Where are the Low-Cost Competitors in the Oil Industry

Steven Pearlstein has written an article in the WaPo [reg] arguing that the oil companies in the US require a nationalised competitor in order to make the market, especially refineries and trading desks, efficient. He writes:

Standard’s first order of business would be to expand refining capacity in the face of the industry’s disciplined efforts to keep supply always a bit behind demand. It’s rather telling that, after complaining for years about the difficulties of siting and permitting, not a single company has taken up President Bush’s offer to site a new refinery on federal land and expedite the approval process.

I have seen the price of a gallon of petrol in the US go from $1.50 to $3.50 in the space of two years. You can argue all you want that US petrol prices need to increase, but that level of inflation is regressive, and many people are now facing weekly commuting bills that are double what they were two years ago.

What I don’t understand is, if, as Pearlstein argues, the oil companies have acted as an international cartel, deliberately restricted supply and have manipulated trading desks; then why haven’t we seen a low cost refiner/distributor – an oil version of Walmart. Surely the behaviour Pearlstein describes from the industry incumbents leads to new competitors undercutting them? If so, why haven’t they appeared?

This entry was posted in Economics and public policy. Bookmark the permalink.

21 Responses to Where are the Low-Cost Competitors in the Oil Industry

  1. JC says:

    “What I dont understand is, if, as Pearlstein argues, the oil companies have acted as an international cartel, deliberately restricted supply and have manipulated trading desks”

    We shouldn’t necessarily assume all he is saying is correct.

    The majors don’t decide the price; OPEC is the entity that makes most of the decisions about oil supplies and therefore influences the price. The majors wouldnt dare to try to create any form of cartel these days. If they even tried that caper, executives would face 25 years in jail judging the mood of the people over the cost of gas. Dont bet there isnt someone at Justice trying this on at this very moment. There would be anything sweeter for some Federal Attorneys if the could get a few oil executive scalps.

    It’s all very good he tells us that Bush is allowing refineries to be built on federal land, but what does that entail exactly? How many regulations would they have to meet in order to get a refinery through the process? What is the cost of that process? We don’t know that. Compare that to simply importing juice from overseas refiners.

    The other issue is the US refiners have been very good at “grafting” on added capacity to existing plants. I read somewhere that current capacity has increased by about 35% over the years at existing plants.

    We shouldnt we assume that the SU has a refinery problem anyway. It may not be a refinery problem; it may simply be a problem of raw supply.

    Lastly, it would take several years to execute a plan and a few more to build the plant itself. How does he know no plants are in the planning stages?

    Sorry, but is not enough information and we can only speculate.

  2. Cam says:

    JC, Refineries appear to be the bottleneck. Bush’s speeches on energy always include a sentence on increasing refining capacity. The bill to place refineries on federal land went through under a Republican Congress, though it was one of those where the vote was held open for 50 minutes while reticent republicans changed their vote. I don’t think regulation is the issue as it appears to be under the pattern of executive emergency style governance;

    The GOP legislation would give the federal government greater say in locating a refinery, at times, critics said, over community or state objections. It directs the president to select a number of closed military bases and other federal land available for refineries.

    IIRC refineries used to make up about 20% of the cost of a US gallon of gas, about equal to taxes. The petrol stations take about 12% and the cost of crude is the rest. Supply appears to be the issue, and if as Pearlstein says no new refineries are being built, even under policies that promote new ones being built, why not? And why haven’t low cost competitors come into the market to undercut the refineries that are restricting supply because of non-scheduled maintenance issues?

  3. JC says:

    Cam

    We still don’t know the full regulatory pic. and unless he has taken a look neither has he.

    Listen, one of the largest refiners in the US at the moment is J Aron, Which is Golman Sachs trading arm. Those guys would be in on the game in NY minute if they thought they could build plants and make a trurn on investmet.

    The point is Cam, that we really don’t know the full pic. How tough are the environmental hurdles in getting a US refiner up and going. I’m sure it’s tougher than say India or Vietman etc., so why wouldn’t they simply build the plants there where you would have all this headache from the EPA and every nimby in the state laying across the road stopping the trucks and then broadcast on the evening news?

    It very easy to go some pleace else when you have all those headaches as the entire operation is financed in US dollars and the commodity trades in Dollars anywya.

    So it would be interesting to see what’s being built around the wrold.

    Example

    I think BHP wanted to build a LPG processing plant off the coast of California. Now this thing was out on the ocean so it wouldn’t be visiable. Arnie stopped it. Keep in mind that US gas supply is also very tight. Arnie stopped it on environmental grounds.

    So the point is that the guys could be building capacity outside of the US to simply skirt onerous regulations.

  4. JC says:

    Cam

    We also need to know if the guys aren’t also adding to existing plants the way they have done in the past.

  5. JC says:

    Cam

    I just read the piece. He’s arguing that the government go into the oil refinery business which in itself is an amazing suggestion. He barely looks into the reason why there hasn’t been a refinery built and immediately suggests the US federal gov. is the solution. This is the same government that is “managing” its southern border so well 12 million illegal immigrants have got through its clutches.

