Storm Stretches Refiners Past a Perilous Point
By JAD MOUAWAD - New York Times
Published: September 11, 2005
For the nation's oil refiners, Hurricane Katrina was a disaster long in the making.

Analysts and industry executives had for years feared the consequences of a storm ramming into the country's largest energy hub - a complex infrastructure that spans most of the coastline between Texas and Alabama, where nearly half of the nation's refineries are located.

Hurricane Katrina confirmed the worst predictions. Wreaking havoc along the coastal states, drowning New Orleans and leaving many dead, the storm shut down nearly all the gulf's offshore oil and gas production for over a week. Racing to restore operations, the industry has brought about 60 percent of that back.

But even more crucially, it knocked off a dozen refineries at the peak of summer demand, sending oil prices higher and gasoline prices to inflation-adjusted records.

The events of the last two weeks have demonstrated how close to the edge the country's refining system had been operating, even before the storm. Because the last American refinery was built nearly 30 years ago - with only a single new one now in the works - the problem is unlikely to disappear quickly.

As a consequence, even though crude oil prices have fallen back to pre-Katrina levels, prices for gasoline, heating oil, diesel and jet fuel are expected to remain higher than they were before the storm for a much longer period of time.

"There is now a greater realization that we don't have much extra capacity," said Edward H. Murphy, a refining specialist at the American Petroleum Institute, a trade and lobbying group. "It doesn't take a Katrina, but even a smaller event can create a dislocation in the market. Disasters like this can give you a billboard on the need to address this. We need more capacity."

The rapid run-up in oil prices over the last two years has translated into a boon for refiners after many years of meager returns. This year, the refining margin - the difference between the cost of buying crude oil and selling refined end products - has exceeded $20 a barrel, far above the long-term average of $6. That has meant record profits for oil companies and refiners and above-average stock performance on Wall Street.

With profits soaring, the nation's refiners are now being blamed by many drivers and politicians for contributing to the run-up in prices. Indeed, to critics of the industry, the higher profits are evidence of a policy to intentionally limit refining capacity to improve the bottom line.

"Oil companies have jacked up gasoline prices through a simple mechanism: reducing inventories and refining capacity," said Jamie Court, president of the Foundation for Taxpayer and Consumer Rights, an advocacy group, whose views are widely shared by industry opponents.

"They are supposed to compete and bring the lowest price to consumers," Mr. Court said. "But the truth is that a small number of oil companies cheat by working together by artificially reducing supplies."

But that argument misses the point, said Bob Slaughter, the president of the National Petrochemical and Refiners Association.

"What's happened can be explained by the higher cost of crude oil, the difficulties in building new refineries and the disaster that cut right through the heart of the industry," Mr. Slaughter said.

Currently, four major refineries, owned by Chevron, Exxon Mobil, ConocoPhillips and Murphy Oil, are either flooded or without power, and are likely to be out of commission for several weeks, perhaps months. Together, these refine 880,000 barrels a day, or 5 percent of domestic capacity. "It's very significant," said Colm McDermott, an oil analyst at John S. Herold Inc. The loss is equal to 1 percent of the world's refining capacity. "It's a global market and that's certainly enough to have an impact on a global level."

As many as 15 other refineries, also affected by the storm, are resuming production, but some are still operating at limited capacity.

"There's going to be a lot of pressure on these people to get things up and running and deal with the maintenance issues as they come up," said James W. Jones, a vice president at Turner, Mason & Company, a refining consultancy in Dallas.

Many parts of the industry are recovering rapidly. The most damage offshore was sustained by Royal Dutch Shell, which said Friday that its production, usually about 450,000 barrels a day, would be down by 40 percent through the end of the year.

But even as oil and gas production returns in the gulf, the time that it will take refineries to get back to full speed will be a key factor in determining how long product prices will remain elevated.

Under normal conditions, because of the close proximity of volatile materials, high pressure and fire, restarting a refinery is a dangerous process that can take anywhere between three to seven days.

In the refinery, oil is heated to around 1,110 degrees Fahrenheit, turned into vapor and then collected at various temperatures, creating products that are further refined to remove impurities, allowing for the production of gasoline, heating oil, diesel fuel and kerosene.

