Economy up, but so are fuel supplies as market changes
By MONICA HATCHER
HOUSTON CHRONICLE
Jan. 23, 2010, 1:16AM
http://www.chron.com/disp/story.mpl/business/6831597.html
It wasn't long ago that the mighty oil refining industry was pulling in record profits as demand and prices for gasoline and diesel soared in the booming economy.
Average profitability was 22 percent from 2004 to 2007, a level not seen since the U.S. Energy Department started keeping track more than three decades ago. Refiners sunk billions of dollars into beefing up their facilities to produce more fuel. And, even that wasn't enough. Millions of extra gallons flowed into the U.S. from other countries.
Then the downturn sent profitability plummeting to 3 percent in 2008, and analysts expect an even worse showing as the industry reports year-end numbers over the next few weeks.
But the bruising reversal of fortune facing the nation's oil refiners can be blamed only partially on the economic slowdown.
Shifts in the marketplace that include changing driving habits, more efficient vehicles and a greater push toward renewable fuels underlie the upheaval in the sector, which employs tens of thousands in Houston and others parts of the Gulf Coast.
And things could get even dicier for the industry if climate change legislation requires costly measures to curb carbon emissions.
“It's a perfect storm for refining,” said Steve Arbogast, a professor at the University of Houston's Bauer College of Business Global Energy Management Institute. “You have spare capacity from the recession, surging low cost imports of gasoline and then you have the increasing invasion of fuel from outside the refining business, including ethanol.”
Fourth quarter and year-end earnings being reported by the major refiners in the next couple of weeks are likely to provide further evidence of the industry's struggles.
Loss expected
The country's largest independent refiner, San Antonio-based Valero, has warned investors that its 2009 results will show a second straight annual loss, the result of rising oil prices and weak demand.
Other big refiners, including Chevron and Houston-based ConocoPhillips, also said refining margins will be down sharply. The refining margin is the difference between what a refiner pays for crude oil and the price it gets for refined products.
Valero and ConocoPhillips report financial results Wednesday and Chevron reports Friday.
In another sign of distress, Chevron told employees last week it will overhaul its downstream division – which includes refining and marketing—resulting in layoffs and possibly sale or closing of refineries and withdrawal from some markets around the world.
“The downstream environment is very difficult and the industry is going through a very tough cycle,” Chevron spokesman Lloyd Avram said in an interview last week.
The company employs 700 people in its downstreamdivision in Houston.
Consumers won't necessarily feel the pinch being experienced by the companies that make their gasoline.
Roger Ihne, a principal with Deloitte's oil and gas practice in Houston, said only a fraction of the money motorists pay for a gallon of gasoline goes to refiners. When pump prices spiked to $4 a gallon in 2008, it reflected crude oil prices that were pushing $150 a barrel.
More closures on way
But industry woes do exert an indirect effect. When profit margins shrink and supplies bulge, companies reduce the capacity they use at refineries and supply tightens. Over the last two years, refiners have closed or announced the closure of five plants in North America and one in the Caribbean, reducing supply by 700,000 barrels a day.
Analysts say more closures are on the way.
Reduced supply can force prices up if demand rises or other factors—hurricanes, for instance— disrupt production. It's hard for refineries to respond quickly to such supply needs, because of high costs and regulatory hurdles to open a facility that has been shut down.
A range of motion
Refiners now are using just under 80 percent of their production capacity, said Lynn Westfall, senior vice president and chief economist with Tesoro Corp, a midsize San Antonio-based refiner. And that is still too much, given the weak demand.
“To get utilization rates up you have to have demand increase and-or capacity shut downs,” Westfall said.
Many refiners and analysts believe the gasoline and diesel demand hit its lowest point of the downturn in 2009. With a modest economic recovery under way, people should start driving more. But even if demand rose by 2 percent, utilization rates would rise only to the mid-80 percent range.
The U.S. Energy Information Administration forecast this month that in the U.S., the world's largest gasoline consumer, demand will rise by a 0.6 percent in 2010, with consumption of distillate fuel, mostly diesel and heating oil, increasing by 2.1 percent.
“The industry cannot operate refineries at 75 or 78 percent capacity. They need to be in the high 80s to give them any glimmer of hope,” said Fadel Gheit, a managing director and senior analyst with Oppenheimer & Co. in New York.
Challenges ahead
Short-term economic hardships aside, more fundamental changes will pose the biggest challenges.
After gas hit $4 a gallon, many Americans switched to smaller cars and tweaked their driving habits.
And new fuel efficiency regulations will require auto makers to improve average fuel economy in 2011 to 27.3 miles per gallon, eliminating the need for 887 million gallons of fuel, according to the National Highway Traffic Safety Administration. Fuel economy requirements increase to 35.5 miles per gallon five years later.
The grim landscape doesn't discourage Peter Beutel, president of Cameron Hanover, an energy risk management firm in Connecticut. In the short-term, refineries will use the lull for maintenance and upgrades. And growth in emerging economies will compensate for the permanent drop in U.S. demand, he predicts.
“As soon as the economy recovers,” he said, “anything they can't sell here, they can sell it Asia.”
monica.hatcher@chron.com