    He next wants to have the gov. trade oil. Okey dokey, that would sure be anotrher disaster in the making. Why stop at oil, why not trade stocks and bonds as well.

    This is a silly soltuion to the problem.

    Did he even consider asking the guys why they haven’t taken advantage of the opportunity afforded by Bush? Why not? Maybe he didn’t like the answer.

  6. Cam says:

    JC, you haven’t produced any data yet, all your arguments so far are emotive.

    If the market was efficient, and given the supply issues, we would expect new refineries to be built, especially as the placement of them has come under executive emergency. Where are they? And why haven’t low cost refinery competitors appeared to take advantage of the inefficiencies in the present refinery system?

  7. JC says:

    Cam

    There’s nothing I’ve said that displays emotion other than the fact that I think it’s a superficial analysis by Pearlstein

    We need cold hard facts to make these judgements. All Perlstein does is offer a few paragraphs whining about the lack of new refineries and then tells us the government should build one, two etc., as well have a trading desk.

    The US would probably be a high cost producer in the refinery business compared to 3rd world countries , not because of higher labor coests, but because of environmental regulations etc.

    Unless we have the information to those questions I have posed we are blind to the reasons. We can’t make conclusions without those answers.

    Thoughout the 90’s and late 80’s the US had surplus refinery capacity with quite a few of these plants having to be moth balled from time to time. Do you think the government should have come in at the time and taken the plants off the market. It was a reverse problem, so do you think it required intervention in the reverse?

  8. Cam says:

    JC, All Perlstein does is offer a few paragraphs whining about the lack of new refineries and then tells us the government should build one, two etc., as well have a trading desk.

    I posted to a news story which said refineries were the bottle neck. The Midwest has higher prices than New Jersey because of its lack of refineries. This site suggests that no new refineries have been built since 1976. This fellow suggests that it is market failure because the US has been divided up into market regions.

    You haven’t answered the question I asked, nor bothered to look for data to answer it, your argument is “it’s silly” and we don’t know. Something is up as petrol has doubled in price in a couple of years. Consumer grade petrol is not getting to the market.

  9. observa says:

    US industry engaged in such long life projects is no doubt very conscious now of a new govt signing on to Kyoto or the like, over the life of a plant. Unless they can pull off a 25 year exemption deal like Bluescope Steel did with the Iemma Govt, why wouldn’t they go offshore with such investments? Welcome to the threat of GW, but look at it another way, the higher resulting price of petrol is reducing demand to some extent. Lefties get a bit upset that a defacto tax is perhaps being creamed off here by big biz, but what the hell, they want to give them the right to tax under Kyoto type cap and trade arrangements anyway. What’s their beef here then? Besides their union mates can get a bit of the cream too out of the existing refineries.

  10. Cam says:

    observa, No new refineries have been built since the 1970s. So your zomfg lefty kyoto conspiracy theory fails it.

  11. JC says:

    Cam

    1. The US oil market is very complex and as you say regionalized. Some areas require more ethanol, others more additives because of the cold condtions ec.

    2. This is a blog not a research operation. In other words it’s mostly a conversational medium.

    3. These plants cost $us5/6 billion to construct so it is not as cheap as you or Perslstein think it is.

    4. I put up a lot of questions that Perslstein hasn’t answered.

    5. i wouldn’t be too quick to scream out market failure before you can answer those questions.

    The oil market is one of the most efficent markets in the world. Unless Perlstein goes and talks to the players and gets all that information one can rightly conclsue his piece is a shallow bit of writing.

    So if you want to get to the bottom of this, i suggest we get some answers to those questions I asked above.

    One other question. How does Perslstein know the US refinery market is bottlenecked? Certainly not by the fact that none have been built on federal land since the law was passed.

    We’re coming into the summer driving season in the US which always means higher gas demand. It could also be that the 12 month cycle is quite well balanced and tighens up during the summer months like it does here.

    This is a complex issue that hardly speaks of “market failure” unles you have the facts.

  12. JC says:

    Cam

    Listen to me. There might not have been new plants built since the 70’s but it doesn’t mean new capacity hasn’t been added to the existing ones. That is what has happened.

    Your observation in the last comment isn’t correct.

