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Squeezed At Both Ends | Oil Watchdog

Squeezed At Both Ends

Wed, May 14, 2008 at 11:24 am

    Squeezed At Both Ends

    Squeezed At Both Ends — Independent Refiners Watch Profits Sink As Consumption Falls

    While drivers are facing sticker shock at the pump these days, here is
    a bigger shock: high prices are putting a strain on oil refiners.

    After last year’s stellar profits, American refiners are going through
    a traumatic period. In a time of record gasoline prices, some of them
    actually lost money in the first quarter, and for virtually all
    refiners, profits are down sharply.

    Experts say the refiners are caught in a double bind. The price of
    their raw material, oil, is rising because of strong global demand. At
    the same time, consumption of gasoline in the United States is falling
    as a result of slower economic growth and consumer efforts to conserve.

    However much the companies would like to raise gasoline prices enough
    to pass along the full increases in oil, analysts say they have been
    unable to do it. Oil prices doubled in the past year, while wholesale
    gasoline prices rose a mere 39 percent.

    “Refiners are having a terrible time,” said Lawrence J. Goldstein, an economist at the Energy Policy Research Foundation.

    For decades, global oil prices were tightly coupled to the ups and
    downs of the American economy. But in recent years, world oil prices
    have been pulled upward by heavy demand for diesel fuel from developing
    countries like China. American economic growth weakened in the last few
    months, but that has mattered little in the upward march of oil prices.

    “What we see at the gasoline pump is increasingly driven by what is
    happening elsewhere in the global economy,” said Daniel Yergin, the
    chairman of Cambridge Energy Research Associates, a consulting firm.

    Gasoline prices rose on Tuesday to a nationwide average of $3.73 a
    gallon, according to AAA, the automobile club. That is yet another
    record. Diesel prices also set a record, at $4.39 a gallon. Crude oil
    futures closed at $125.80 a barrel, up $1.57, or 1.3 percent, on the
    New York Mercantile Exchange.

    In its latest monthly report, the International Energy Agency, an
    adviser to industrialized countries, reduced its forecast for global
    oil demand for this year, as consumption drops by a
    bigger-than-forecast 300,000 barrels a day in the developed world.

    But that decline will be more than offset by growth from developing
    countries. Consequently, global consumption is expected to rise this
    year by 1 million barrels a day, to 86.8 million barrels a day. Nearly
    all that growth will come from China, the Middle East and Russia.

    In the United States, there is no longer much doubt that consumers are
    responding to higher fuel costs by driving less. Oil consumption fell
    by 3.3 percent in March, compared with March of last year.

    But even as gasoline demand softens, the price keeps rising, driven by
    higher oil prices. The cost of oil represents about 75 percent of the
    price of gasoline at the pump, according to the Energy Department;
    state and federal taxes account for 12 percent, and refining and
    distribution make up the rest.

    The rising oil prices have led to a sharp drop in refining profit
    margins, or the difference between the cost of oil and the cost of
    gasoline. These margins, at $12.45 a barrel on average, are 60 percent
    below their year-ago level, and in the lower half of their five-year
    range, according to a report by UBS.

    In response to falling gasoline demand and rising costs, refiners have
    cut their production rates. Refining utilization rates, for example,
    slumped to a low of 81.4 percent in the second week of April, compared
    with 90.4 percent at the same time last year. Earlier this month,
    refineries were running at 85 percent of their capacity.

    All this has translated into a tough quarter for some refiners. While
    large integrated companies, like Exxon Mobil, reported big profits in
    the first quarter thanks to their oil sales, smaller independent
    refiners that buy their oil, instead of producing it themselves, have
    been losing money.

    Tesoro, Sunoco, and United Refining all posted losses in the first
    quarter. The hardest hit have been small refineries that tend to
    process the most expensive types of crude oil into gasoline. Sunoco,
    for example, lost $123 million in the first quarter, while Tesoro
    posted a $82 million loss for that period, in contrast to a profit of
    $116 million last year.

    “We’re just not able to pass along the increased cost of crude oil on
    the gasoline side,” said Lynn Westfall, the chief economist at Tesoro.

    At Valero, the nation’s largest independent refiner, first-quarter
    profit melted by 76 percent. Its refining capacity allows it to process
    heavier grades of crude oil that typically trade at a discount. Still,
    its profit dropped to $261 million in the first quarter compared with
    $1.1 billion last year.

    Some consumer advocates say they are deeply suspicious about the
    behavior of refiners who are sharply cutting production at a time of
    record gasoline prices.

    “They are not sitting in a boardroom and colluding, but they can see
    easily enough where their benefit lies, and it doesn’t lie in a price
    war,” said Judy Dugan, the research director at Consumer Watchdog. “In
    a truly competitive market, you might see some of these providers try
    to improve their market share by reducing prices. But this is not
    happening. They are all better off by restricting production to keep
    prices up.”

    Mark Cooper, director of research at the Consumer Federation of
    America, said mergers in the 1990s had cut the number of refiners in
    the country and contributed to reduced competition in the refining

    “We let them accumulate market power through the wave of mergers, and
    we’ve been paying the price in the last five years,” he said. “If there
    is a small number of players in the market, they learn from each
    other’s behavior.”

    The demand for diesel has been one of the main drivers of oil demand in
    recent years. Diesel and other so-called middle distillates are used as
    transportation, power generation and industrial fuels.

    In China, for example, oil imports have surged in recent weeks, a
    signal that the government is stockpiling oil and diesel in
    anticipation of the Olympic Games. Beijing, the International Energy
    Agency report said, is seeking to avoid a repeat of the embarrassing
    fuel shortages and power disruptions that plagued the country last

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