Refining sector at its limit even before hurricane hit

PHILADELPHIA — Even before Hurricane Katrina shattered the heart of the U.S. refining sector this week, the industry was stretched to the limit.

Growth in refining capacity has not kept pace with growth in demand for years, as oil companies eliminated excess capacity that had depressed profits in the 1980s and 1990s.

Over the past 24 years, the nation's oil-refining capacity has fallen by 10 percent — while demand for gasoline, for example, is up 37 percent.

The result has been susceptibility to price spikes whenever something goes wrong in the gasoline-supply chain.

High profits over the past couple of years have not been enough to spur widespread investments of hundreds of millions of dollars in large capacity increases.

"Refiners have long memories," said Bill Veno, a research director at Cambridge Energy Research Associates. "Although things might be rosy right now, they might not be down the road."

Even if expanding capacity were a top priority for refiners, it would be difficult because they have spent $46 billion — enough money to build more than 20 refineries — to meet clean-fuel requirements and to reduce emissions, said John Felmy, chief economist at the American Petroleum Institute.

Over the long term, "the returns are really awful" for oil refiners, he said.

But consumers, who have seen the price of gasoline double over the past five years, have little pity for oil refiners, whose key product — gasoline — has the most visible price on the planet, displayed on thousands of gas stations around the country.

Rising gasoline prices are also visible because consumers pay them directly. With many other commodities — whose prices are determined almost entirely by supply and demand — price increases many times are absorbed by a chain of producers.

For example, Sunoco produces chemicals from crude oil that it sells to a maker of chemicals. It turns them into ingredients for paint it sells to paint makers.

U.S. refiners have helped themselves by reducing the number of operating refineries from 324 in 1981 to 144 now. Most of the closed refineries were small, landlocked operations that were no longer competitive.

At the same time, the industry has undergone a massive consolidation. In 1980, for example, seven companies owned the seven refineries on the Delaware River that produce fuel.

Now, with Valero's acquisition yesterday of Premcor, which owned the refinery in Delaware City, Del., just three companies own the seven refineries.

The consolidation nationally has helped improve the average return on investment in refining from about 4 percent through most of the 1990s to 7.5 percent in the early 2000s, according to the Petroleum Industry Research Foundation.

Returns were even better this year and last, but Veno, of Cambridge Energy in Cambridge, Mass., doesn't expect the extraordinarily good times for refiners to last. "This is an anomaly," he said.

Now that the refiners' environmental expenditures are largely behind them, he said, they "will have the wherewithal to make more investment in plant expansions and capacity expansions."

Typically in a commodity business, capacity expansion leads to lower prices until demand catches up.