  13. observa says:

    Here’s a sample of the threats to profits big refiners face http://www.theage.com.au/articles/2004/06/15/1087244915855.html?from=storylhs
    It mentions the closure of Adelaide’s Port Stanvac refinery in 2003, due to losses. As I recall Adelaide was operating then on an uneconomic 2-3 c/L refining margin, when they needed at least 4c/L long term. Within a year of closing, refining demand had seen refining margins world wide climb to 6c and then 8c/L, and Mobil were tossing up whether to reopen again. They didn’t and we continue to ship it in ‘just in time’ from Singapore. However, that had teething problems and with Katrina and the like Adelaide’s supply was threatened a few times by late shipments. The state govt wanted suppliers to stockpile a much bigger supply, but they were reluctant to because of discount cycles,(imagine holding a million litres and the price drops 10c/L) oil price movements and the like. The govt baulked at the cost of underwriting such a risky venture themselves and backed off and left it to the importers. That’s the rub with refining. Apart from needing to build in a risk factor to any perceieved cost/return impact over the long life of the plant, you have to deal with the vagaries of oil price and discounting, etc. Given all this and the recent memory of low refining margins, is it any wonder refiners are extremely cautious, ‘just in time’ types nowadays. Govts and taxpayers enter that world at their peril. Better to invest some Future Funds in refiners and oil Cos instead, on behalf of taxpayers.

  14. observa says:

    Cam,
    The Kyoto thing is probably very pertinent in concert with refiners having recent experience of uneconomic refining margins(which implied too much supply capacity) It heightens their sensitivity to risk and they’re not going to invest in new refining capacity until it’s absolutely bleeding obvious they should.(sustained fat profits) Only those with very deep pockets and intimate knowledge of the market are going to do that, hence the lack of new chums. It’s very much like the recent oversupply of world shipping, which has largely been ameliorated only recently by a booming world economy and shipping co amalgamations. They’d only be starting to dust off plans for new ships again, now that shipping rates have returned to healthy(profitable) levels again.

  15. JC says:

    New York Times Today:

    In his State of the Union address in January, President Bush called for a sharp increase in the use of biofuels, along with some improvement in automobile fuel efficiency to reduce Americas use of gasoline by 20 percent within 10 years. Congress is considering legislation calling for a nearly fivefold increase in the use of ethanol.

    That has forced many oil companies to reconsider or scale back their plans for constructing new refinery capacity.

    In hearings before Congress last year, oil executives outlined plans to increase fuel production by expanding existing refineries. Those plans would add capacity of 1.6 million to 1.8 million barrels a day over the next five years, for an increase of 10 percent, according to the National Petrochemical and Refiners Association.

    But those plans have since been scaled back to more than one million barrels a day, according to the Energy Information Administration, an arm of the federal government.

    If the national policy of the country is to push for dramatic increases in the biofuels industry, this is a disincentive for those making investment decisions on expanding capacity in oil products and refining, said John D. Hofmeister, the president of the Shell Oil Company. Industrywide, this will have an impact.

    The concerns were echoed in a recent report by Barclays Capital, which said the uncertainty about the ethanol growth will do little to accelerate desperately needed investment in complex United States refining units.

    http://www.nytimes.com/2007/05/24/business/24refinery.html?hp=&pagewanted=print
    ———————

    The point being there is no regulatory certainty over the issue of bio at present.

  16. observa says:

    Yes JC I’m constantly amazed at how consumers, politicians, public servants and motoring organisation officials who are all such deft experts at using discount shopper dockets and playing the discount cycle so well with servos, cannot appreciate why refiners dealing with millions of litres of the stuff act in such funny ways too. The former play games over 50 or 60 litres of the stuff at a time and yet understand their own behaviour implicitly.

  17. derrida derider says:

    Why haven’t there been new entrants? Simple – a new refinery built by a new operator would undoubtedly attract predatory pricing from the existing firms (which have very, very deep pockets and so can easily outlast a new firm). The economics of refinery operation are such that you really must keep it going at full capacity to make a quid (that’s what drives all that very-short-term volatility in petrol prices at the pump in Oz), so it’s an industry where these tactics are very effective.

    Think of the fate of Compass Airlines.

  18. Christopher says:

    Geoff Styles (Energy Outlook blog – http://energyoutlook.blogspot.com/)- has a take on this: they’re at the end of a cycle where high environmental requirements led to limited investment over the past decade.

    And Menzie Chinn over at Econbrowser had a more data driven look at this yesterday (http://www.econbrowser.com/archives/2007/05/gasoline_prices_3.html)

    Although, in line with what DD says about Australia, there’s ample evidence of non-competitive outcomes in US refinery behavior – I think I’ll go with the ‘lumpy investments takes time’ view here.

    cheers,
    Christopher

  19. JC says:

    DD

    However I couldn’t think of one new entrant to the market that isn’t an established player. So the idea that they will pecked to death by he bigger palyers won’t stand up to real scrutiny. They already are the big players.

    There aren’t any new players around, just the same set of guys waiting around to see what the new plants will look like after the poliicians decide on the new regualatory rules. At 5 bill a pop it’s worth waiting on .. as the NYT piece implies.

  20. MikeM says:

    Remember the California energy crisis of 2001? There’s nothing like some unscheduled maintenance (on top of interruptions from Hurrican Katrina) to boost profitability in a market where there is only a small number of players.

    Why would one of the existing refiners want to spoil it all?

  21. JC says:

    Mike

    That’s the reason the market is so thight at the moment. There have been a few fires at a couple of refineries and some others have been taken down for repairs and maintenance.

Comments are closed.