Tomorrow's Petrol Price Will Be Even Higher

Refining the Problem
Prices at the pump are climbing, but crude oil isn't the only culprit

By
MATTHEW YEOMANS

Sunday, Sep. 18, 2005
The modest protests last week in Britain over rising fuel costs did not bring the country to a halt, as similar protests had in 2000. Even so, by staging their protests at oil refining plants, the handful of angry truckers who spoke out did manage to throw a spotlight on a major, if little-understood, factor behind the current international fuel crisis.

In the past, when gas prices spiked, notably in the late 1970s, the problem was caused by high crude oil prices. This month, as global gas prices took a steady upward march in the wake of Hurricane Katrina, the price of crude oil � although still high by recent standards � was actually falling. That's because the real problem isn't crude oil prices. Crude oil is useless unless it is refined into the products we really need � gasoline, heating oil and jet fuel.

Refining is a simple but essential step in getting from oil in the ground to gas in your car's fuel tank. Oil's various refined products, such as gasoline, kerosene and diesel, have different boiling points. The lighter the chemical composition of the desired product, the lower the temperature needed to separate it from the crude. It's not cheap; refining costs account for nearly 19% of the price of gas sold in Britain. Today's refineries are so efficient that they can extract 44.6 gallons of refined petroleum products from a 42-gallon bbl. of crude.

That's good, but not good enough, especially not after Katrina knocked out 10% of U.S. refining capacity. Sixty-seven percent of America's oil demand comes from its transportation sector and even before the storm hit, the U.S. was importing about one-tenth of its refined petroleum needs. With no clear indication of when America may return to full refining capacity, and with no extra refining capacity anywhere else in the world, the U.S. thirst for oil products has created a new global petroleum crunch. Already spare European supplies have been sent to the U.S. where they can attract a premium. That would seem to lock in relatively high prices at pumps on both sides of the Atlantic for months to come.

How did we get in this mess? After all, it's not as if oil companies don't engage in long-term planning. In fact, it's exactly because oil companies watch their profits so carefully that refining has been neglected. The last major refinery construction in the U.S. was undertaken in the late 1970s � just before the price of oil dropped, and stayed low for nearly a decade. With oil languishing at around $15 per bbl., few oil companies had the appetite to lay out huge capital expenditure on refineries, which traditionally yield low profits. Then there was the dizzying mix of regulatory conditions placed on refining both in the U.S. and Europe; in one of America's many energy quirks, gasoline refined in 49 states can't be sold in California because it doesn't meet that state's more rigorous environmental standards. Such restrictions, however sensible, meant different refineries couldn't easily service new markets. Most of all though, the major Western oil companies had other things on their minds. Having lost lucrative Middle East concessions in a wave of nationalization in the 1970s, Big Oil was more obsessed with finding increasingly rare supplies of crude oil rather than worrying where to refine it.

With all these distractions, oil companies didn't see the refining crunch coming, or preferred to look the other way. Even five years ago, there was still a large gap between global demand and refining capacity. Since then, the massive surge in oil consumption � driven mainly by China and India � has taken the industry by surprise and left the global economy vulnerable.

Is there an easy fix? Obviously, building new refineries is one answer. French Finance Minister Thierry Breton last week told oil companies to come up with structural plans (including new refining initiatives) to lower oil prices or risk a windfall tax. With oil at $63 per bbl. and oil-company profits at record highs, a new era of refinery construction seems imminent. Last week, serial entrepreneur Richard Branson floated the idea of building a refinery just to provide his Virgin Airways and other airlines with jet fuel. U.S. politicians have been putting pressure on domestic oil companies to build new facilities for some time, while China and India are already undertaking ambitious new construction.

Trouble is, new refineries don't spring up overnight. Each can take at least five years to build, at a cost of over $3 billion. So even if construction begins today, by the time new refineries come online around 2010 global oil demand is projected to be 89 million bbl. a day, compared to 83.5 million now. Who's to say how much refining will be needed then? In the meantime, a secondary oil shock � be it another hurricane or a terrorist attack � could give all of us a nasty taste of what oil dependency really means. Just a few weeks ago, George W. Bush suggested Americans might need to think about how much oil they use. When this President starts talking about conservation, you know it's time to ditch the suv.
From the Sep. 26, 2005 issue of TIME Europe magazine