The Oil Drum

I really do think we are presently at Peak Oil, and this may be reflected in the refinery market where PO has been anticipated by not expanding capacity.

If the above is true, your analysis raises another important question. How long will we be able to maintain the plateau, especially in the light of heavier crude entering the market?

These factors are better explained by measures of complexity and conversion, which refer to the ability of a given facility to produce valuable products. Complexity describes the stages of refining that occur after distillation, primarily cracking. These stages are capital intense, actually transform the molecular structure of crude and significantly alter the output of a facility.

If you were to measure the amount of gasoline produced and/or the dollar value of investment in the sector, you would get a completely different result. It is inaccurate to claim that refinery development ground to a stop in the 1990s.

The main reasons why new capacity did not come on line in the recent past are:

1. Adequate crude intake capacity
   
2. Ability to produce more product from other investments in the facility
   
3. Regulations that made new facility development difficult, and most importantly,
   
4. Refining was not a profitable industry and did not proivide acceptable returns on investment.

It do think fear of peak oil could be an issue in the future, but see little evidence it has in the past.

I grew up in Newfoundland, Canada, and we were very aware of the status of the "Come By Chance" oil refinery, completed in 1974/1975, and then mothballed after about a year of unprofitable operation. It was started up again in 1987 and is fully operational now, but anybody aware of the history would be very reluctant to build a new refinery without being certain we won't get a repeat.

So the particular reason for the decline in refinery capacity additions in the last few years could be expectation of near-term oil price spikes; given that the recent flatness (2001-2004) is coincident with the Bush administration's tenure, maybe oil industry executives knew to expect something... But we wouldn't want to get into conspiracy theories...

A new era in gas storage is dawning in 2006. The passage of the Energy Act of 2005 has provided FERC with broad new powers to drive storage expansion. They have responded by proposing new rules for market-rates for interstate gas storage to spur the development of storage capacity. Hurricanes Katrina and Wilma also demonstrated the value of gas storage facilities, and have caused many players in the gas market to step up their efforts to develop or acquire more storage capacity. High gas prices, increasing volatility, and increasing liquidity of gas markets have increased the intrinsic value of storage facilities to both active market participants and investors, driving an unprecedented round of acquisition and aggregation plays. Likewise, the introduction of new LNG and pipeline sources is likely to change the potential value of existing assets and drive the development of new storage facilities. Gas storage operators, pipeline operators, gas customers, and storage investors must examine the changes in the regulatory and market landscapes to form effective strategies to profit from opportunities in 2006 and beyond.

It seems that the natural gas industry is not running scared to make investments because of potential supply constraints.

The general thrust of the argument about (non peak oil) refining capacity is this:

Margins were very bad in the 80s & 90s, therefore no capacity was added. In fact in the USA around 0.9mbpd was closed down.

The oil industry/markets were complacent about demand growth.

Complex refineries are far less than simple refineries in number; hence discounted OPEC heavy/sour crudes.

Now a lot of refineries are being built in the middle east, nigeria, indonesia and china to refine product.

In addition Valero, Conoco & others (i dont have my notes!) are building additional capacity in the USA and europe in existing refinery complexes.

The catch up will come with the next recession, by 2010 when some years of slow demand will allow complex refineries to be built to handle heavier grades.

That's the argument, i'm not saying its mine so dont flame me!!

Here's a recent piece I did: Refinery capacity to test crude price in 2006 http://www.resourceinvestor.com/pebble.asp?relid=15460

all the best
adam

However, the record shows - supported by documents I have obtained - that there is more to the story.  Specifically, the documents suggest that major oil companies pursued efforts to curtail refinery capacity as a strategy for improving profit margins; that competing oil companies worked together to subvert supply; that refinery closures inhibited supply; and that oil companies are reaping record profits, yet may benefit from a proposed national energy policy that would offer financial incentives to expand refinery capacity.

That last bit rings true. Here's the industry spokesman in September 05:

Bob Slaughter, the president of the National Petrochemical and Refiners Association, told a House committee last week that Congress could expand tax incentives included in the energy bill as a way to encourage growth of the refining industry

So that's another idea: The industry is waiting for a  government handout.

Another view:

Today investors are in no mood for refinery building even if funding were available," Arjun Murti, managing director of Goldman, Sachs Co., told a recent congressional hearing on the dearth of U.S. refining capacity. Any executive who might pursue a new $3 billion refinery risks his company's stocks taking a hit, said Murti.

