Refining Woes Mount as Gasoline Prices Rise
Consumers may be in for more bad news on the dreary march to $4 a gallon gasoline as the largest refinery on the East Coast is expected to close this Summer - eliminating nearly 25 percent of the region's gasoline refining capacity. The closure of the Sunoco refinery is due in large part to high oil prices and decreasing domestic fuel demand, leading to substantial economic losses. Unfortunately, the trend may continue in the region as experts predict two other refineries are expected to close because of unsustainable financial impacts. If so, nearly half of the refining capacity on the East Coast will be gone with some economists predicting a 15 cents per gallon spike in New England because more imported gasoline will be needed to meet demand.
Although the refining process of converting crude oil into petroleum products is a complex business, their economic models are easier to understand. Essentially, refineries are "price-takers" not "price-makers" because they purchase crude oil on a globally traded marketplace and then manufacture it into a host of products in addition to gasoline. Their margins, which are already thin, get hammered when the price of oil spikes and fewer barrels of oil are consumed in the markets they serve. According to the Energy Information Administration, 72 percent of the cost of a gallon of gasoline is based on crude oil prices with refining making up 12 percent and the remainder consisting of marketing, transportation costs, and then federal and state taxes. Refineries on the East Coast rely more heavily on imported Brent crude oil, which is often referred to as the world price of oil. U.S. produced barrels are more closely tied to the benchmark pricing of West Texas Intermediate, which is trading nearly $20 a barrel cheaper than the world price tied to Brent crude prices. Although domestic fuel demand continues to decline due to a weak economy and improved US vehicle fuel economy, global energy consumption - especially demand from China and India - and growing tensions in the Mideast between Israel and Iran are pushing the price of Brent crude higher.
The closure of Sunoco's 335,000 barrels per day refinery near Philadelphia underscores the market challenges of many older operations. In the fourth quarter of 2011, the company lost $362 million and over the last three losses have totaled nearly $1 billion on its refining operations. Older and uneconomic refineries are often limited in their ability to refine a variety of crude oils which can limit the types of products they make. In essence, the heavier "sour" crudes cost more money to refine into diesel than the more commonly known "light, sweet crudes." Investing in hydrocrackers to produce more low-sulfur diesel fuel can cost billions of dollars, and retrofitting refineries in the densely populated Northeast would be prohibitively expensive due to stringent environmental regulations. Thus, many large integrated oil companies are beginning to exit the refining industry for more lucrative exploration and production opportunities.
The industry notes that environmental regulation, state and federal boutique fuel requirements, and biofuel and ethanol mandates have contributed to rising fuel costs further pushing closures of refineries. A study commissioned by the American Petroleum Institute found that proposed EPA regulation for tailpipe sulfur emissions would lead the closure of four to seven additional refineries and add 12 to 25 cents per gallon to the cost of gasoline. In January, the New York Times reported that refineries were required to pay nearly $7 million to the Treasury for cellulosic ethanol - which does not currently exist - in order to comply with a federal renewable fuels standard authorized by Congress in the 2007 Energy Bill.
One suggested policy solution to address the expected shortage of refined gasoline in the Northeast would be to temporarily waive the requirements of the Jones Act. The Merchant Mariners Act of 1920, more commonly referred to as the Jones Act, requires all vessels delivering goods or people between domestic ports to be a U.S.-flagged vessel with a crew of mostly U.S. citizens. The refining industry has asked for a waiver to allow foreign-flagged tankers to ship cheaper, surplus fuel from the Gulf Coast to the Northeast. The transportation cost savings on a foreign-flagged vessel would be would be nearly half for a tanker traveling from Houston to New York. Waiving the Jones Act is strongly opposed by US shipping companies and unions who see the provisions as critical to maintaining the health of a domestic vessel fleet.The Vice President of Crowley Maritime Corporation said, "If they waive the Jones Act to move product from the Gulf to the East Coast that would really knock the stuffing out of the confidence to invest in American vessels." The President has the authority to waive the Jones Act to help partially ease some price increases, but critics contend that it will only save a few cents a gallon and would ignite a political controversy during an election year.