The Ripple Effect Of Refinery Fires
Production Breakdowns Push Gas Costs Higher Across Industry

By Steven Mufson
Washington Post Staff Writer
Friday, June 22, 2007

In February, fire broke out at a 74-year-old oil refinery in the heart of the Texas Panhandle.

At about 2 o'clock on a Friday afternoon, liquid propane escaped from storage tanks, formed a vapor cloud and ignited. Within minutes, buttresses that held pipes 25 to 30 feet above the ground collapsed, spilling more fuel on the fire. Three 1-ton cylinders of toxic chlorine gas were damaged. A dozen people were injured, one critically.

The accident also put a dent in the nation's gasoline supplies. It was the fourth fire at a Valero Energy oil refinery this year and one of a dozen to have hit U.S. refineries since Jan. 1.

The rash of fires and other breakdowns, known euphemistically in the industry as "unplanned outages," helps explain why motor-fuel prices have soared 36 percent this year. With the U.S. oil refinery industry already stretched thin, breakdowns and maintenance shutdowns have drained gasoline inventories just when the nation's refiners would usually be ramping up for the summer driving season.

"When these facilities have one of these catastrophic events, it can have a disproportionate effect on the gasoline market," said Carolyn W. Merritt, chairman of the Chemical Safety and Hazard Investigation Board. Lynn Westfall, chief economist and vice president for strategic planning for Tesoro, an independent refiner, said that because "we're operating on such a razor-thin margin, we're always one refinery incident away from a spike in prices."

The amount that consumers paid to refine a gallon of gas more than tripled between January and May, according to the Energy Information Administration. In the past couple of weeks, a wave of gasoline imports has boosted inventories and eased prices slightly, putting the national average at about $3 a gallon. Yet gasoline inventories are still 10.6 million barrels, or 5 percent, below comparable levels a year ago, said Eitan Bernstein, oil analyst with Friedman, Billings, Ramsey Group.

Bernstein said "inventories will remain low throughout the summer, supporting the current high refining margin environment with any unexpected supply disruptions producing price spikes," Bernstein said.

Peter K. Ashton, president of Innovation & Information Consultants, which specializes in analyzing the petroleum industry, said inventories are near the minimum level for smooth operation of the entire distribution system. "The system itself is moving closer and closer to the breaking point, such that any little hiccup in terms of a supply curtailment, even one that lasts only a couple of days, can cause precipitous price spikes," Ashton said. "This was not the case prior to the year 2000, when the companies carried larger inventories."

With gas hovering at about $3 per gallon and with refining profits at record levels, consumers and lawmakers are asking whether the oil industry has conspired to fix prices.

"On the surface, it seems that Big Oil is pumping cash rather than petrol," Sen. Charles E. Schumer (D-N.Y.), chairman of the Joint Economic Committee, said at a recent hearing on whether to break up the major oil companies. He said that in 1993, the five largest oil refiners controlled a third of the U.S. market; by 2005, they controlled 55 percent, and the 10 largest held more than 80 percent. And he questioned why the major oil companies were buying back shares instead of investing more in refinery additions or maintenance.

"I don't understand how an industry that makes tens of billions per year can still have rusty refining plants that constantly break down," Schumer said. "And I don't know any other industry where an equipment breakdown in one company benefits every other company by raising prices."

Profits are certainly soaring, not only for exploration and production firms that benefit from high crude oil prices but also in the refining business, where the crude is turned into such products as gasoline, heating oil and naphtha. Bernstein estimates that profit margins for refining hit $28.75 a barrel at the end of May, far beyond traditional levels.

The oil industry says it's not to blame for high prices. "I would beg to differ about whether it is a question of industry competition instead of a factor of supply and demand," said David Sexton, head of U.S. oil products for Shell Oil.

Rex W. Tillerson, chief executive of Exxon Mobil, blames rising prices on consumers, who are using about 1.5 percent more gasoline this year than last despite the high prices. "The industry is producing record volumes of gasoline today, but the consumer is burning record volumes of gasoline today," he said at Exxon's recent annual meeting.