In these circumstances [the price differential], many refiners were reluctant to lift. While such heavy crude could be processed in the surplus primary distillation capacity around the world, the extra transport costs and the problem of disposing of the unwanted fuel oil only made such an exercise worthwhile at the right crude prices.

This development reflects an important fact in the oil market with significant price implications:

• OPEC tends to produce heavy sour crudes
• The cartel has a strong, vested interest in ensuring that the price of the heavier crudes do not fall too far below light crudes since it directly affects its members' revenue streams.
• Tight product markets are likely to continue as long as OPEC seeks to protect the price of heavy sour crudes.

Sheik Ahmad Fahd al-Ahmad al-Sabah, Kuwait's energy and oil minister and the president of the Organization of the Petroleum Exporting Countries, is scheduled to lead the group's first talks with China on Thursday as members like Saudi Arabia and Kuwait plan investments in Chinese refinery projects worth more than $8 billion. Saudi Arabia has used oil refinery investments to ensure sales in Japan and South Korea....

Saudi Aramco, the world's largest oil company by production, agreed in 2001 to expand a refinery in Fujian Province jointly owned with China Petroleum & Chemical, or Sinopec, and Exxon Mobil at a cost of $3.5 billion....

Kuwait and China have agreed to develop a refinery complex near Guangzhou, with the capacity to produce 200,000 to 400,000 barrels a day of gasoline and other fuels, Ahmad, the OPEC president, said in Kuwait on Dec. 12. That project, which would use Kuwait oil supplies, may cost as much as $5 billion, he said....

A 200,000-barrel-a-day refinery would cost more than $2.5 billion and would require margins of about $9 a barrel for 20 years to provide an 8 percent to 10 percent return, says Joel Maness, 55, senior vice president of refining and supply at Sunoco Inc., the biggest refiner in the U.S. Northeast. U.S. refining margins have never averaged more than $9 a barrel for more than eight consecutive months.

``It would appear there's a purposeful effort to keep refining capacity tight because it increases profits,'' Senator Dianne Feinstein, a Democrat from California, told executives at the November hearing.

Mulva, whose ConocoPhillips controls 3 percent of global refining capacity, disputed the senator's contention. ``Not only are we adding capacity but we're modernizing our refineries so we can make more gasoline, jet fuel and heating oil,'' Mulva told Feinstein during the hearing.

• I agree about the changes in refineries, complexity, etc.  I agree there's been a lot of investment in debottlenecking and improving the output mix - especially in the US/Europe where we've moved away from using resid and fuel oil for heating, industrial processes etc, and are increasingly mainly using oil for transportation.
  
• In my experience of raising money, investors don't usually say why they aren't investing, they just tell you to keep them posted and then stop returning your calls.  They play their cards close to their chest.
  
• Investors all talk to each other all the time, do extensive due diligence before investing, and are familiar with the range of viewpoints on the market by the time they put money into a project.
  
• Savvy members of the investment community like T. Boone Pickens, Matt Simmons, etc have been talking about peak oil for several years, as have energy analysts like Henry Groppe and Charles Maxwell.  I'd be very surprised if a sophisticated energy investing professional has not been at least aware of the hypothesis for some time.  They may or not buy into it, but it's bound to affect the FUD (Fear Uncertainty and Doubt) in the deal.
  
• Forget all about explicit peak oil theories, and just look at the price signals.  The market signal for "we have a big problem with refinery capacity: build more" would be at least one refinery input would be cheap and at least one refinery output would be expensive.  That would make a screamingly obvious business case to build refinery capacity to improve the path from the cheap input to the expensive output.  We do not have that market signal even today - instead refineries face high but volatile output prices, and high but volatile input prices on all inputs.  Heavy crude is not cheap; even though the spread from light sweet has increased, it's still gone up a lot and it's still volatile (not what you want to see as an investor)  That's a market signal saying "wait and see" which is exactly what refiners have been doing in the US and Europe (by and large) in terms of increasing total capacity.
  
• The places where building refinery capacity makes obvious sense even in a post peak scenario (with modest decline rates) are BRIC countries (stronger growth will be more resilient than that of US/Europe, so will be able to buy more of the world's supply over time), and the Middle East (move more of the value chain home).  That's exactly where new capacity is going, to a first order approximation.
  

I don't find 1) very plausible - what has changed to suddenly make OPEC more disciplined?  2) says imminent peak oil.