The electrical power shortages in California will compel the state's refining industry to re-evaluate its existing power conservation and supply policies.
The industry is working through the electricity crisis by conserving during peak-demand periods, optimizing cogenerated electricity output, and searching for alternative fuel sources.
Refineries in California are both producers and consumers of electricity. Refiners both make their own electricity and receive some from utilities-in some cases with interruptible supply contracts. Much of the cogeneration capacity in refineries burns natural gas.
Natural gas has been the favored fuel during the past decade, due both to its attractive price and relatively low air emissions. As the price of gas rises relative to other fuels, this equation is changing. In times of crisis, California may have to consider temporary relaxation of its air emissions standards to keep the lights on.
California power
California imports almost 20% of its electricity and about 80% of its natural gas, making it depend on out of state suppliers to meet local demand. This means that critical components of California's energy supply system are beyond the control of the State Public Utilities Commission (PUC).
California's electric power problems began in the summer of 2000 when growing demand strained the state's supply capabilities. High demand for power generated from natural gas, which represents the incremental fuel in California's electricity supply mix, made it impossible to replenish the gas storage volumes that are normally held in reserve to meet peak winter heating demand.
The utilities began to buy power at increasingly high spot prices but were unable to pass the higher costs on to their retail and industrial customers due to continuing rate regulations.
An abnormal seasonal demand and supply imbalance in December and January, due in large part to unanticipated plant outages, coupled with cash flow problems experienced by wholesale suppliers, due to slow payment by the utilities, led to reserve shortages and the first rolling blackouts in January.
What began as a power supply problem escalated to a financial crisis for the utilities and their power suppliers, located both in California and out of state. Neither utilities nor power generators (which the utilities could no longer pay) were able to continue to finance the escalating cost of power for California.
In March, the lack of available power to maintain system integrity necessitated additional rolling blackouts. The crisis moved to a new level, threatening the fiscal integrity of the state itself. In response, the PUC approved a significant rate increase at the end of March to bring additional funds into the system.
The state also is negotiating to purchase the transmission facilities of the major utilities, intending to receive tangible assets in return for providing an injection of cash needed to maintain the financial stability of the utilities.
Repercussions
In early April, Gov. Gray Davis's proposal for a structured rate increase for the utilities offered additional relief. Believing that this effort was insufficient, however, Pacific Gas and Electric declared Chapter 11 bankruptcy to reorganize its finances under the supervision of the court.
The situation affects business segments beyond California's utilities and power suppliers. Industrial and commercial customers have occasionally experienced power outages during the "rolling blackouts" imposed when power reserves fell below safe limits. They can expect higher electricity bills as a result of higher natural gas prices.
Small businesses including restaurants, dry cleaners, and grocery stores are feeling the pinch of higher energy prices. If they are unable to pass these costs to their customers, they may have to shorten business hours or eliminate energy-intensive product lines, which could result in increases in unemployment.
Did California really deregulate its electricity industry? At best, California only partially deregulated its electricity industry, and then only at the wholesale level.
In a well-intended but counterproductive move, California required its main electric utilities to sell off 50% of their natural gas and oil-fired generation facilities and to refrain from making long-term power purchase contracts. In the end, the utilities elected to sell all of these facilities to third-party suppliers of electricity.
The utilities missed the opportunity to make long-term supply purchase contracts when prices were low, and the state is now negotiating long-term contracts under less favorable market conditions.
The deregulation process also failed to grasp the importance of the load leveling and dispatch functions performed by the utilities. There was a failure to ensure a smooth transfer of these and other functions to the independent system operator, which was set up to handle these activities after deregulation. The systems engineering approach to dealing with these issues collapsed, and new rules and responsibilities have had to be worked out in real time under crisis conditions.
Supply problems
California's electricity balance in the coming months will remain precarious, and supplies will remain tight through the summer.
Summer months generally experience periods of peak electricity demand, due both to air-conditioning requirements and to increased water pumping. The fact that problems first surfaced in the winter months is an ominous sign for the future.
Summer peak-day demand runs 30-35% higher than winter peak demand, which is experienced in early December, and 50% higher than the demand levels that led to rolling blackouts in recent months.
Hourly peak requirements are an even bigger problem. Late summer afternoons represent the period of absolute maximum demand, when industrial, commercial, and residential loads overlap. It was peak-hour demand, not peak-day demand, that led to the rolling blackouts in January and March 2001.
