Building a new refinery

Building a new refinery is tough. Here is a story on an Arizona refinery:

Investors have been working on the project for more than a decade and have already spent an estimated $33 million and countless hours on permit applications and meeting with regulators, citizen groups, financiers and others. In April, they finally reached a milestone, getting an air emissions permit that lets them move forward.

Still, there's plenty to do, including raising most of the $2.6 billion needed to build the refinery and adjoining pipelines and completing negotiations with the Mexican government for crude oil. Even then, construction isn't expected to start until late next year, with completion in 2010.

Why aren't there more refineries?

It might have something to do with the inelastic demand for gasoline -- when prices go up or down, the amount that people consume (i.e., quantity demanded) doesn't change by very much. Goods that are a bit addictive or habit forming like cigarettes, alcohol and, yes, gasoline, tend to have inelastic demands. From the story:

Tyson Slocum, a research director at the watchdog group Public Citizen, said oil companies could have added or expanded refineries at any time in the past three decades if they wanted to. But "they had no financial incentive to create surplus capacity," Slocum said. By adding more refining capacity, oil companies would increase supply and decrease prices -- and in turn, their profits, he said.

With inelastic demand, price decreases lead to smaller increases in consumption. The decrease in revenue due to the falling price outweigh's the increase in revenue due to increased consumption. I don't have any numbers to back up the assertion above, who's to say why there have been no new refineries (has any economic research been conducted on this one?), but it is not all due to the constraint of air quality regulations (which, don't forget, has its own benefits).

Comments

[gmoke]

from http://www.consumerwatchdog.org/energy/pr/?postId=5110&pageTitle=Internal+Memos+Show+Oil+Companies+Intentionally+Limited+Refining+Capacity+To+Drive+Up+Gasoline+Prices

NEWS RELEASE
September 7, 2005

CONTACT: Jamie Court (310) 392-0522 ext 327 or Tim Hamilton (360) 495-4941

Internal Memos Show Oil Companies Intentionally Limited Refining Capacity To Drive Up Gasoline Prices

Santa Monica, CA -- The Foundation for Taxpayer and Consumer Rights (FTCR) today exposed internal oil company memos that show how the industry intentionally reduced domestic refining capacity to drive up profits. The exposure comes in the wake of Hurricane Katrina as the oil industry blames environmental regulation for limiting number of U.S. refineries.

The three internal memos from Mobil, Chevron, and Texaco ( Click here to read the memos. ) show different ways the oil giants closed down refining capacity and drove independent refiners out of business. The confidential memos demonstrate a nationwide effort by American Petroleum Institute, the lobbying and research arm of the oil industry, to encourage the major refiners to close their refineries in the mid-1990s in order to raise the price at the pump.

"Large oil companies have for a decade artificially shorted the gasoline market to drive up prices," said FTCR president Jamie Court, who successfully fought" to keep Shell Oil from needlessly closing its Bakersfield, California refinery this year. Oil companies know they can make more money by making less gasoline. Katrina should be a wakeup call to America that the refiners profit widely when they keep the system running on empty."

"It's now obvious to most Americans that we have a refinery shortage," said petroleum consultant Tim Hamilton, who authored a recent report about oil company price gouging for FTCR. ( Click here to read the report. ) "To point to the environmental laws as the cause simply misses the fact that it was the major oil companies, not the environmental groups, that used the regulatory process to create artificial shortages and limit competition."

The memos from Mobil, Chevron and Texaco show the following:

* An internal 1996 memorandum from Mobil demonstrates the oil company's successful strategies to keep smaller refiner Powerine from reopening its California refinery. The document makes it clear that much of the hardships created by California's regulations governing refineries came at the urging of the major oil companies and not the environmental organizations blamed by the industry. The other alternative plan discussed in the event Powerine did open the refinery was "... buying all their avails and marketing it ourselves" to insure the lower price fuel didn't get into the market. Click here to read the Mobil memo.

* An internal Chevron memo states; "A senior energy analyst at the recent API convention warned that if the US petroleum industry doesn't reduce its refining capacity it will never see any substantial increase in refinery margins." It then discussed how major refiners were closing down their refineries. Click here to read the Chevron memo.

* The Texaco memo disclosed how the industry believed in the mid-1990s that "the most critical factor facing the refining industry on the West Coast is the surplus of refining capacity, and the surplus gasoline production capacity. (The same situation exists for the entire U.S. refining industry.) Supply significantly exceeds demand year-round. This results in very poor refinery margins and very poor refinery financial results. Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline. One example of a significant event would be the elimination of mandates for oxygenate addition to gasoline. Given a choice, oxygenate usage would go down, and gasoline supplies would go down accordingly. (Much effort is being exerted to see this happen in the Pacific Northwest.)" As a result of such pressure, Washington State eliminated the ethanol mandate -- requiring greater quantities of refined supply to fill the gasoline volume occupied by ethanol. Click here to read the Texaco memo.

FTCR is nonprofit, nonpartisan consumer group. For more information visit: http://www.consumerwatchdog.org

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[joshua corning]

"Goods that are a bit addictive or habit forming like cigarettes, alcohol and, yes, gasoline, tend to have inelastic demands."

On a side note these are also goods that are heavily regulated both in thier production and sales.

[joshua corning]

"Goods that are a bit addictive or habit forming like cigarettes, alcohol and, yes, gasoline, tend to have inelastic demands."

wait a second "alcohol"?? I am afraid that the market for alcohol is highly competetive...this implys that your premise that inelastic goods cannot be competetive is incorrect....of course it also implys that my premise that highly regulated good cannot be competetive is inncorect. :P

[joshua corning]

"Significant events need to occur to assist in reducing supplies and/or increasing the demand for gasoline."

replace diamonds for oil and it could be a deberes memo...of course this implys that like the diamond industry the oil industry is trying to make a common limitless comodity appeer scarce....so much for the myth of peak oil :)

[John Whitehead]

Joshua,

Inelastic demand is a function of consumer preferences, not the competitiveness of the market. The amount of competition has implications for the supply side of the market.

John

[joshua corning]

so beer wine and vodca can compete becouse they can have actual differance and compete for the consumer...but oil can't becouse the product is the same no matter who you buy it from...is that what you are saying?

[John Whitehead]

Retail gasoline stores compete with both price and non-price characteristics (products available in the mini-mart, etc). Different brands of alcohol compete on quality, etc. Everybody competes in one way or another.

[joshua corning]

So what is keeping refinaries from being built if it is not lack of competition and not over regualation?

[John Whitehead]

My guess is that the price of oil/gas has been so low that there has been little incentive to expand capacity. That is no longer the case.