(Steve Ueckert Chronicle file: Work will continue on the expansion of the Motiva refinery in Port Arthur, despite uncertainty throughout the industry.)

Refiners slowing momentum

Dwindling demand may put some projects on back burner

By BRETT CLANTON Copyright 2008 Houston Chronicle

Nov. 15, 2008, 12:45AM

A recent pullback in plans to expand or upgrade U.S. oil refineries may herald a more cautious era for refining companies, now facing uncertainty on many fronts after enjoying high profits for several years.

The uncertainty stems from volatility in commodity and capital markets, as well as from a historic decline in gasoline usage this year that has raised doubts about long-term demand for petroleum-based fuels.

Marathon Oil Corp. and Valero Energy Corp. said late last month they would delay or cancel refinery upgrades as part of broader cuts to capital spending programs in 2009. And given current economic difficulties, experts warn other projects could follow.

“I think it’s a trend you’re going to see until at least 2009, and it will continue beyond then if refining margins don’t improve,” said Brian Youngberg, an energy analyst with Edward Jones in St. Louis.

The gross refining margin is the difference between what a refiner pays for a barrel of crude and what it gets for the products made from it. As recently as summer of 2007, margins were near $30 per barrel. This summer, that fell by half as oil prices skyrocketed and demand weakened.

A refining slowdown in the short term mostly would affect the industry and its employees, but a prolonged reversal could send prices at the pump up again after a significant recent drop. Oil companies and the Bush administration had promised that refinery additions would help unburden a strained refining system and ease gasoline prices. Without them, pump prices could remain under pressure.

Yet several major refinery projects are moving forward and are unlikely to be affected by the downturn. They include Marathon’s 180,000- barrel-per-day expansion of its Garyville, La., plant, targeted for completion late next year, and Motiva’s 325,000- barrel-per-day addition to its Port Arthur refinery, wrapping up in 2011.

The latter project is moving full steam ahead, said Bob Pease, chief executive of Motiva, a joint venture of Shell Oil and Saudi Arabia’s state-owned oil company.

“It’s a long-term investment designed to add significant supplies of Shell-branded products for our customers well into the future,” he said.

Projects in earlier stages of development or still awaiting final investment decisions may be at more risk.

In recent years, refiners announced aggressive plans to expand and upgrade refineries as profits rose and global demand for petroleum products such as gasoline and diesel fuel grew more quickly than the capacity to produce them.

In the U.S., refineries had been running near capacity, particularly during peak summer demand periods, so additions were viewed as safe, despite the huge investment required.

Shifting gasoline picture

But the gasoline market has weakened recently because of increasing supplies and shrinking demand.

On the supply side, increased blending of ethanol with gasoline means a gallon of gas stretches to more than a gallon of motor fuel. And more imported gasoline is available because Europeans are switching to diesel vehicles. Finally, refinery upgrades boost the amount of gasoline that can be squeezed from a barrel of crude.

Meanwhile, gasoline demand has dropped 3 percent amid a slowing economy and $4 gasoline prices this summer. If the trend holds, it would be the first time in more than a decade that demand has not increased over the previous year.

“We’ve gone from basically a refining shortage a couple of years ago to being at a glut now,” Youngberg said.

Case for more capacity

Declining demand has been a major factor in refiner decisions to delay or cancel projects, said Cindy Schild, refining issues manager at the American Petroleum Institute in Washington.

But she said there is still a case to be made for more refining capacity. One reason is greater flexibility to supply the nation’s fuel needs because the U.S. now imports more crude than it has refining capacity, she said.

Today, U.S. refining capacity stands at about 17.8 million barrels per day over 150 refineries, more than half of which are on the Gulf Coast. The U.S. consumes 20 million barrels per day of crude oil.

Expansion projects in the pipeline today will add about 900,000 barrels a day of crude distillation capacity by 2014, said Joanne Shore, analyst with the U.S. Energy Information Administration.

That’s roughly in line with the pace of additions over the past decade, but lower than the 1.5 million barrels per day or more refiners had planned to add a couple of years ago, she said.

If all projects on the books now are completed, the U.S. will no longer need to add more refining capacity, the Energy Information Administration recently forecast.

“You basically are going to have enough capacity at that point,” Shore said.

Accelerating slowdown

The number of refinery projects started slipping before the current economic downturn, partly because of rising labor and material costs, but has accelerated recently and could fall further still, she said.

Last month, Houston’s Marathon Oil said it would delay a $1.9 billion upgrade of its 100,000-barrel-per-day refinery in Detroit.

San Antonio-based Valero, the nation’s largest refiner, said it would indefinitely postpone or delay expansions and upgrades at plants in Port Arthur, Memphis, Tenn., St. Charles, La., and Quebec.

In a conference call with financial analysts to discuss Valero’s third-quarter financial results, CEO Bill Klesse urged competitors to follow Valero’s lead because of low refining margins.

“The industry must cut back,” he said.

The downturn has not been limited to the U.S.

Last week, Houston-based ConocoPhillips and the state-run Saudi Arabian Oil Co. said they would delay plans to build a 400,000-barrel-per day refinery in Yanbu, Saudi Arabia, citing uncertainties in the financial and contracting markets.

It may not be the last, said Pierce Riemer, director general of the World Petroleum Council in London.

If the world tips into recession, he said, “I think there will be many projects that will be put on hold.”

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