Valero disputes the assertion that it would intentionally shut down refineries to boost prices. "In high-margin environments, we'd much rather have our refineries running at full capacity," said Bill Day, a Valero spokesman.

The criticism over refining profits strikes many veteran oil executives as an odd twist of fortune. For decades, refining was the dregs of the oil business. The major oil companies were integrated from the oil well to the automobile gasoline tank, and the refineries in the middle of that chain were valued mainly as a means for moving as much oil as possible. Fadel Gheit, oil analyst at Oppenheimer & Co., says it was like an amusement park owner who gave people free transportation to the park.

In the 1980s, refineries operated at 78 percent of capacity, on average. Profit margins were small and competition was stiff. Unions were strong, and small, independent refiners ran tiny units known as "tea kettles" to take advantage of regulations favoring them.

However, acceptance of that changed. Business consultants and academics taught executives to treat every part of the business as a profit center. Investments in refining slowed. In 1983, Mobil did a study about the feasibility of selling its entire refining business.

"The industry was not going to throw good money after bad," said Gheit, who worked at Mobil. "They never earned decent returns. Capital goes where it's treated best."

Companies also trimmed inventories, thus saving by not tying up the money it takes to buy extra oil, while consumption grew. Gasoline stocks are now enough to cover 21.1 days of typical consumption; in the early 1980s they were enough to cover about 40 days. (The Strategic Petroleum Reserve holds only crude oil, which does not alleviate the refining crunch.) The industry complains that the Clean Air Act and other environmental regulations have forced refiners to spend on expensive upgrades to slash sulfur dioxide and nitrogen oxide emissions. The American Petroleum Institute said environmental upgrades cost billions of dollars. Refinery expansions lagged. With an end to oil price controls that had helped small, inefficient refineries, many of the tea kettles closed down.

Though a new refinery has not been built for 30 years, capacity expansions at existing refineries have amounted to the equivalent of 10 new refineries over the past 10 years, according to API. But capital investments in refineries are expected to total 6 percent of the investments in U.S. exploration in 2007, according to the Oil & Gas Journal. And several refinery expansion projects have been shelved recently because of rising costs.

Now U.S. refineries routinely operate at more than 90 percent of capacity and still cannot satisfy the needs of American motorists. The United States imports 13 percent of its gasoline supply from 43 countries, said Westfall, the Tesoro executive. The stepped-up use rates help explain this year's breakdowns and long maintenance shutdowns, oil analysts said. The breakdowns result from pushing refineries too hard, some industry executives say. After hurricanes damaged some refineries in late 2005, that meant other refineries had to work extra hard.

That also led to longer maintenance shutdowns, Westfall said. Gheit adds that the explosion at BP's Texas City, Tex., refinery, which killed 15 people in March 2005, also lengthened maintenance times because all companies wanted to be more careful. "It is like slowing down on the highway after seeing an accident," Gheit said. "It is taking longer for refineries to come back from typical regular maintenance because the accident with BP put everyone on guard."

A shortage of skilled workers is another factor. A report from the Chemical Safety and Hazard Investigation Board on BP's 2005 explosion showed that the refinery's staff was overworked and undertrained. Valero's chairman has complained to analysts that he was having trouble hiring good engineers. He was not only competing with lucrative jobs in places like Saudi Arabia; nowadays, engineers can earn about $300,000 on tar sands projects in Canada, where as Gheit says, people speak English, can buy a beer and watch football on television.

Now, oil companies say they are hesitant to build more refineries because of potential competition from biofuels, with which President Bush wants to replace 20 percent of the nation's petroleum-based motor fuel. Tillerson said: "When we do the numbers, you don't need another refinery. If these biofuels objectives are to be met, and they're mandated to be met, to build another refinery would be a very risky proposition."

Other energy analysts question the oil companies' reasoning. Tillerson, at the same annual meeting, told shareholders who were pressing him to have Exxon invest in renewable energy resources that the world would be thirsty for oil for as long as he could imagine.