Gas inventories that were low going into the winter have been further depleted, reducing summer's incremental electricity supply from gas-fired generation. Gas supplies, while easing, have remained tight, and pipeline capacity appears insufficient to meet both demand and the need to replenish inventories.
Low volumes of stored water in the Pacific Northwest will restrict the hydroelectric power available for export to California. A below average snow pack in California also will limit in-state hydroelectric generation this summer.
Demand management
Although voluntary demand reduction and conservation efforts could ease the pressure on electricity supply during the coming summer, they require changes in consumer behavior and comfort levels.
The proposed price increases will reinforce conservation efforts. Since they did not start until June, however, prices will only have a modest impact in summer months.
Nascent energy conservation programs requiring investment will not permanently reduce electricity demand in these few months. Past conservation and efficiency investments have already reduced the opportunities for rapid gains in the near future.
Furthermore, a slowing national economy (including parts of Silicon Valley) will not have much impact on the state's electricity demand since California's industry is not particularly energy intensive compared with other large states. California ranks 47 in the nation with respect to per-capita use of electricity. Its generally favorable climate and the absence of energy intensive industries allows its residents to consume only about 60% of the electricity consumed by the average US resident.
The role of interruptible electricity customers is another problem that has not received much public attention.
In the previously regulated environment, the PUC granted large industrial customers lower rates in return for their willingness to accept occasional interruptions in their power supply. Because such interruptions rarely occurred in the past, some customers who needed a firm power supply banked on the historical absence of interruptions in their decision to obtain the lower rates.
These customers include both industrial customers and service businesses for which power interruptions are extremely costly.
Interruptible electricity-supply contracts generally provide that a customer can have its power interrupted only a certain number of times or for a certain number of hours in a specified period. Interrupting power supply to these customers has allowed utilities to limit the number of rolling blackouts for all customers.
Many of these contracts have now been cancelled with an attendant loss of future flexibility for the utilities going into the peak summer demand season. The effect of this action is that virtually all customers will be entitled to "noninterruptible" supply in the future. This will make it more difficult for the utilities to maintain continuous electricity supply to their residential and commercial customers, exacerbating their political and public relations problems.
Refiners' response
The utilities have asked large industrial customers, including refineries, to curtail peak power demand at critical points during the day. These voluntary efforts will be insufficient, however, to carry the system through the peak demand of summer months.
As a result of the rate schedules approved by the PUC, California's electricity consumers face electricity price increases of 30-45%. In general, business and industry will see increases at the high end of the range and residential consumers at the low end. Consumers able to reduce consumption compared with last year will receive incentive rates. Over time, these higher prices will reinforce existing conservation programs at refineries and probably induce additional investments in cogeneration facilities.
In the short term, however, higher power prices will be absorbed in petroleum product costs. If oil market conditions do not permit these costs to be passed on at the pump, California refiners may reduce output. Refiners may, for example, reduce the amount they pay for incremental electricity supplies by trimming output to match their own electricity production from cogeneration.
There are four reasons why a refinery (or any industrial company) makes conservation and cogeneration investments: reliability, economics, the environment, and profit.
- System reliability. Many industrial operations require power supplies to be consistent and of consistently high quality. This is particularly prevalent in businesses that rely on process integrity to ensure product quality.
For example, manufacturers of electronic equipment such as computer chips generally require power of higher quality with fewer voltage fluctuations than do traditional industries that can deal with small variations in voltage.
- Economics. Cogeneration economics will be enhanced by rising costs of purchased electricity. The wild card is the future cost of purchased natural gas; refiners probably will be unable or unwilling to burn liquid fuels in normal operations.
- The environment. Businesses consider the environment when they decide to make investments in conservation or cogeneration. Environmental permit restrictions may limit the operating flexibility of a refinery, leading to the decision to make such investments.
- Profitable growth. The final factor that leads to conservation or cogeneration investments is the desire to enter into a new line of business that will provide profitable growth for the company.
Some petroleum companies have sought opportunities in power production, either as the result of new technologies or because of the availability of economic power supplies from cogeneration or the availability of a unique fuel. This could be refinery gas, wellhead casing gas, an otherwise unsalable refinery by-product stream, or even coke.
Some companies have strategically sought opportunities to build stand-alone electric generation facilities to gain entry to the electricity business, which has been growing faster than the market for conventional petroleum products.
Conservation programs
Just as California's consumers use energy more sparingly than people in other parts of the country, California's refineries have also devoted considerable attention to energy efficiency programs.
