Why We Pay So Much for Gasoline, and Other Answers
Once again the economy and the stock market are distracted by worries over energy prices and the Middle East. Financial markets are gyrating. President Clinton opened the emergency petroleum reserve. Even Fed Chairman Alan Greenspan was constrained last week to include a comment on oil in a speech on monetary policy.
Greenspan thought oil prices would fall if the Middle East’s “political difficulties” didn’t “impinge on available supplies.”
If that’s the best big thinkers can say, what should ordinary folks do to gain peace of mind? Focus on the business of energy and ask three pointed questions:
* Are investments being made to increase the flow of crude and natural gas, and will that bring prices down?
* Are there other bottlenecks--such as a shortage of refinery capacity--behind the 45% rise in prices for gasoline and other refined products in the last year? What’s the outlook?
* If once again we are worried about the Middle East “impinging” on our economy, are investments finally being made in new forms of energy to free us from such fears?
The quick answers:
* Oil and natural gas supplies will increase in the next two years thanks to large investments made in recent years in exploration and development. But major companies are not rushing to boost investments today, when oil is more than $30 a barrel, because they don’t believe prices will stay that high.
* However, gasoline prices will stay relatively high because refining capacity is in tighter supply than it used to be. That also means that refining is a good business for investors to watch in the next two years.
* Yes, investments in new energy are picking up. Look to wind power and hybrid cars for the short term. Over the balance of this decade, cleaner fuels rather than dramatically new fuels will help solve our problems.
Now to go behind the sound bites. Because of development projects underway for years in deep waters of the Gulf of Mexico, offshore West Africa and in the former Soviet Union, world oil supplies will increase by roughly 4 million barrels a day, or 5% in the next two years, says Daniel Yergin, chairman of Cambridge Energy Research Associates and author of “The Prize,” nine years after its publication still the definitive history of the oil industry.
As that 5% growth in supply is slightly higher than projected increases in world demand, experts see crude oil prices declining to about $20 a barrel from the current $34. Natural gas prices also may soften, because independent oil and gas companies are drilling aggressively for new supplies.
But prices of gasoline, heating oil, jet fuel and diesel may not fall by a comparable percentage, because refinery capacity hasn’t been expanding as fast as demand for oil products.
As the Organization of Petroleum Exporting Countries released more oil and Clinton pushed extra crude onto the market from the Strategic Petroleum Reserve, prices of gasoline and other fuels didn’t fall as much as the price of crude did. Refineries in the United States couldn’t easily handle the increased flow.
“It was like pushing a golf ball through a soda straw,” says analyst Douglas Terreson of Morgan Stanley Dean Witter in Houston.
That tight refining situation will persist through next year, Terreson predicts, giving major oil companies and independent refining companies higher profit margins on their refinery operations.
Refining capacity is particularly tight in California. In fact, the state is heading for a possible gasoline shortage in the next five years.
So how did such a bottleneck come about? Because refining has been a lousy business for years. Tosco Corp., Valero Energy Corp. and Ultramar Diamond Shamrock Corp., all independent refining companies with refineries in the state, and Sunoco Inc. of Philadelphia, which refines for the Northeast and the Midwest, earned combined average returns on investment of 6.9% from 1996 through 1999. They could have earned more with less risk from a government bond or a bank certificate of deposit.
Facing such poor returns, refiners invested as little as possible to expand capacity. And as demand for gasoline and other products grew, a refining pinch resulted.
Now analysts project returns on refining at 14% a year. And new investments will be made to add refinery capacity.
For one thing, refiners must spend large sums to meet Environmental Protection Agency mandates for cleaner gasoline. In the process, companies often increase output by making efficiencies and installing newer equipment. The net result nationally is that there will be no long-term shortage of refinery capacity, says Thomas Manning of Purvin & Gertz, a Houston-based research and consulting firm that is the leading authority on oil refining and marketing worldwide.
But California faces special problems because the next phase of refining investment in the state is to remove methyl tertiary butyl ether, or MTBE, a substance added to gasoline to reduce air pollution but being phased out because it contaminates ground water.
Simply put, taking out the MTBE will reduce refinery output by 10% to 11%, says Leslie Watson of Purvin & Gertz’s Long Beach office. And no compensating efficiencies are likely to make up for all of that reduction.
“Supplies will diminish somewhat,” Watson says, although refinery expansions are being planned, notably by Ultramar Diamond Shamrock at its plant in Wilmington and also at Avon in the San Francisco Bay area.
The upshot: Californians will continue to pay more for environmentally cleaner gasoline and other refined products. But there will be no severe long-term shortage of products, and refiners will invest in expanding output in the state because, as one refining executive declares--although he asks not to be named--”it’s the greatest refining market in the world.”
So we’ll muddle through on energy. But even as we do so, we are conscious that secure supplies of reasonably priced energy are a priority for the economy. So investments in alternative energy will accelerate in the next few years.
Wind power is becoming serious, for example. Companies such as Enron Corp. and Reliant Energy Inc. are investing in windmill complexes for generating electricity. The new windmills are improvements over the 1970s versions, with bigger and more efficient turbines. Windy places such as West Texas and the Plains states are ideal for such experiments, says Stephen Taub, a researcher in energy technology at Cambridge Energy.
“The central Plains are the Saudi Arabia of wind,” he says.
Hybrid electric-gasoline cars such as Toyota Motor Corp.’s Prius and Honda Motor Co.’s Insight, which get 50 to 60 miles per gallon of gasoline, will be seen in greater numbers in years ahead.
And for the balance of the decade, efforts to produce cleaner fuels by adapting natural gas and improving motor gasoline will get increased investment and attention.
Once again energy has given the economy a jolt. And it’s a sign of economic health that the response will be new investments and efficiencies.
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Refining--and Improving
Oil refining has been a subpar business for years, earning average returns on investment of less than 7% a year. But now, as demand for gasoline and other refined products has caught up with available refinery capacity, returns are moving up to an average of 14%, analysts say. And independent refining companies have seen earnings and stock prices rise.
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Ticker Friday 52-wk. 52-wk. June Company symbol close high low EPS* Sunoco SUN $29.31 $33.25 $21.94 $1.50 Tosco TOS 29.50 33.81 24.06 0.94 Ultramar Diamond Shamrock UDS 26.81 28.63 20.56 1.45 Valero Energy VLO 34.75 35.56 17.25 1.51
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Sources: Morgan Stanley Dean Witter, Bloomberg News
Researched by NONA YATES/Los Angeles Times
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James Flanigan can be reached at jim.flanigan@latimes.com.
