The Hazards Of Hitting The Gas

Two quick ways to reduce prices at the pump: lower the cost of oil and make more gasoline. By themselves, refiners can't do much about the first one. As for the second option, they're also constrained. There's just not enough refining capacity in the country. In June, U.S. refineries were cranked up to 93% of capacity to gear up for the summer peak in gas demand. Meanwhile, they've reported round after round of eye-popping profits because the bottleneck gives them such enviable pricing power.

While consumers fret over a capacity shortage, before long the industry could be staring down just the opposite scenario: overcapacity. Since 1990 incremental additions have nudged refining capacity from 15.5 million barrels per day to today's 17 million. But over the next five years, refiners have plans to spend billions of dollars to add another 10% to their capacity. That's about double the expected increase of 5% in demand for products like gasoline in that same period, figures Aileen Jamieson, a Wood Mackenzie Ltd. consultant. All of the announced projects would easily cost more than $20 billion; ConocoPhillips (COP ), the second-largest refiner in the U.S, alone will shell out $5 billion by 2011 to increase output up to 15% at some plants.

The building boom isn't confined to the U.S. Saudi Arabia and Venezuela are among international players that are planning big-scale refineries capable of making products to sell here. Already the U.S. imports about 10% of its gasoline. That figure shot up more than 18% in the first half of this year because of strong demand and limitations on output from damage done by Hurricanes Rita and Katrina.

For the moment industry executives aren't sounding the alarms, at least publicly. Valero Energy (VLO ) Executive Vice-President Rich Marcogliese points out that historically not all announcements lead to actual construction. He expects some of the current industry exuberance to wane. In fact, Tesoro (TSO ) just announced big cost overruns in its expansion program, and canceled a $250 million addition to its refinery in Anacortes, Wash.

But there are still more signs of frothiness than caution in the industry. According to Wall Street sources, half-a-dozen bidders, including Conoco and Petrobras (PZE ), are competing to buy a large refinery near Houston, jointly owned by Lyondell Chemical (LYO ) and Citgo. The deal could fetch $5 billion, which translates to $20,000 per barrel of capacity, double the rate a couple of years ago. The refining industry saw miserable years in the 1990s, when excess capacity led to razor-thin margins and dozens of refinery closings. But it appears that memories are getting short.

By Mark Morrison

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