Energy-conservation programs employed by California refineries include replacement of major energy-consuming facilities, such as crude units, with more modern and efficient units. Refineries have also modernized their steam and electrical systems during the past decade.
One refinery in California saved more than $750,000/year solely as a result of electrical system upgrades.
One of the key changes in refinery design comes from integrating energy efficiency into the standard design parameters. During the design phase, both for new and replacement equipment, energy efficiency is now one of the prime considerations. Normal maintenance shutdowns are also regularly used to improve efficiency of existing units, by electrical system upgrades or addition of insulation, for example.
These efforts have resulted in energy efficiency improvements for a similar output mix of 10-20% since the recovery from the oil price collapse in the late 1980s and of 30-40% since the first oil-price shocks almost 30 years ago.
Even so, petroleum refining remains a very energy-intensive business.
Higher standards of petroleum-product quality required to meet tightening air emissions standards have counteracted efforts to improve refinery energy efficiency. More intensively refined products require more energy.
The smaller average size of California's refineries also hurts overall energy efficiency per barrel of throughput compared with the larger US Gulf Coast refineries.
Because refineries consume large amounts of heat in process units, they are prime candidates for cogeneration applications. Many refineries have begun or completed the switch away from boilers to make process steam in favor of combined cycle electric generators that provide both heat and power. This switch considerably raises the overall efficiency of the refinery energy balance.
Oil companies have also improved efficiency throughout their operations, including in their office buildings. Although the absolute amount of energy savings is much smaller than in a refinery, it is meaningful. Energy efficient lighting, more balanced indoor-air management systems, and more efficient electric and electronic equipment are among the approaches used to reduce building energy consumption by more than 50% in some cases.
Power from refineries
The California electric power supply mix has changed considerably during the past decade. Nonutility generation has risen from 20% of total generation to 35% of total supply. Although California generates about 30% of its total power from natural gas, more than 70% of the power generated by nonutilities is based on natural gas.
During the past several decades, gas-fired cogeneration plants in California's refineries have become one of the more important sources of nonutility power. Many refineries generate part or all of their internal requirements and, at times, are able to sell surplus power to the grid. This reduces the demand on the utility systems and provides the utility with some generation flexibility.
In the past, the utilities often considered cogeneration opportunities in preparing their electricity capacity-addition programs. By coordinating plans for major power plant expansions with smaller cogeneration additions, for example, they kept their capacity additions growing in line with expected demand.
When new incremental electricity supply capacity was not yet needed, they granted a large, potential cogenerator like a refinery a preferential rate for power. Later, when the utility's need for new capacity increased, they raised this rate to encourage construction of cogeneration facilities.
Almost all of California's refineries generate some electricity, and many of them can sell excess power to the grid. As a general rule, however, they run their facilities to optimize output of petroleum products and not to generate electricity.
Many refiners have been cooperating with the utilities during recent periods of insufficient electricity capacity by trimming their peak-period purchases and supplying incremental power to the grid.
Although not strictly part of the refining sector, the vast steam-injection projects to enhance recovery of heavy oil in the San Joaquin Valley represent another major source of electric power from cogeneration.
Originally, these projects burned heavy crude in boilers to provide the steam to enhance oil recovery. In the past decade, as natural gas pipeline-supply capacity increased and natural gas prices fell relative to crude oil, it became economically attractive to burn gas instead of oil.
New gas combustion facilities were usually combined-cycle gas turbines, which generate both steam and electricity. As the price of natural gas rose above the energy equivalent value of heavy crude oil, some producers cut back on steam floods to divert the natural gas to higher valued uses.
Dependence on natural gas
The oil industry has maximized its use of natural gas to meet its own energy needs, meet California's emissions standards, and keep costs down. The price of natural gas has historically been 80-90% of the equivalent refinery fuel derived from crude oil.
PADD V refiners, which include those in California, Washington, and Oregon, accounted for about 5% of total gas consumed in PADD V in 1999.
When natural gas was cheap and readily available, this was an advantageous strategy. Refineries prioritized their energy sources as follows: first refinery gas, then purchased natural gas, and finally liquid fuels.
As natural gas becomes more costly and relatively less available, this approach must be re-evaluated.
The natural gas situation going into the summer of 2001 was not favorable. Increased demand in the summer of 2000 made it impossible to replenish stocks. High demand this past winter has continued to deplete remaining inventories.
As demand for gas has grown, pipeline capacity has not kept pace, making it logistically difficult to bring additional supplies into the state.
Interrelationships
Refining is closely interconnected with other parts of the California industrial infrastructure.
