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Last Updated: Sunday, 2 October 2005, 17:37 GMT 18:37 UK
Global refinery shortage shifts power balance
By Adam Porter

When American oil refineries fail, it is not just residents of Louisiana who pay more at the pump. You do too, wherever you are.

Petrol station in London
Petrol prices are rising across the world

Refineries, or rather the lack of them, have become the latest hot topic in the oil market. They turn crude oil into kerosene, heating oil and many other related products. But most importantly, they make petrol.

Even before the hurricanes hit America the oil market was worrying about the lack of refining capacity. Especially so in the United States and Europe.

"There is just no slack," said Barclays analyst Paul Horsnell.

"There really was very little leeway for any accident, any unexpected disruption, [because there is] no spare capacity.

"Prices had been very sensitive to refinery disruptions already in the US, and it was getting to the point where even relatively small refinery disruptions were feeding through into significant impacts on prices."

Emergency stock

Low refinery capacity would at first suggest that oil prices should fall. After all, if there is no more space at refineries there will be surplus oil on the market waiting to be refined. So logically crude oil prices should fall.

There are no firm expansions in refining capacity, not just in the US but in North America, South America and Europe. All of the expansions are in the Middle East and Asia
Barclays analyst Paul Horsnell

But the oil market has no real mechanisms to make this happen.

It only has crude prices at one end and pump prices at the other to regulate demand.

As a result if refinery capacity is limited the price of crude will rise, as an incentive to reduce demand. The idea being that high pump prices kill demand for petrol, in turn lowering the price of crude.

It can best be seen in reverse.

Post-Katrina, governments and the International Energy Agency released emergency stocks of crude. The USA released 60 million barrels from its Strategic Reserve, for only the second time in its 30-year history.

They did this to reduce the shock of high pump prices, especially for American consumers in the hope that if they flooded the market with crude oil then oil prices would fall.

This in turn would pull back American pump prices from a record nationwide average of $3.12. Only a year earlier the price had been $1.87.

Reduced capacity

But why does this refinery shortage exist?

During the last 29 years, US gasoline consumption has risen 45%, yet not a single new refinery has been built.

A refinery in Baytown, Texas
People dislike it when refineries are built close to where they live

US environmental laws have made it near impossible to build refineries close to residential populations.

But the primary motive behind the lack of US refinery new builds is a basic one, a lack of profits for oil companies.

In the 1980s and 90s, the fashion for American refineries was not to build more, but to close existing ones.

In 2001, Senator Ron Wyden authored a comprehensive report on the state of the US refining industry.

He noted that between 1995 and 2001 there were a total of 24 refinery closures in the United States.

These lost America around 830,000 barrels per day of gasoline. That is about the same amount of capacity lost to Katrina alone.

No new refineries

Wyden uncovered several memos and internal documents from major oil companies. These charted the way that capacity in the US refining industry was reduced to maintain higher profits.

Wyden received one such memo from oil company Texaco, written in 1996. The company felt it was quite clear that petrol supplies needed "reducing."

"The most critical factor facing the refining industry on the West Coast is the surplus refining capacity, and the surplus gasoline production capacity," said the memo.

"The same situation exists for the entire US refining industry. Supply significantly exceeds demand year-round. This results in very poor refinery margins, and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline."

The same basic premise has operated in Europe. Not only have no new refineries been built for two decade; there are no plans to build any in the future.

There is a plan for one small 150,000 bpd US refinery in Arizona near the town of Welton, but even that has many hurdles to overcome.

"If you had a magic wand solution, your magic wand would give you a few more refineries within the US system," said Paul Horsnell to his clients.

"That is not going to happen."

Changing power balance

However this has opened the way for other nations to capitalise on the current shortages.

HE Sheikh Ahmad Fahad Al-Ahmad Al-Sabah
Sheikh Al-Sabah blames 'Nimbys' for the refinery shortage

That is especially the case with the eleven Opec nations.

The future of the refining industry could well be shifting, away from rich countries like the USA and those in Europe, to nations with significant oil reserves.

To illustrate this, the last Opec meeting saw the sitting President, Kuwaiti oil minister HE Sheikh Ahmad Fahad Al-Ahmad Al-Sabah, attack Gordon Brown's widely reported pronouncements on Opec.

His stinging response was aimed at the high tax take of the UK government, but also at its failure to build new refinery output.

"It is the tax problem and the procedures to build refineries; nobody wanted a refinery in the back yard of his house," he said.

As a result it is Opec that is building the new refineries for the world.

Indonesia is to build a new refinery in Tuban, Java. Kuwait is spending $9.8bn to build a huge new 600,000bpd refinery near Kuwait City plus upgrades to other refineries in Al Ahmadi and Mina Abdullah. Nigeria are investing over $2bn in refinery capacity and Qatar are undertaking billions of dollars of investment in gas-to-liquids (GTL) which produces liquid fuels from natural gas deposits.

Saudi Arabia are to spend $11.3bn upgrading some existing refineries, but also to build a massive new plant at Yanbu on the Red Sea. As well as this, the Saudi state oil company Saudi Aramco are investing in joint ventures overseas in China in Qingdao and Fujian.

Paul Horsnell from Barclays Capital again

"We're stuck in an imperfect world," observed Mr Horsnell.

"Refining shortages are going to play a key role in price formation.

"There are no firm expansions in refining capacity, not just in the US but in North America, South America and Europe. All of the expansions are in the Middle East and Asia."

There is a undoubtedly a problem with the world's refining capacity. Opec's new refineries will not come online until around five years from now. By then demand levels could be even higher than they are now. But what it may cost to fill your car by then, is anyone's guess.

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