Consumer Energy Report is now Energy Trends Insider -- Read More »

By Robert Rapier on Jun 1, 2007 with no responses

The Cost of Environmental Regulations

That title will immediately raise some eyebrows, but I am not suggesting that we don’t need the environmental regulations we have. Rather, I just want people to understand that this is part of the cost for gasoline. I want them to understand that they aren’t getting a free lunch here. But by no means do I condone the watering down of environmental regulations in order to make gasoline cheaper.

Rather, I want to reiterate something I wrote in a previous essay. When politicians enact new regulations, they need to have an understanding of what this means. First, this necessarily redirects capital that might have gone into expanding refining facilities. Second, it increases the costs of producing the fuel. Third, this additional level of processing reduces the overall product yield. Fourth, and perhaps of greatest importance, it increases the complexity of the refinery.

Those are the consequences. The more complex the refineries are, the more unreliable they are going to be. There are more ways for it to now break down. There is more danger as the inventory of hazardous materials is increased. So, politicians who are passing these laws shouldn’t sit around and ask “Gosh, I wonder why gasoline prices are going up?” Stricter environmental regulations – which I agree with – are one more piece of the puzzle. They have helped crimp supplies and add to costs.

Along those same lines, I received a comment following a previous essay that should be its own essay. He addresses some of these issues in a good bit of detail. While I don’t agree with everything he says, there is a lot of very good information in his comments. Here they are:

26 year old refinery guy said…

More than half of the 300+ US refineries that were in operation in the early 1980’s have closed their doors…”. The thing that Congress and the news media isn’t talking about is why all those refineries closed permanently.

Although there are probably several different reasons, I believe the main reason is from the Tier II Regulations that were passed by the EPA. Most people (including those in Congress) don’t realize the cost that each refinery had to invest to meet the Tier II Regulations. In general terms, these regulations state that gasoline must have less than 30 parts per million of sulphur and diesel fuel must have less than 15 parts per million of sulphur. Previous requirements were 300 ppm for gas and 500 ppm for diesel.

To meet the new regulations, each refinery was required to spend huge amounts of money, from tens of millions for smaller refineries to hundreds of millions for larger refineries. Refineries had to make a choice, spend the huge amounts of money to upgrade and stay in business or not spend the money and shutdown.

For smaller refineries, the profits at the time didn’t justify the huge investment to upgrade so they stopped producing gas and diesel fuel. Most of these refineries became storage terminals because, without the upgrades, they could no longer sell their products and the cost of closure, which includes demolition and clean-up, prohibited them from actually closing. In other words, the EPA sees them as an operating facility but they no longer produce gasoline and diesel fuel. In the early years of some of the refinery closures, other larger refineries de-bottlenecked (increased capacity) which offset the loss of capacity from the closed refineries. Once these large refineries increased capacity as much as practical, other smaller refineries were still continuing to close.

Eventually, we end up where we are today, total refinery capacity in the USA is less than current demand. I can remember in the early 1990’s when gas was cheap and refineries were losing money during certain times of the year because there was an oversupply of product. Where were the Congressmen and news media back then. I never heard one Congressional request for an investigation back then into why gas prices were so low. Another thing about the Tier II issue is that the cost to meet the regulations was so huge, the refineries that did make the investment were limited on the money they could spend on other capital improvements. These are the improvements to become more efficient and more reliable.

Most refineries took about 3 to 4 years from start to finish to meet the Tier II Requirements. During this time, the refineries continued to operate but were not making the normal improvements that they would have without the Tier II cost. Most people don’t realize that process units in refineries must take turnarounds every 4 to 5 years. This must be done to operate safely and maintain equipment properly. Depending on the refinery, some schudule turnarounds for different process units during different years to minimize production downtime and limit their exposure to market conditions. Most refineries try to schedule turnarounds during the time of year when they believe demand and margins will be at their lowest. This is usually during the spring and fall. However, during the last few years, demand has been continually increasing even during the spring and fall. Imports is another issue. I believe that the imports from Europe still have a 50 part per million sulphur specification.

This means that every gallon of imported gasoline must be blended with gasoline that is less than 30 ppm so the level at the gas pump meets the EPA required 30 ppm. Because most refineries don’t make a gasoline blend that is significantly lower than 30 ppm to blend with the 50 ppm imported gasoline, imports will continue to be limited until Europe requires the same 30 ppm specification. Regarding ethanol, must people don’t understand that it takes more energy to make a gallon of ethanol than it does to make a gallon of gasoline and ethanol doesn’t have the BTU value of gasoline.

In other words, you would have to use approximately 20% to 30% more E85 gasoline to go the same distance you would with 100% gasoline. E85 gas is a mixture of 85% ethanol and 15% gasoline. Another thing most people don’t realize is that the gasoline blend that is used to make the E85 gas and the 10% ethanol blended gasoline must start out at a higher octane rating than the 87 octane that you buy at the pump. When MTBE was used, it had an octane rating around 100. MTBE could be blended with a low 80 octane blend and the final product still ends up with the 87 octane. The higher the octane blend stock the more expensive it is to make. That’s why 93 octane premium grade is higher than 87 octane regular gas.

Back to the EPA, I believe there is talk that they want to reduce the sulphur requirement to below 10 ppm in the future. In this regulation gets passed, the remaining operating refineries will have another huge investment and the cycle will start all over again. By the way, lowering the sulphur in gas and diesel doesn’t make your vehicle go any farther on a gallon. Eventually, you get to a point of diminishing returns. In other words, the huge investments required to meet the regulations never justify the end results. I believe that the Supreme Court has ruled that the EPA does not have to consider cost in its decisions when passing regulations. Maybe I don’t understand how the EPA works but it seems that they actually violate the Constitution of the United States since they make their own laws, they pass their own laws, and they enforce their own laws. I thought this country was set up with three branches of Government so one body wouldn’t be able to have all of the power.

Regarding one of Gas Guys comments about the cost of building a new refinery, he was a little low. The cost in today’s dollars to build a 200,000 barrel per day refinery would be about $5 billion to $7 billion and it would take about 5 to 7 years assuming you could get the necessary EPA permits in a timely manner. With Congress talking about passing Windfall Profits Taxes and President Bush talking about reducing demand by 20% in the foreseeable future, I don’t know of any company that would be considering building a new refinery. If you were a “widget” manufacturer and there was a widget shortage, you would want to make as many widgets as you could if they were selling as fast as you made them at a price that was higher than the previous 5 year period. However, if there was talk of a “Widget Tax” for future profits and the government was going to take action to reduce the demand for widgets, would you as a widget manufacturer be willing to spend billions of dollars without knowing if you will ever get a return on your investment?

By the way, I saw an article the other day that talked about the Kuwati Government cancelling their plans to build a 600,000 barrel per day refinery. The article stated that the estimated cost went from an earlier estimated $6 billion to the latest revised cost of $15 billion and that was without the US EPA being involved.

The costs with the EPA are estimated at 50 cents per gallon by