Engineering News

On The Road To Recovery?
On Friday May 8, 2009, 6:31 pm EDT

Are Americans starting to hit the road again?

According the the U.S. Department of Transportation, motorists traveled 5.2 billion miles in February, up 2.7% from January and the highest total since October, when Americans drove 5.4 billion miles.

That's a positive sign for U.S. refiners, which have struggled as the recession leads to less travel and fewer morning commutes to work. Falling demand has forced refiners to stockpile, rather than sell, large amounts of gasoline.

"Refiners have scaled their production to meet sharply reduced demand for gasoline, which has been crushed by the recession," said Ann Kohler, an analyst at Caris & Co.

From deep job cuts at Sunoco, to refinery closures at Valero Energy, oil and gas refiners are managing costs as they wait for signs of stability.

Valero noted that gasoline demand could begin to improve in the next few months.

The price of crude oil has fallen sharply in the past year from well over $100 a barrel to $50 now.

And prices at the pump are not likely to surpass $2.25 a gallon this summer, analysts say. That's just more than half the record $4.11 a gallon gas went for at its July 17 peak, according to the AAA Daily Fuel Gauge Report.

"With pump prices around 40% lower than this time last year, gasoline demand could improve with the summer driving season," said Valero CEO William Klesse in a conference call with the media.

As of Friday, oil and gas refineries ranked No. 40 among IBD's industry groups, up from No. 170 seven months ago.

1. Business

Oil and natural gas refineries are a critical link in the oil supply chain. Some 149 operable refineries in the U.S. produce 17.6 million barrels per day, according to the U.S. Department of Energy.

Independent refiners -- 35 of which are publicly traded -- process 40% of the total capacity in the U.S., while integrated oil companies, such as Exxon Mobil, account for the rest.

Roughly half of the gasoline consumed in the U.S. is refined along the stretch of Gulf coast from Corpus Christi, Texas, to New Orleans.

Refiners are the downstream component of the gas chain. They buy barrels of crude oil on the open market to process and refine into more useful petroleum products, such as gasoline, natural gas, diesel oil, jet and other fuels, asphalt, and petroleum coke.

A barrel of crude oil -- next to useless in its raw form -- has a mixture of hundreds of different hydrocarbon molecules. Refineries separate the molecules by boiling the crude at different temperatures.

Refiners squeeze as much as possible out of a barrel to limit the waste. The various petrochemical products are used in everything from aspirin to fertilizer to Kevlar.

About 65% of crude oil goes toward gasoline and on-road diesel. Liquefied petroleum gas, petrochemicals and lubricants make up 16% of production, jet fuel 9%; residual fuel 4%; and heating oil and off-road diesel 6%.

The refined products are then distributed and sold to gas stations or, in the case of petrochemicals, to various manufacturers. It's all for the purpose of serving the consumer.

Some companies in the group, such as World Fuel Services, only market and sell petroleum products.

Some refiners operate gas stations, but those outlets account for a small percentage of their business. Sunoco and Valero -- the most recognizable gas stations in this group -- boast 4,700 and 5,800 retail gas outlets, respectively.

"Refining is obviously their meat and potatoes," Kohler said.

Name Of The Game: Refiners must find the right balance between refining as much crude oil as they can and managing operating costs to make a profit. With high fixed costs, refiners will try to maximize profit margins by squeezing as much as possible from each barrel.

2. Market

The 35 publicly-traded, independent refiners churn out roughly $56.8 billion in sales annually, according to company reports.

But the real measure of a refiner's mettle is profit margins, or crack spread, says Charles Drevna, president of the National Petrochemical and Refiners Association.

The crack spread is the gap between the cost of crude and the price of the refined products -- which at one point actually sold for less than a raw barrel of crude as oil prices made their rapid ascent to record highs last year.

"High crude oil prices hurt refiners just as much as they hurt motorists at the pump," Drevna said. But falling crude oil prices should alleviate some of that squeeze, he added.

Argus Research analyst Phil Weiss says refiners face heavy maintenance costs, big debt loads and billions of dollars in capital expenses to build extra capacity; a new refinery has not been built in the U.S. since 1976.

"A lot of those costs cannot be passed through to the consumer," Weiss said. "This business is all about trying to earn back the cost of capital investments."

But gasoline margins have rebounded recently, he says, albeit in response to refiners curbing output and slashing capital spending.

Valero, the first major refiner to report first-quarter earnings, reported its throughput margin per barrel rose to $8.77 during the quarter from $8.48 in the same period a year ago.

3. Climate

Refineries face many challenges, but none more daunting then the political gamesmanship involved with proposed environmental legislation.

The negative stigma surrounding oil -- which now includes worries about greenhouse-gas emissions -- has triggered overlapping and costly regulations, including the proposed "cap-and-trade" system. Such a system would set a limit on carbon emissions and require companies with higher volumes of emissions to purchase credits from those that pollute less. Other proposals include a punitive carbon tax and the mandate requiring at least a 10% ethanol blend in gasoline.

If imposed, such policies could raise U.S. refiners' costs, making them less competitive on the global stage and leading to higher domestic fuel prices.

Critics say policymakers want reductions that are too costly with today's technology. That threatens not just the oil industry, but the overall economy, they contend.

"The fact is refineries are the linchpin of the U.S. economy because, as the axiom goes, energy drives the economy," said the NRPA's Drevna. "And refineries provide the fuel to drive this economy."

4. Technology

Not many new advances are occurring in the refining market, even as their upstream cousins -- exploration and production companies -- try to develop new ways to efficiently extract hard-to-reach oil and gas reserves.

Sasol is one exception. It has developed two new-generation separation technologies that allow it to produce synthetic fuel, which is any liquid fuel obtained from coal, natural gas or biomass.

Outside of refining, advances in hybrid- and electric-car technology could put a long-term dent in gasoline demand. One of the biggest bottlenecks is battery technology, but several companies are working on lighter, less expensive cells for more efficient hybrids and all-electric autos.

5. Outlook

In the face of weak gasoline demand, some refiners have ramped up their diesel production, which kept them in the black in 2008 and could hold the key to growth in an eco-conscious era. Diesel leaves less of a carbon footprint than regular gasoline.

Tesoro is one of the largest independent refiners to shift its output toward diesel, using its U.S. West Coast location to export fuel to South America.

One potential pitfall: Few U.S. cars have diesel engines.

"While diesel sells at a premium, margins on the distillate product have fallen," Weiss said. "Gasoline is still more profitable than diesel."

Upside: The Economic Cycle Research Institute announced that the end of this recession is finally in sight, probably by summer's end. A recovery should increase demand for refined petroleum products, especially gas, as discretionary driving begins to pick up.

Risks: Political uncertainty and conflicting climate change policies remain the biggest challenge facing U.S. refiners today.

Source: Brad Kelly

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