Oil refineries at capacity, but low margins make new ones unlikely Fuel costs to keep rising

Ian McKinnon Financial Post, with files from Reuters Building an oil refinery can cost a prohibitive $1-billion, and many Canadian refineries have shut down in the last decade.

CALGARY - Tight supplies for fuel oil, diesel and jet fuel are being exacerbated by a shortage of excess refinery capacity, a situation observers expect to translate into even higher fuel costs for consumers.

The Calgary-based Canadian Energy Research Institute said the world is awash in crude, but Canadian refiners can't crank up production of middle distillates, which include diesel and heating oil, to take advantage of the supply imbalance south of the border.

In the last decade, just as a growing population, increased driving habits and larger vehicles have steadily pushed up fuel demand, numerous Canadian refineries have shut down.

With a new refinery costing at least $1-billion, it is unlikely large petroleum firms like Imperial Oil Ltd., Husky Energy Inc., Petro-Canada, Shell Canada Ltd. and Suncor Energy Inc. will ramp up production.

"The historical margins at the refineries have been bad. It's well-known that the downstream [refining] sector have had returns on capital that really would not justify them staying in business," said Michael Ervin, president of MJ Ervin & Associates in Calgary.

Besides the enormous capital cost, the economics of building new plants are hostage to a volatile commodity cycle that can viciously hammer profits. Petro-Canada, for example, had a negative return of 23% on capital employed in 1991, when the Persian Gulf War caused prices to fluctuate wildly. Only in 1997, when oil prices crashed, has Petro-Canada earned more than 10% from its refining operations in the past decade.

"There is a general belief that we're making piles of money, but the downstream business in particular is a very low-margin business," said Donna Hildebrant, a company spokeswoman. "You don't invest a billion dollars to have a profit ride from zero to 5%."

Bill Simpkins, a vice-president with the Canadian Petroleum Products Institute in Ottawa, said maximizing production at existing plants is the priority for refiners, not building new facilities.

"The returns have been very low and there is not a lot of incentive to build new facilities, but there is a lot of incentive to debottleneck, improve and become more efficient," he said.

The high cost of environmental compliance is another reason for the dearth of new refineries. Ms. Hildebrant said Petro-Canada expects to spend between $250-million and $300-million in the next few years to meet stringent sulphur content rules for gasoline.

Fuel prices soared to decade highs earlier this month of US$37.50, before the release of 30 million barrels of oil from the U.S. government's reserves last week sent them back to just under US$31.50 per barrel.

But Judith Dwarkin, vice-president of global energy for the Canadian Energy Research Institute, says consumers should take little comfort from the respite. The energy think-tank is predicting crude could soaring past US$40 per barrel by early November.

"It's not going to be a long-lived thing, it's going to be a spike," Ms. Dwarkin said. "We don't see the stocks of middle distillates moving much and that's going to restore that jitteriness to the market. The refineries are operating at capacity and they can't add to the stocks, in fact stocks went down last week by a million barrels instead of up."

Heating oil rose 2% to US94.8" per gallon in New York yesterday after a report showed supplies were 36% below last year's level. Prices are up 53% from the same period in 1999.

The U.S. government is appealing to its refineries to delay maintenance they typically do in the fall during the lull between the summer driving season and the winter heating season. That shutdown would cut American refinery production by half for about a month. Instead, the government yesterday asked the refineries to concentrate on building up inventories of heating oil.

Ms. Dwarkin said some firms have already put off maintenance programs because of strong gasoline markets during the summer and may not be able to wait any longer, prolonging the squeeze on supply.

Iraq's Saddam Hussein could also increase the volatility by withholding Iraq's production in protest against 10 years of sanctions by the United Nations and to put pressure on the Nov. 7 U.S. presidential vote, Ms. Dwarkin said.

"The very fact that we increase the demand on whatever spare infrastructure that there is out there raises the price. It's certainly becoming a seller's market," said Mr. Ervin. "I think we're going to see an increase in refiner margins if we continue to see demand increase."

http://www.nationalpost.com/home/story.html?f=/stories/20000928/411902.html

-- Martin Thompson (mthom1927@aol.com), September 28, 2000

Answers

Good snapshot of what's going on in Canada. I had been wondering about that.

-- RogerT (rogerT@c-zone.net), September 28, 2000.