Oil Watchdog

Soaring gasoline prices this spring and summer may have pinched
drivers, but they helped U.S. oil refiners rack up huge quarterly
profits and extend a hot earnings run that began several years ago.

Refining profits for 22 of the largest energy companies jumped
more than 20 percent to $11.8 billion in the April-to-June period this
year compared with 2006, according to the U.S. Energy Department’s
Energy Information Administration.

That’s nearly double their second-quarter profits three years
ago, and a record since at least the first quarter of 2000, when the
Energy Information Administration began regularly compiling the profit
figures.

Recently, however, a drop in a closely watched indicator of
refiner profitability has spurred questions about how much longer the
industry’s winning streak will last.

The difference between what refiners pay for a barrel of oil
and the selling price of gasoline and other fuels made from it is known
as the gross refining margin. That spread, calculated before taxes and
expenses are subtracted, has narrowed sharply in recent weeks.

After averaging a record $27.65 per barrel in the second
quarter, the margin is about half that level today, said Eitan
Bernstein, industry analyst with Friedman, Billings, Ramsey & Co.
in Arlington, Va.

"The second quarter was great for refining margins," he said. "Third quarter? Not so much."

Refining margins tightened partly because higher crude prices
have made gasoline more expensive to make. Also, many refineries that
were down this spring for unplanned outages have returned to
production. That put more gasoline on the market, reduced the need for
imports and weakened the price that refiners
— and ultimately gas stations — can charge for it.

The average price for gasoline was $2.75 a gallon Monday, down
3.6 cents from a year ago and the lowest since April, the Energy
Department said in a weekly report.

But a separate Energy Department report showing a
sharper-than-expected drop in the nation’s gasoline supplies last week
sent crude and wholesale gas prices up, and may put renewed pressure on
pump prices, the department said.

It’s common for margins to fall this time of year as gasoline demand cools at the end of the busy summer vacation season.

Yet the suddenness of the collapse this year has caught industry
observers by surprise, prompting speculation about what else may be
going on.

Some blame a pullback by financial players in the gasoline
futures market, who were drawn to the industry’s strong run in recent
years but were spooked when margins began to soften. Others suggest the
market is anxious about proposed increases to auto fuel economy rules
and biofuel mandates, both of which could cut into gasoline demand and
make refineries less profitable.

"There’s plenty of room for those who are optimistic and for
those who are pessimistic to have their say," said Fadel Gheit, energy
analyst with Oppenheimer & Co. in New York.

Yet he believes the short-term outlook is strong for refining
profits, noting that despite the recent drop, margins remain more than
20 percent higher than their five-year average.

The earnings and stock prices of refiners have skyrocketed in
the last few years as demand for gasoline and other petroleum products
has grown faster than the industry’s capacity to produce them. This era
of record profits, which follows many lean years for the industry, has
been called the golden age of refining.

In the second quarter, the run continued as refinery outages
and higher-than-usual demand pushed pump prices above $3 a gallon
nationwide.

Chevron earned $1.3 billion in profit from its refining and
marketing operations in the second quarter, a 30 percent improvement
from $998 million last year. Exxon Mobil, Royal Dutch Shell and
ConocoPhillips also saw gains in U.S. refining operations.

Independent refiners — companies that make gasoline and other
products but do not pump oil and natural gas from the ground — fared
well, too.

San Antonio-based Valero Corp., the nation’s largest refiner,
earned a record $2.2 billion in the second quarter, up from $1.9
billion a year ago. Tesoro Corp, also of San Antonio, posted record
quarterly earnings as well. So did Dallas-based Holly Corp. and
Houston’s Frontier Oil Corp.

"It’s our view that the golden age of refining is not over," said Doug Aron, Frontier’s vice president of corporate finance.

But the big profits prompted backlash from consumers and
politicians who charged the industry with manipulating the market for
its own gain.

"These increases have happened quarter after quarter since
Hurricane Katrina, giving U.S. drivers higher-than-hurricane prices
without a natural disaster," said Judy Dugan, research director of
Santa Monica, Calif.-based consumer group Oilwatch.org, in a report
last month.

Dugan and other industry critics have called for investigations
of this year’s refinery outages and for stronger government oversight
of refinery maintenance and production.

Charlie Drevna, executive director of the National
Petrochemical and Refiners Association in Washington, said that is
unnecessary. The refining industry already is shelling out billions to
comply with federal regulations, and is experiencing more outages this
year in part because those rules are so onerous, he said.

He also dismisses the idea that refiners would deliberately
shut down facilities at a time when refining profits are near record
levels. That "just doesn’t make economic sense," he said.

Refining margins have rebounded a bit in recent days, but still
are unlikely to be as high in the second half of the year as the first,
said Peter Beutel, analyst with Cameron Hanover.

However, an active Gulf Coast hurricane season or a sudden change in the national economy could change that, he said.
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