US refiners should be able to make the mandated transition to lower-sulfur gasoline and heating oil by mid-2006 without significant problems, the National Petroleum Council's Committee on Refining and Inventory said. But the committee expressed concerns over the required phase-in of ultralow-sulfur diesel (ULSD) in its report to US Sec. of Energy Spencer Abraham.
The concerns center on possibly inaccurate ULSD testing procedures and product degradation in delivery systems downstream of refineries, NPC members were told during a presentation of the report's findings at a recent council meeting in Washington, DC.
Inaccurate tests could result in diesel fuel that met required specifications being designated off-specification because the US Environmental Protection Agency has declared that a widely variable method will be used, explained Don Daigle, vice-president, refining, ExxonMobil Refining & Supply Co., and chairman of NPC's refining subcommittee.
The committee recommended that NPC urge EPA to make its current ULSD testing tolerance more precise before erroneous enforcement actions begin to disrupt supplies.
Daigle also said that there are growing indications that small quantities of higher-sulfur product from earlier shipments could linger in delivery systems, particularly those that are larger and more complex, and be picked up by the ULSD.
"The magnitude of this supply degradation could be quite large," he warned.
Lee R. Raymond, ExxonMobil Corp.'s chairman and CEO, who also is the NPC committee's refining cochair, reiterated one of Daigle's key points.
"When you get a product that's ultralow in anything, the possibility for contamination increases, particularly in the distribution system beyond the refinery gate," he told reporters following the council's meeting.
The committee recommended that EPA work with the Department of Energy and various fuel suppliers to consider emerging information about ULSD's behavior in the distribution system "and how to achieve program goals while recognizing distribution system realities."
Regulations final
EPA did not follow the council's recommendations made in 2000 for the timing and specified levels in developing ULSD regulations. The federal environmental regulator's rules require a 15 ppm sulfur cap for ULSD instead of the 30 ppm average that the NPC recommended 4 years ago.
EPA also will require sulfur enforcement at the retail level instead of retaining the refinery-gate approach that has been used successfully for reformulated gasoline and Tier II gasoline sulfur programs, as the NPC recommended in 2000.
EPA also established a mid-2006 implementation instead of the deadline 1 year later that the NPC recommended, which would have avoided overlaps with the Tier II sulfur gasoline investments.
Nevertheless, the council's latest report noted that the regulations and their timing have been finalized and should not be changed so close to their implementation date since refiners already are making investments to comply. It did not provide estimates of the expenditures.
The report also said that domestic refining capacity has increased during the last 10 years as existing installations have expanded. But it said the growth rate has slowed recently and has not kept pace with increasing demand.
Raymond blamed erratic returns on equity and capital employed for a reduction of capacity additions since 2000 from a rate of 2-3%/year to 1-2%/year now.
"The refining business has not been a barn-burner in returns. There have been lots of peaks and valleys," he said.
The report pointed out that overall petroleum industry returns on equity lagged the Standard and Poor's 500 Index until 2000, and return on capital employed (ROCE) in refining and marketing usually is behind total petroleum ROCE.
"Clearly, investments in US refining and marketing have not been attractive relative to other businesses," said Daigle. "This is a capital-intensive industry with long lead times and long paybacks for investments." A major refinery addition's investment can take 4 years or longer to implement, he said.
The report recommended a reduction in the depreciation schedule for all refining investments to 5 years from the current 10 years, which would be consistent with the treatment of similar process equipment in similar industries. Depreciation schedules for petroleum pipelines and storage facilities should be similarly reduced, it added.
NPC has not identified any government actions that could significantly increase domestic refining capacity for 2005, according to Daigle.
"Any planned investments are the results of policy decisions over the last few years," he said.
Imports to grow
Consequently, the council expects product imports to grow as an economic US supply component, primarily gasoline from Europe, supported by a continued shift of demand from gasoline to diesel fuel on the other side of the Atlantic Ocean.
"Refineries in Europe, Canada, and the Caribbean basin have been undergoing modifications to meet new US product specifications," Daigle said.
Regulatory uncertainties also discourage refinery capacity investment, according to the report. Daigle cited new source review and what he termed "EPA's retroactive reinterpretation over the last few years," national ambient air quality standards, and a proliferation of boutique fuels, oxygenate issues, and renewable fuels mandates.
The report urged Congress to adopt comprehensive energy legislation, as embodied in the conference report on HR 6 in the 108th Congress, to address these issues.
"While there are parts that some companies may not like, overall they can live with it," Daigle said.
The report also recommended congressional approval of limited liability protections for defective product claims involving methyl tertiary butyl ether and other federally required oxygenates—but only for Clean Air Act violations and not for the cleanup of spills and other accidental releases.
The report was a response to the energy secretary's request during the NPC's June 22 meeting for an assessment of factors affecting refiners and distributors' ability to meet future demand and potential near-term options to meet transportation fuel and heating oil needs over the next year.
Since the council was dealing with a short time frame, it decided to reactivate its 1998 and 2000 study groups to review and supplement their prior work and respond largely in a qualitative manner based on the study participants' experience since time did not permit significant new quantitative analysis.