Cost of the Clean Air Act

A late-year report by the U.S. Energy Information Administration could haunt refiners in future environmental battles. The report, The Impact of Environmental Compliance Costs on U.S. Refining Profitability, examines financial effects of the Clean Air Act Amendments of 1990 (CAAA) on refining and marketing results of major U.S. oil and gas companies.

The effects, EIA concludes, "have been minor in relation to the overall deterioration in the financial performance of the industry." Measurable consequences of CAAA requirements may indeed represent a fraction of the past decade's financial slump in refining and marketing. But characterization of those consequences as "minor" is a mistake and a disservice to the industry.

EIA's yardsticks

EIA applies two yardsticks to the financial performances of refiners. The first is net cash margin, essentially the spread between feedstock and product values, less operating costs. The other yardstick is return on investment, adjusted to facilitate comparison. For each yardstick, EIA compares results of 1988-89, a period of relative prosperity, with 1993-95, when CAAA provisions were taking effect.

The net cash margin for major companies' refining and marketing operations fell by $1.52/bbl (1995 dollars) in this period, says EIA. Of that decline, costs attributable to CAAA provisions represent about 5%. Over the same period, return on investment fell by 12 percentage points. Increased capital outlays and operating costs for pollution abatement accounted for slightly more than 1 percentage point, or 9%, of the decline. More important contributors to refining financial woes, EIA says, were declining product prices and a narrowing of light-heavy price spreads for crude and products.

Refiners may find technical flaws in EIA's analysis. Overall, however, the assessment of industry fundamentals in the 1990s seems sound. It is simply difficult to justify portrayal of a 5% knock on margins and a 9% knock on returns, in a period of deteriorating economics, as minor effects.

Furthermore, EIA overlooks the nature of the CAAA requirements, which was to hike the price of entry in the U.S. market for oil products. A refiner that sold gasoline in areas troubled by ozone smog either retooled to make reformulated gasoline or shut down. A refiner that sold gasoline in areas troubled by carbon monoxide either bought oxygenate or the ability to make it, or it shut down. A refiner that sold diesel fuel either invested in desulfurization equipment or shut down.

A number of U.S. refineries shut down. Since 1990, 29 plants representing 688,000 b/d of distillation capacity have closed (OGJ, Mar. 10, 1997, p. 21). The CAAA burden, of course, wasn't the only reason to close any of them. For many companies, however, the increased cost of mere participation in the business was enough to turn marginal economics hopelessly negative.

EIA's cost analysis takes no account of refinery closures. Indeed, by focusing on integrated companies, its results are biased toward the group most likely to keep refineries in operation and thus to benefit from capacity cuts. The bias must lead to understatement of CAAA costs. In any case, no government initiative that plays a role in decisions to scrap manufacturing capacity of any kind can be said to have had only "minor" effects.

More than semantics

The argument would be only semantic if environmental pressure groups did not use retrospective distortion of fact to accuse oil companies of exaggerating the costs of environmental regulation. It happened in the debate over global warming. Next time, the groups will happily cite EIA's conclusion about CAAA costs as a reason not to believe the industry.

EIA is guilty of nothing more than using unfortunate wording to communicate a questionable conclusion. But the industry will have to deal with the lapse the next time costs of environmental compliance become an issue.