EIS Idea — June 5, 2007: Refining
An ironic trend has emerged: very little new capacity
is being built in North American refining. There are two reasons:
1. The enormous government push for alternative fuels, including subsidies
for ethanol and biodeisel, is causing refinery operators to fear that
more competing fuels will enter the market, thus limiting demand for
their services and therefore inhibiting their desire to build new
refineries. Isn’t it ironic that government subsidies for new fuel
capacity serve to inhibit the growth of unsubsidized fuel capacity?
(It's almost enough to make you want to become a Republican.)
2. At the same time, because of the risk that global oil production
may be peaking, refiners see the possibility that there may not be
much more oil available for refining into products in future years.
In fact, it looks worse if you gaze down the road far enough. In,
say, ten years global oil production capacity will probably be declining.
As global oil production declines, the demand for refining capacity
also declines. That's a heck of a long term growth trend on which
to hang a huge capital investment.
So what would you do if your business required huge investments to
create new capacity, if you see competitors growing because of government
subsidies, and you see the possibility that before the capital costs
of your new plant could be amortized the availability of product that
it could process will be declining in all likelihood? Who would build
new capacity in that environment? Nobody, and that’s who’s building
new refining plants. Really you’d almost have to be brain dead to
build a new refining plant today.
On the other hand, a new refinery was recently proposed;
we'll see if it gets financed. Perhaps the proponents see an intermediate-term
opportunity. It would be caused by the fact that our use of gasoline
continues to grow at the long term historical rate of about 1% per
annum. So refinery shortages will probably develop during the next
ten years before global oil production declines and before sufficient
alternative fuels are available. Absent new refinery capacity, the
growing demand would be satisfied by some minor refinery expansion
projects that are in fact expanding capacity slightly and the balance
will come from imports, which have been growing. How do we compete
for imported gasoline against demand for it in Europe, the Far East
and the Middle East? We pay a higher price.
Hence: regardless of what happens to the price of oil, the price of
gasoline will likely stay high and go higher for the next several
years. The same is probably true for the “crack spread” - the difference
between the price of oil and the price of gasoline - which is around
historical highs today. That’s the value added by refiners. Congress
hates it and makes it a whipping boy, but in the end Mr. Market rules.
So it looks like refiners should continue to be a good investment
over the next few years. I own Western (WNR) and Tesoro (TSO).
The likelihood of continually higher gasoline prices
is actually a very good thing. We must have the right price signals
for the market to adjust to the coming oil scarcity before it is too
late - see It’s the Transition,
Stupid. If our population was smart enough to allow its government
to enact truly intelligent energy legislation, then Congress would
pass a massive tax on gasoline. But Americans are not that smart and
they get the government they deserve, as all peoples do.
Incidentally, the growing need for imported gasoline contributes to
the growing global demand for oceanic shipping capacity. I own TBS
International (TBSI) which is a wonderful company although it does
not happen to ship gasoline. But the growing demand for gasoline shipping
capacity does help to tie up total global ship building capacity which
helps all existing shippers.