The decision to invest in oil refining is a complex one, with many
factors to consider. Government regulation, input prices, and output
prices all have a role to play in a long-term decision to invest in an
increase in capacity.
In the United States especially, government regulation has played a
huge role in the profitability of oil refining. Many regulations have
been introduced to improve air quality and prevent groundwater
pollution that have increased refining costs. A large number of
reformulated gasoline blends are required in many parts of the nation,
which even vary over the course of the year based on seasonal changes.
Environmental regulations and "not in my backyard" sentiments have
also made it extremely difficult to invest in additional refining
capacity in the United States. In fact, no new refineries have been
built since 1976.
Recently, however, governments have shown considerable increased
interest in promoting the development of new refineries. For example,
the United States Congress is considering legislation to reduce the
burden of environment regulations and to compensate oil companies for
delays resulting from unforeseen litigation and delays caused by
government authorities. Tax incentives relating to depreciation have
also been included in the Energy Bill.
Input prices and availability play an important role because they
contribute significantly to the operating costs of a refinery. High
quality crude oil is increasingly harder to find. Middle Eastern
refineries tend to have already refined oil once in less sophisticated
refineries, leaving residual oil for many US refineries. This is a
much more difficult oil to process because it contains significant
amounts of sulfur and heavy metals, and it must be heated in order to
even get it to flow into the refinery. These characteristics increase
Output prices are also extremely important because they determine the
refinery's revenue. As demand has increased for refined products,
prices have risen, improving refinery margins. However, this has not
always been the case. A global excess of refining capacity resulted
in many refineries being shut down. Many refineries in United States
were shut down in the early 1980s because they were unprofitable, and
a second wave followed in the late 1980s and 1990s because of
continued poor profitability resulting from low gasoline prices. Oil
and gas production has historically been far more profitable than
refining and marketing, leading to a lack of interest in investing in
new oil refining capacity.
Given the considerable increase in refining margins in recent years,
interest in investing in oil refining is increasing. Refinery
utilization rates have increased significantly in recent years,
increasing the risk of supply disruptions and keeping prices for
refined products high. Several existing refineries are planning
significant expansions in the United States, and nontraditional
players, such as Virgin's Richard Branson, are considering entering
the market. Branson believes the world needs as many as 20 new oil
refineries, which would indicate considerable room for expansion by
many players before margins would be adversely affected.
When considering invest in oil refining, one must examine future
demand, the availability and price of inputs, competitor activities,
and future potential government regulations. Because an oil refinery
is a long-term investment (typically requiring several years from the
preparation of engineering drawings to the start of operation, not to
mention a multi-decade operating life), an investment climate that
looks to be attractive for many years is critical. Global demand
forecasts from the International Energy Agency suggest that as many as
30-40 world scale refineries may be needed just by 2010 to prevent
considerable significant increases in prices of refined products.
50-70 world scale refineries would be needed to return refining
margins to their historically lower levels. This suggests there is
considerable room for error before excessive refinery investment would
occur globally, making such an investment more attractive.
Reductions in sulfur appeared to be a major regulatory theme
worldwide. In order to achieve this, demand for sweet crude oil will
rise. Since Asian and European refineries have made less of an
investment in sour crude refining capability than those in the United
States, sweet crude will become even less available in the United
States and even more expensive. A shortage of sweet crude and/or a
second rise in its price may make some marginal refineries in capable
of producing low sulfur gasoline and diesel fuel, resulting in a
further decline in global refining capacity.
Projected growth in China and India's demand for energy products plays
a huge role in estimates of future demand. If the Goldman Sachs
projections for Indians owning 610 million automobiles, Chinese 514
million automobiles, and Americans 233 million automobiles by 2050
holds up, there will obviously be enormous demand for gasoline and
diesel fuels. Clearly, many more refineries would be required to
supply distillates to the world's drivers.
It is always possible that the marketplace will overreact and too many
refineries will be built or that a global economic slowdown will cause
the growth projections to not pan out. Some speculations that global
oil production may be at or near its peak may also create insufficient
supplies of reasonably priced oil to allow a dramatic increase in the
number of refineries. However, that could make existing refineries
more valuable. Investors considering an investment in oil refining
must incorporate data from many sources to formulate their own
forecasts of how supply and demand will interact with one another,
along with the number of refineries, to determine refining margins.
