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

By Robert Rapier on Oct 9, 2009 with no responses

What Would Ron Wyden Do?

The refining sector has been in the news a few times this week, and not in a good way:

A Fine Mess For U.S. Refineries

HOUSTON — Excess capacity, weak demand for fuels and rising product inventories continue to squeeze margins for U.S. oil refiners.

Sunoco, the second-largest refiner in the country that doesn’t produce its own oil, said late Tuesday that it will soon shutter its Eagle Point refinery in Westville, N.J., which has a capacity to handle 145,000 barrels of oil per day. During the second quarter, Philadelphia-based Sunoco lost $77 million in its refining business and told analysts Tuesday that the third quarter could be worse.

A point that I have tried to stress is that for the most part, refining is not a lucrative business. It is a risky business. You may have five poor years and then one or two really good years. And then when you have a good year, you are accused of gouging and everybody wants a bigger piece of the profits – while sharing none of the risk. You can’t find those people during the bad years; they only show up when times are good.

I couldn’t help but think of Oregon Senator Ron Wyden when I read about the shuttering of the Sunoco refinery. You see, Senator Wyden has devoted a lot of time to investigating these sorts of “shady” practices, where refiners shut down refineries just to limit capacity and boost profits. He produced a comprehensive report on this a few years ago:

The Oil Industry, Gas Supply and Refinery Capacity: More Than Meets the Eye

Two excerpts from the report:

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.

The major oil companies had a financial interest in seeing the closure of independent refineries. By reducing the overall supply of oil and gas and reducing the number of companies involved in producing it, the major oil companies can have tighter reins on the supply and the price.

You see, Senator Wyden believes that when refineries shut down, it is some sort of organized attempt by “the industry” to reduce capacity and boost prices. When prices are sky high, this may seem like a plausible explanation. When a refiner is losing millions quarter after quarter, it no longer seems so plausible. It looks like someone exiting a business they no longer find profitable.

I documented some of Wyden’s silliness in Gasoline Prices Part II: Long-Term Factors. The bottom line is that refiners may eventually once again benefit as excess supply is shut down. And that’s the way it works in any business. If you are producing too much of something, the price is low and marginal producers go out of business.

A lot of refiners are in trouble right now. Sunoco won’t be the last one to shutter a refinery. Maybe two or three years from now, we will once again see a short burst of profitability as the supply/demand balance tightens back up. But maybe Sunoco’s Eagle Point refinery has lost half a billion dollars by then. This is the calculation they have certainly gone through, and their conclusion is that they will be better off to shutter the refinery.

But what would Senator Wyden do if he owned Eagle Point? I have to conclude, based on his report above, that he would continue running it so prices remained low for everyone. In fact, I wouldn’t be surprised to see him expanding capacity. He might end up losing a few hundred million dollars each year, but hopefully he has a big pile of money to draw upon. It reminds me of the joke about the farmer who won the lottery. When asked what he would do with his winnings, he replied “I’m just gonna keep farming until the money is all gone.”

Senator Wyden – and a great many others who think as he does – would apparently keep refining until the money is all gone.