Refining Rules : Oil Firms May Not Pass Along All the Costs of Cleaner Gas


The state’s strict new rules requiring oil refiners to produce lower-emission gasoline will cost refiners billions--and that is certain to translate into higher prices for motorists at the gasoline pump.

But quirks in the way the rules will apply to the state’s refiners could affect just how much of the costs are passed on. They could mean lower-than-expected price increases at the pump--and a broad variance in the way the tough rules will affect different refiners.

Specifically, small refiners could have a market advantage for a while, while larger ones may find themselves swallowing huge capital investments for longer than they might want, analysts say. Marginal operators unable to bear such costs could be hurt--even driven out of business, they say.

Still, all of the state’s refiners seem resigned to complying with the new rules, adopted by the California Air Resources Board late last month, which would require most refiners to make the cleaner gasoline by March, 1996.


Refiners are sharply divided on the costs of the new rules. For its part, the ARB estimates that it will cost the state’s refiners $3 billion to $6 billion simply to install equipment to make the new gasoline, which will be the nation’s cleanest.

California is one of the nation’s bigger refining centers outside the Gulf Coast, with 37 refineries, according to the Western States Petroleum Assn., an industry group. Employment varies from 200 at the smaller refineries to as many as 1,250 people at the largest.

The refiners include most of the major oil companies, two independent, mid-size refiners and a host of smaller independents.

The ARB figures that the new rules will add about 13 to 17 cents to the price of a gallon of gasoline. Others, including Texaco Inc. and the Western States association, say the price increase will be more like 20 cents a gallon.


But there are real questions about how much of the increase will find its way to the corner gas pump, given the state’s competitive market. And there is concern as to whether some refiners would survive if costs could not be passed along, analysts say.

One of the twists in the new rules would give small refiners--defined as those that process fewer than 55,000 barrels of crude oil a day--an extra two years to comply.

The delay is designed to answer concerns by such refiners that they would be unable to get financing to upgrade their plants until banks were convinced that motorists would buy the expensive new gasoline.

Regulators were persuaded that the small refiners--who have less access to capital than their major oil company counterparts--are a vital part of the market and should be given a chance to survive.


But the delay for the small players complicates the competitive situation for the others. That’s because prices in the hotly competitive California market are typically paced by the lowest-cost operator.

As a result, it’s possible that the new gasoline could actually cost motorists less than expected, at least in the short term.

If the smaller refineries are able to continue producing cheap gasoline from 1996 to 1998, it will force the bigger ones to keep their prices relatively low--even though they will have already incurred the huge capital costs.

“If people expect that competition amongst the refining industry takes (the price increase) down to 10 or 12 cents a gallon, refiners that have had to make significant capital costs will hurt,” said Scott T. Jones, president of AUS Consultants Inc. in Philadelphia. “Competition amongst existing refiners will intensify, and after a period of two to three years, you’ll have fewer players.”


Some of the major oil companies express concern about that scenario.

“If small refiners don’t pass costs along on the same time scale (as the rest of us), that would prohibit us from passing along our full costs,” added Dennis Lamb, manager of refining and marketing at Unocal Corp. “That is a concern.”

At Atlantic Richfield Co., which strongly supports the new rules, officials acknowledge that there could be some consolidation in the industry. “It’s a competitive market anyway,” said George Babikian, president of Arco’s refining and marketing division. “Returns on the refining end of the business are not very good.”

At one of the state’s mid-size refiners, Long Beach-based Ultramar, Vice President Michael Hileman called the quirk “an unfair advantage” that amounts to a two-year subsidy for the small refiners. The ARB will decide in the spring whether to extend the exemption to Ultramar and the other medium-size refiner, Tosco.


Al Gualtieri, president of Powerine Oil Co., runs one of the small refineries that will benefit from the rule. “We’ll simply remain competitive as we always do, pricing our gasoline along with the majors,” he said.

But Gualtieri added: “It would not be very responsible for us to discount our gasoline in an attempt to prevent the others from recovering their investment costs, because we’ll be there in two years anyway.”

In any event, the prospect of billions of dollars in new capital costs couldn’t come at a worse time. Profit margins in refining have been squeezed to almost nothing recently, due in part to slack demand for petroleum products as a result of the recession.

The industry’s poor economics have led Shell Oil Co. to cease refining operations in Southern California, selling part of its Wilmington refinery to Unocal Corp.


In addition, Fletcher Oil and Refining Co. next month will suspend production at its tiny Carson refinery “until refining margins improve,” President James Lopeman said.

Texaco, which has two refineries in the state, continues to protest the new rules as costly, ineffective and burdensome to taxpayers and consumers alike.

“I believe the cost of making the fuel will go up, and . . . competitive pressures of the marketplace will raise the price of gasoline to the consumer, who will pay more than he should pay if more cost-effective methods had been taken,” President James W. Kinnear said in an interview.

Kinnear is particularly worried that the new rules will spill over to other regions, including the Northeast--a particular concern to Texaco, which operates five refineries outside California.


On the other hand, Arco--which pioneered production of cleaner-burning gasolines--says the new rules are just what the smog doctor ordered. Arco contends that tougher environmental standards will ensure that gasoline--and not some exotic fuel such as methanol--will be the motor fuel of the foreseeable future.

“Reformulated gasoline . . . is the most cost-effective way to clean up the environment, and the least disruptive,” Arco’s Babikian said. The alternatives include expensive and cumbersome controls on stationary sources--including refineries.

In the middle, Unocal Corp. seems resigned to the rules, though it considers them costly. “We have calculated we can comply within our proposed capital budget,” Lamb said.

Individual refiners’ costs in meeting the new gasoline rules will vary widely, as will economies of scale and access to capital.


Among major oil companies with deep pockets, Chevron Corp.--whose refineries in El Segundo and Richmond produce about 180,000 barrels of gasoline a day--expects to spend about $1 billion.

Arco, whose sophisticated refinery in Carson produces 130,000 barrels a day, says it will spend $700 million to $800 million. Unocal, Texaco and Shell--the latter still has a refinery in Northern California--either won’t say how much they will spend or haven’t figured it out yet.

In contrast, Ultramar, whose Long Beach plant produces 50,000 barrels of gasoline a day, estimates its capital costs at $50 million. As a unit of the British oil giant Ultramar Ltd., the firm should have no problem with capital.

At the bottom of the refinery food chain, Fletcher--whose 52-year-old refinery makes only 15,000 barrels of gasoline a day--figures that its costs will exceed $100 million. Powerine’s Santa Fe Springs refinery, which produces about 20,000 barrels of gasoline a day, faces an $80-million hit.


Brave New Gasoline

Most refiners will have to produce gasoline that meets the California Air Resources Board’s new specifications by March, 1996. Small refiners have an extra two years to comply. Refiners can either make sure every gallon conforms to an absolute limit or use an average of all gallons produced over 90 days, provided that no one gallon exceeds a maximum, or “cap.” Each element contributes to the formation of ozone, the principal component of smog.

Characteristic Allowed Absolute Average/ Now Limit Cap Aromatics 32% (high-octane factor) by volume 25% 22%/30% Olefins 9.9% (another high-octane by volume 6% 4%/10% component) Benzene 2% 1% 0.8%/1.2% by volume Sulfur 150 40 ppm 30 ppm/ (parts per million) ppm 80 ppm Volatility 7.8 pounds (tendency to /square inch 7 psi evaporate) Boiling point 330 degrees (at which 90% Farenheit 300 290/330 vaporizes) Boiling point 220 degrees (at which 50% Farenheit 210 200/220 vaporizes)