Many governments and private institutions make all kinds of
energy-related forecasts that can be of considerable use, such as
those available in the sources below. I have collected several
resources you should find helpful in understanding the economics of
oil refining and how they may develop in the future.
"Cars, Cars, and Cars" by I.R.Sharma, Indra's Drishtikona (Viewpoint)
(October 23, 2004) http://www.drishtikona.com/archives/manufacturing/000562.php
"ICF Consulting Warns That Refinery Capacity Investment is Lagging
Global Demand Growth" ICF Consulting (August 4, 2005)
"The Emerging Oil Refinery Capacity Crunch" ICF Consulting (Summer
"Crude Economics" by Tom Bearden, PBS (December 12, 2000)
"Gasoline" ConocoPhilips (December 1, 2005)
"Refining" Energy Information Administration
"Refinery Bottleneck to Ease" by Ron Scherer, The Christian Science
Monitor (November 23, 2005)
"Richard Branson, Oil Tycoon?" BusinessWeek (September 20, 2005)
Matthew Simmons is a well-known advocate of global oil production
having reached its peak and is skeptical about future Saudi Arabian
increases in oil production. His recent papers and speeches are
from the Simmons & Co. International web site
Clarification of Answer by
09 Dec 2005 10:09 PST
Some changes to taxation of depreciation are currently available, and
some have been proposed.
What is currently available was passed in the recent Energy Bill:
"Expensing for refinery investments. Allows taxpayers to expense (depreciate
immediately) 50 percent of the cost of refinery investments which
increase the capacity of an existing refinery by at least 5 percent or
increase the throughput of qualified fuels by at least 25 percent.
Qualified fuels include oil from shale and tar sands. As a condition
of eligibility, refineries of liquid fuels must report to the IRS on
refinery operations (e.g., production and output). Cost: $406 million
Determination of small refiner exception to oil depletion deduction.
Presently, a producer may qualify as an independent producer for this
purpose if its refining operations, runs, do not exceed 50,000 barrels
on any day in the taxable year during which independent producer
status is claimed. The provision increases the current
50,000-barrel-per-day limitation to 75,000. It also changes the
refinery limitation on actual daily production to an average daily
production for the taxable year. Cost: $158 million"
"Overview of the Energy Tax Incentives Act of 2005" United States
Senate Committee on Finance
Several other pieces of legislation have been proposed that could
affect oil refinery economics, but not yet passed into law. They
include acclerated depreciation provisions, simplification of the
number of gasoline and diesel blends required in the US, and
facilitation of permitting for new construction. Links to the text of
the legislation is provided by the sources below:
"On September 28, Congressman Todd Tiahrt (R-KS) announced two bills
related to the refining industry; H.R. 3923, the Refinery Streamlined
Permitting Act of 2005, and H.R. 3924, the Refinery Expansion Act of
2005. The bills streamline the permitting process and provide tax
incentives for refineries to increase their capacity.
The text of both pieces of legislation is now available.
H.R. 3923, the Refinery Streamlined Permitting Act of 2005 H.R. 3924,
the Refinery Expansion Act of 2005
Senator Orin Hatch (R-UT) has introduced S. 1781, which would amend
the Energy Policy Act to allow for 100% expensing of certain refinery
capacity additions, and would change the depreciation schedule for
refining properties to five years."
"In the Senate, on October 7 Senator Richard Burr (R-NC) and three
co-sponsors including Senator George Allen from VA, introduced S.
1859, the ?Affordable and Reliable Gas Act of 2005.? It would limit
the number of gasoline and diesel fuel formulations to a total of
five; one on-road diesel and four gasoline blends."
"In the Senate, S. 1772, the Gas Petroleum Refiner Improvement and
Community Empowerment Act, was introduced by Chairman of the Senate
Committee on the Environment and Public Works James Inhofe (R-OK).
Among other things the bill would ease federal permit restrictions."
"Energy Policy" NPRA http://www.npra.org/issues/energy.cfm
Title: To expedite the construction of new refining capacity in the
United States, to provide reliable and affordable energy for the
American people, and for other purposes."
"H.R.3893" The Library of Congress (2005)
Additional material on US energy usage and the development of US
energy policy can be found here: "U.S. Energy Policy" solcomhouse