Bottleneck Blues = Good News for Refiners

by Justice Litle

“We see an almost infinite increase in the level of demand. We also see there are finite resources… I do see a real challenge facing the world if we’re going to meet that level of demand.”

– Spencer Abraham, former U.S. energy secretary

Imagine driving down a big, broad, eight-lane highway, flowing along with traffic at a decent speed. With little warning and no advance notice, you realize this superhighway is about to transition to a narrow private road, one lane in each direction, with no clear means to pass. The drivers to your left and right see the dilemma at the same time you do and begin to speed up.

What happens next? At best, you get a bottleneck as vehicles hit the brakes and change lanes, slowing traffic dramatically. At worst, the slightest accident quickly escalates into a pileup, blocking all lanes.

This rough analogy applies to the energy markets, as the eight-lane highway of supply gets bottlenecked by woefully inadequate refining capacity. Crude oil isn’t useful in its raw form – it has to be processed and transformed into various end-user products. The refineries are running flat-out, and there simply isn’t enough capacity to handle demand. So a bottleneck develops as more barrels pile up. Ali Naimi, Saudi oil minister and top dog of OPEC, says the bottleneck is worldwide. Federal Reserve Chairman Alan Greenspan has mentioned his concern as well, calling the status of world refining capacity “worrisome.”

The refinery bottleneck is a result of past complacency and classic NIMBY (“not in my back yard”) politics. In the United States, the ’90s was the decade of the sport utility. Urban areas overflowed with Ford Explorers, Chevy Blazers, Lincoln Navigators and the like. The “bigger is better” idea was finally taken to an extreme with monstrosities like the Hummer and the Ford Excursion. But hey, why not? Gasoline was cheap back then. (You might think it was still cheap today, considering that consumers haven’t eased off the gas pedal one bit.) The other factor, NIMBY politics, explains why a new refinery hasn’t been built in the United States since the late 1970s, with more than a hundred refineries being mothballed in the past 30 years. It’s not hard to see why people would object to a dirty, messy, disruptive and dangerous refinery in the neighborhood… though we are now paying the price for collective shortsightedness. In the past, strict environmental regulations and risky economics have also done their part to keep investment away from refineries.

With gasoline prices sky high, the bottleneck isn’t all bad news. Many refiners are rocking and rolling. Profit margins have exploded from previous levels just a few years ago. And what’s more, though more capacity is desperately needed, you simply can’t get a refinery up and running quickly. (Nor can you halt production very easily; if you shut down and restart later, the refinery explodes. I wonder if someone had to find that out the hard way.)

Another source of pain is a general lack of processing ability for heavy, sour crude, as opposed to the light, sweet grade. With energy demand so strong, we are now forced to make more use of the sour variety, which requires expensive modifications that most refiners aren’t equipped for. The Wall Street Journal reports:

Though Saudi Arabia and other countries are adding refineries, it can take years to expand existing facilities and much longer to build new ones. Consequently, industry analysts and OPEC officials expect the refining crunch to keep product prices high until 2008 at the earliest. Global demand for oil products is once again expected to outpace refinery capacity growth next year.

“The first year that the situation could change is 2007,” says Lawrence Goldstein, president of New York-based Petroleum Industry Research Foundation. He estimates that demand for oil products grew by 4.6 million barrels a day in 2003 and 2004, while refinery capacity grew by only 700,000 barrels a day. Tight refining capacity has been an often-overlooked factor in the rise in oil prices in the past 18 months.