Pipelines are a critical part of the distribution network for crude oil products. Most of the product pipelines use electric pumps. These lines not only distribute products to terminals nearer to the point of consumption, thus reducing road tanker traffic, but they also bring products directly to major consumers, including industrial customers, power plants, and airports.
In some cases, storage facilities buffer these supplies, but refineries and their customers generally try to minimize inventories to reduce costs.
When a power interruption threatened the pipeline to the San Francisco Airport during the yearend holiday season of 2000, the airport came within 1-2 days of shutting down for lack of jet fuel. Only intervention at the highest government levels averted this potential stoppage.
Should the government require California refineries to curtail natural gas or electricity consumption in the summer, the impacts on other sectors of the economy could be significant. Peak summer electricity demand periods coincide with the peak driving season.
There is also a safety concern. Abrupt loss of power in a rolling blackout can wreak havoc in a refinery. Furthermore, it often takes several days to reestablish stable operations in a refinery that has endured an emergency shutdown.
California gasoline standards (CARB gasoline) make it difficult to obtain incremental supplies of California specification gasoline from out-of-state sources. Although this situation has eased in the past year, it remains a concern for California refiners and policymakers.
A critical part of the California economy is its highway and rail transportation system. Trucks and trains that burn diesel fuel move most goods, both inside California and across state borders. Curtailments of refinery operations in the summer months could jeopardize supplies of diesel fuel.
Similarly, supplies of jet fuel for air cargo and travel could be affected, with severe national and international economic consequences.
Another potential demand for distillate products may come from hundreds of new package diesel generators being installed across the state to help individual industrial, commercial, and service business customers handle expected rolling blackouts.
Although these facilities may operate for only a few hours during the year, each requires some diesel inventory, which will strain the supply of distillate fuels in the coming months.
Prognosis
Energy challenges for California refineries come from both the supply side (electricity and natural gas availability and cost) and the operational side (balancing output of refined products with reducing electric consumption and supplying cogenerated electricity to the grid).
Energy-conservation programs will continue to have a high priority, but operational considerations, including the optimization of the mix of fuels consumed, will dominate the activities of refinery planners in the coming summer months.
Supply and logistics departments will have to keep close tabs on refinery energy supply and related output to ensure that alternative supplies of gasoline and diesel are available if refinery operations within the state have to be curtailed for lack of electricity supply.
Shortages of electricity supply to refineries could occur in two ways:
- Refineries that still rely on the grid for incremental supplies of electricity could find power curtailed, especially if they have interruptible power contracts.
- Lack of natural gas deliverability could lead to less cogeneration. Without electrical system reserves and with air-quality limitations on the firing of liquid fuels, less cogeneration might result in partial or complete plant shutdowns. If firing of liquid fuels leads to increased NOx emissions in excess of permit allowables, refineries will have to curtail operations and reduce petroleum-product output.
If California heavy oil producers are unable to acquire sufficient quantities of natural gas at economically attractive prices, they may curtail operations, which would lower total crude oil production. Refineries that depend on California crude may be forced to reduce or rearrange their crude slates.
As in the refineries, facility limitations or emissions permits may, in some cases, preclude San Joaquin Valley producers from switching back to crude burning. One option being considered is the burning of light gasoline components (like pentanes, for example) that may have to be removed from the gasoline stream to meet changing product quality requirements.
In the event of a declared electricity supply "emergency," it is conceivable, although not likely, that the government could require cogenerators to produce and feed maximum amounts of electricity to the grid, even at the expense of internal plant needs.
A government edict that turned cogeneration plants into power plants would be an extreme, but not impossible measure. If this were to happen, however, there would be immediate impacts on the availability of liquid fuels throughout the entire West Coast market.
In fact, on June 28, the PUC exempted the California petroleum supply system from the rolling blackouts likely to be experienced by other businesses and residential consumers. This will help ensure that California's electricity woes do not spill over into the petroleum refining and distribution system.
The author
Thomas G. Burns is a principal of Ecoeconergy, an energy and environmental consulting company. He focuses on strategic planning, energy economics, and the global environment. He has 37 years of operational, managerial, and strategic planning experience in the petroleum industry, 11 with Caltex Petroleum Co. and 26 with Chevron Corp. He was Chevron manager of energy economics and science policy advisor before retiring in 2000. Burns holds bachelors and masters degrees in industrial management from Massachusetts Institute of Technology, Cambridge.
Based on a report prepared for the Petroleum Industry Research Foundation Inc., May 2001.
