Engineering News

Refiners Struggle To Cover Costs
Thursday, June 19, 2008

After three years of record profits, the U.S. refining industry has been confronted recently with a hard truth -- that the party may be ending.

Refiners' profits have plunged this year as record crude oil prices have sharply boosted fuel-making costs. At the same time, higher prices at the pump are softening demand for gasoline and diesel, limiting refiners' ability to pass along the bill.

As U.S. drivers pay more than $4 for gasoline and nearly $5 for diesel nationwide, refiners are struggling to cover their costs and are warning investors the situation will remain challenging if crude prices remain high.

The downturn may mark the end of what some had called the golden age of U.S. refining, and a return to more modest profitability, said Ben Tsocanos, who follows the refining sector for the credit rating firm Standard & Poor's.

But the industry is not likely to repeat the low profit levels of previous decades, when a glut of refining capacity, after years of overbuilding, stalled profits and discouraged investors.

"The long history has been of lousy returns. So, we now have three really good years, and the question is what's going to happen after that?" said Lester Lave, an energy economist at Carnegie Mellon's Tepper School of Business in Pittsburgh.

The national average price for a gallon of regular gasoline fell a fraction of a penny Wednesday to just over $4.07 and held at $3.92 in Houston, according to a daily survey by AAA and the Oil Price Information Service.

Summer slump

The uncertainty in refining means one of Houston's biggest industries has been hurt by rising oil prices even as many energy companies benefit.

Typically, refiners look forward to this time of year, when rising gas demand for spring and summer travel brings higher profits. But this year, high pump prices are spurring Americans to pull back.

In May, U.S. gasoline demand fell 1.4 percent compared to year-ago-levels, contributing to a 1 percent decline in demand for the year so far, the American Petroleum Institute said Wednesday.

It was the first gasoline demand drop for the January-May period since 1991, the trade group said.

And that's pinching the refiners.

While gasoline prices have soared almost 40 percent since last year, the price of crude has more than doubled.

Standard & Poor's Tsocanos said refiners tend to do poorly when oil prices are going up because price increases are hard to pass along quickly. They do better when the oil price goes down because they can lower fuel prices more slowly, he said.

But that hasn't happened in a while.

Gross refining margin

The difference between what refiners pay for a barrel of oil and the price they get for products made from it is known as the gross refining margin. This figure is widely used as a rough indicator of the profitability of the refining business.

In recent years, that margin has jumped as high as $30 per barrel during peak periods.

But the average U.S. refining margin was $14.68 per barrel Wednesday, compared with $23 this time last year, according to a report Wednesday by Eitan Bernstein, industry analyst with Friedman, Billings, Ramsey & Co.

The price of light, sweet crude oil increased $2.67 to $136.68 a barrel Wednesday on the New York Mercantile Exchange, a sign that gross refining margins may face a continuing squeeze.

Although refiners say high oil prices can be hard to absorb in the short run, companies try to take a long-term view and invest in projects that allow them to remain competitive in challenging environments.

For most, that has meant upgrading basic refineries with limited flexibility to complex ones that can handle a broad range of crude oils, including the poorest grades.

"These are typically the most successful in periods of lower margins, allowing us to be more competitive when tougher times come," said Tom Purves, vice president of manufacturing at Shell Oil Products U.S.

Future looks good

Despite the challenges, the long-term outlook looks good for U.S. refining, given America's thirst for gasoline, its shortage of refining capacity and the need to continue making specialized fuels for certain parts of the country, Tsocanos said.

Refiners generally have shared that view and plan to add about 1 million barrels per day of new capacity by 2012. Today, the nation's 140 refineries have about 17.5 million barrels per day of capacity.

San Antonio-based Valero Energy Corp.'s geographically diverse portfolio of refineries has allowed it to capture favorable margins in some regions that offset weaker ones in others, said spokesman Bill Day.

Given such advantages and the industry's history of ups and downs, Day questions whether the current period is as grim as some might suggest.

"I don't know if it's fair to say 'the' golden age of refining is over," he said, adding that refining has always been a cyclical business. "It might be fairer to say that 'a' golden age of refining is over."

Source: Houston Chronicle

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