For the four damaged refineries - three are in the vicinity of New Orleans, and the fourth is in Pascagoula, Miss. - restarting will involve a much longer process. First, power must be restored. Once that happens, generators, pumps and other electrical equipment flooded by brackish water will need to be dried out. Removing salt sediments will add to the ordeal. Then the operators must check that none of their main systems have suffered any structural damage before firing them back up.

So far, none of the refineries have provided an estimate of how long all that will take. In its latest report, Chevron, whose 325,000 barrels-a-day refinery is the largest of the four, said "it will be days before a full estimate of damage is known or when operations can be safely brought back online."

Most Americans now pay more than $3 a gallon for gasoline - matching inflation-adjusted highs reached after the Iranian revolution in the late 1970's and early 1980's and the equivalent, on a per-barrel basis, to $126. Oil prices, which touched a high of $70.85 a barrel last week, now trade around $64 a barrel, still about $20 short of the record set in 1981.

"If we lose three or four refiners for two or three months, that shortfall is going to be very difficult to make up," said William E. Greehey, the chief executive of Valero, the nation's largest independent refiner. "I don't know how anyone can blame it on us when we've just had the worst natural disaster in the United States' history."

The refining outages prompted an international response from industrialized nations to send emergency stocks of oil and gasoline to the United States to plug the shortfall.

But that is only a temporary solution to a crisis that has been waiting to erupt for years.

Since the 1980's, the number of refiners in the United States has been cut in half. From a peak of 324 in 1981, the industry has shrunk to 149 as the smaller, less efficient and less profitable operators once protected by price controls closed, leaving mostly larger companies in place.

Refining capacity has fallen about 10 percent, to 17 million barrels a day, while oil consumption rose by 33 percent over the same 24-year period, to 20.8 million barrels a day.

Meanwhile, refiners have been increasing their skill in turning crude into useful products; efficiency improved by 27 percent between 1981 and 2004. Still, the difference must be made up by direct imports of refined products, with gasoline imports now at 1 million barrels a day.

As their numbers dwindled, most remaining refiners expanded their plants and added equipment to process more oil. Many refiners now typically run at 95 percent of capacity, a level that is dangerously high and that has led to a growing number of accidents in recent years.

In March, for example, a blast at BP's Texas City refinery, the country's third-largest, killed 15 and injured 170 people. The company was blamed by investigators with the Chemical Safety and Hazard Investigation Board for "systemic lapses."

Following the agency's recommendation, BP appointed an independent panel last month to review the "safety culture" of its American refining operations.

Only one project to build a new refinery is currently under way. For the last six years, Glenn McGinnis said he has been struggling to line up the permits, funding and oil supplies to build a refinery from scratch in a remote patch in Southwest Arizona.

"The fundamental reason why there has not been a new refinery built for years is really two reasons - economics and uncertainty," Mr. McGinnis said.

Traditionally, the profit margin for refineries has averaged about 6 percent, a rate of return too low to encourage much new investment. Added to that is the lengthy process involved in securing the permits from state and federal agencies. "If you take permits, and engineering, and building," Mr. McGinnis said, "you're talking about a 10-year horizon from the time you decide to build to the day the refinery is completed."

Another issue that has slowed expansion, refiners said, was the cost of complying with environmental regulations set in the 1990's under the Clean Air Act. The American Petroleum Institute estimates that refiners have spent $47 billion over the last decade to meet carbon-emission standards and low-sulfur regulations, with more investments needed through 2007. That, refiners say, is money not spent to raise capacity.

It has been cheaper to add refining capacity through acquisitions rather than new projects. Valero recently bought Premcor for $10,000 a barrel of capacity, a price many analysts deemed high. But that is well below the $16,000 a barrel that Arizona Clean Fuels, Mr. McGinnis' project, expects to invest.

Elsewhere in the world, some oil producers are planning to build new refineries. Saudi Arabia is one of them. "We cannot keep producing oil with no refineries," Ali Al-Naimi, the Saudi oil minister, told the industry newsletter Petroleum Argus a few months ago. "There is a limit."

While helpful, such moves abroad would mostly serve to shift the country's increasing reliance on foreign oil producers to a greater dependence on refiners abroad.

"We are going to be importing more products," Mr. Murphy of the American Petroleum Institute said. "That is a certainty if we don't expand our capacity. But the problem there is that you've changed one form of dependency for another."