valero's headquarters in San Antonio, spokesman Bill Day said higher costs and a shortage of labor have made the company delay some projects. But it just completed one that expanded capacity at its Port Arthur, Tex., refinery to 325,000 b/d, and it is tentatively considering another that would cost $1 billion to raise capacity there to 400,000 b/d, he told OGJ.

'Starving investment'
Caruso's comment led committee member Ron Wyden (D-Ore.) to observe, "We've seen starving investment and record profits in refining the past few years."

A second witness, Paul Sankey, said, "Even with all the uncertainty, there's still tremendous investment, particularly in capacity to upgrade and process heavier crudes." Sankey is managing director of Deutsche Bank AG's oil equity research team in New York.

Their comments and testimony came as the committee held its annual hearing on the summer oil and gasoline outlook. But it came as many members of the 110th Congress expressed concern over recent gasoline price increases.

In his opening statement, Chairman Jeff Bingaman (D-NM) said he called the hearing because gasoline prices have reached historic highs. "Yesterday, the [EIA] posted the highest-ever price for gasoline, at a nationwide average of $3.10/gal. This is the third summer in a row that we are having this discussion about why prices are at record levels," he said.

Chief minority member Pete V. Domenici said while rising gasoline prices frequently bring heightened scrutiny and accusations of manipulation, the main culprit is increased global demand coupled with reduced supplies. "Unfortunately, this particular hearing has become as predictable as the cherry blossoms here in Washington. We may not know exactly when, but you can bet that in the late spring, this committee will hold a hearing to talk about gas prices," he said.

"I don't think there's a free market here at all," said committee member Byron L. Dorgan (D-ND). "You've got [the Organization of Petroleum Exporting Countries] trying to restrict production. You've got major oil companies, which are stronger through mergers. And you have refining, where ownership is highly concentrated."

Robert Menendez (D-NJ), another committee member, said, "This is the third year in a row that consumers are facing prices above $3/gal, yet there's been no event like a hurricane or a major refinery outage to cause it."

Lingering outages
But Caruso said US gasoline production was affected more than usual by refinery outages this spring, which extended past the first quarter into May. That, combined with low imports and seasonally rising gasoline demand, made inventories drop sharply to 193 million bbl by the end of April, more than 14 million bbl less than a year earlier and 12 million bbl less than the lower end of the typical range for this time of year, he told the committee.

"During April, EIA estimated that refinery outages may have reduced gasoline production by 150,000 b/d over average outages for that period. Refinery throughputs have just begun to show the seasonal increase typical at this time and are expected to increase over the next several months, which should ease pressure on gasoline prices," Caruso said in his written statement.

EIA expects average US prices for regular grade gasoline to grow from $2.24/gal in January to $3.01/gal in May. This could ease slightly during the summer before returning to May's level as Labor Day approaches, the EIA administrator said. The price through the summer driving season is a projected $2.95/gal, 11¢ higher than the comparable 2006 period's average, he added.

Sankey added that two of the nation's five largest refineries—both owned by BP PLC—are running at 50% of their usual capacity for safety reasons. The plants in Texas City, Tex., and Whiting, Ind., are producing 400,000 b/d less than usual, with the remainder "operating suboptimally, running rate light, sweet crude when they should be using more abundant heavy, sour grades," he said in his written testimony.

The Deutsche Bank analyst also said years of reduced refining investment have led to 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 to. There is competition from nonrefining investment to exacerbate the problem, notably in Canadian heavy oil sands," he said.

Kevin J. Lindemer, executive managing director of Global Insight in Lexington, Mass., told the committee that a smooth transition from current low inventories and extended maintenance to full production in the next several weeks could bring gasoline prices down to a nationwide average of $2.75/gal by the end of the summer.

"However, the system remains extremely vulnerable to disruptions and events. The risk of higher prices at the retail level comes from refining operations and the global crude market. Further events that increase supply concerns materially could drive average gasoline prices to the $3.25 range by the end of summer," he said.

Minimum inventories
Geoff Sundstrom, public affairs director for AAA, said the motorist organization believes Congress and the administration of President George W. Bush should explore measures that would require refiners to maintain a minimum level of gasoline and other product inventories.

"Such a system exists in Europe and was able to provide critical gasoline to the US during production shortfalls that occurred following the 2005 hurricanes. Should similar or worse disasters occur in the future, our ability to immediately move gasoline to areas that need it will again be critical," he said.

When Bingaman asked if refiners could be required to report planned outages to the federal government, Caruso said it would be difficult to manage. "Even in planned outages, they may find the problem is more extensive than they anticipated. So even if they did report, I don't know if we'd have enough information to say whether they should proceed or wait," the EIA administrator said.

Sankey also was skeptical of calls by some federal lawmakers to give the Federal Trade Commission authority to investigate oil product price manipulation allegations. "We believe there have been enough investigations by Republicans and Democrats to show that there's no price-gouging taking place nationwide. There may be some rogues doing it regionally. But the fact is that refiners are making so much money legitimately that they don't need to do it," he said.

"There's also great concern that all these gasoline investigations which are being proposed will lead to regulations which would make new investments uneconomic," Sankey added.

When Wyden and some other committee members asked why more investments haven't been made in refining with profits so high the past few years, the Deutsche Bank analyst said that the past 3 years of strong earnings followed about 3 decades of miserable results.

"If you look at how the stock market values refiners, they are still among the cheapest investments at about 5 times earnings. It's obvious that investors believe economically attractive refining conditions aren't permanent," Sankey said.

Contact Nick Snow at nsnow@cox.net.

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