WASHINGTON--The route to "energy independence" could be undermined by the very policies intended to promote it.
As lawmakers on Capitol Hill continue their push to reduce U.S. dependence on foreign oil, they're prompting refiners to further question expansion plans aimed at raising the domestic pool of gasoline and other key refined products. Congress' aim to increase fuel economy standards and supplant 36 billion gallons a year of gasoline with ethanol made from corn and other biomass has created uncertainty about future demand. Less demand for refiners' primary product, along with steeply rising construction costs, have led companies to rethink their plans.
House and Senate legislators are scheduled to reconvene after the Labor Day holiday to finalize an energy package that aims to lessen U.S. reliance on hydrocarbon imports.
Rather than reducing the flow of foreign crude oil and gasoline, analysts say, refiners' second thoughts and a huge bet on biofuels could result in the opposite. While some see growing imports as a vital link to global markets and a step toward securing more supply flexibility, others say it works against "energy independence" and raises U.S. exposure to volatile supplies and prices.
The situation underscores the complex challenge of diversifying U.S. energy sources. While biofuels have attracted massive investment as potential alternative transportation fuels, the dual prospect of higher vehicle fuel efficiency and mandated, subsidized use of biofuels has cast a pall over capital investment in oil refineries.
Constraints in the distribution of biofuels across the country could increase demand, somewhat ironically, for overseas gasoline, as could a longer-than-expected timeline to develop ethanol derived from plants other than corn. Lawmakers are wagering on the success of cellulosic ethanol, processed from biomass such as grasses and wood chips, which has yet to be produced on a commercial scale.
"It's safe to say that our imports of gasoline will be steadily increasing over the next several years," said Adam Robinson, an energy research analyst at Lehman Brothers. "The big question is whether or not we can make that silver-bullet jump to cellulosic, and also whether or not we can develop the downstream systems to deliver the ethanol."
Critics of the biofuels bill question whether the country can supply the 15 billion gallons a year of corn-based ethanol that would be required by 2015 without substantially raising the cost of food - or whether the supply can be relied on in drought years. They are also skeptical that the technological breakthrough necessary for mass cellulosic production will occur soon. Vast additions to the fuel-delivery infrastructure - new pipelines and storage tanks, for starters - must also be built to accommodate much larger volumes of ethanol.
Refinery Expansion Redux
Refiners are reevaluating expansion plans. Tax incentives to encourage increased refining capacity are losing support as Democrats target Big Oil - diverting funds away from the petroleum industry and into alternative energy and biofuel programs - and engineering and construction costs continue to rise. Proposed expansion plans now represent an additional 1.057 million barrels a day of capacity by 2011, Joanne Shore, a senior adviser at the U.S. Department of Energy's Energy Information Administration told Congress recently. That's down from an estimated count last year of 1.9 million barrels a day planned and proposed, according to the National Petrochemical & Refiners Association, an industry group.
"We're going to become dependent on foreign refineries," warned Sen. Orrin Hatch, a Utah Republican, at a recent Finance Committee hearing. "If we can't refine oil, others will do it for us, and it's foolish if we don't wean ourselves off imports."
Already, imports are satisfying an ever-larger share of America's thirst for gasoline. As of May, imports stood at 15% of demand, up from 9.9% in the same month in 2002 and 7.4% in May 1998. While the largest foreign suppliers of gasoline outside of the U.S. are nearby Canada and the Virgin Islands, a growing portion of imports are coming from further locations, like Europe, which has a broader choice of markets.
A huge rise in gasoline imports pressured prices in the fall of 2005 after devastating hurricanes hobbled a number of Gulf Coast refineries and sent pump prices soaring. At hearings and press conferences, lawmakers called on refining companies to increase capacity in the U.S. Some refiners, seeking to take advantage of an existing tax incentive, announced plans to increase the size as well as the complexity of plants.
But since then, many industry officials, including a top executive at Valero Energy Corp. (VLO), have begun to question the compatibility of policies that increase the production of petroleum-based gasoline and also cut its consumption by mandating subsidized biofuel use.
"If you want to add refining capacity here, how can you have the president advocating reduced consumption?" said Greg King, president of Valero, the largest independent refiner in the U.S. "It's a mixed message."
King said he's concerned that incentives to encourage expansion are in jeopardy. The House version of the Energy Bill doesn't extend beyond 2008 a provision from the Energy Policy Act of 2005 that allows refiners to expense 50% of the costs of investments that increase capacity by at least 5% at any one refinery. The bill also takes away from refiners a tax deduction granted to other U.S. manufacturers.
In light of the changes and lawmakers' aim to reduce gasoline consumption, refiners say they risk committing to an expensive project only to forego tax savings and sufficient return on their investment at the end of a process that typically takes five to seven years. It's less financially risky for their companies to let the market rely on foreign refining capacity to balance U.S. supply and demand, they say.
"We think the legislation might continue the trend of incremental increase (in gasoline imports) in lieu of encouraging increased refining capacity," King said.
Costs Rise Unabated
Investment in refinery expansion and improvement has become a more difficult financial decision for companies. The costs associated with engineering, manufacturing and construction have risen sharply and the timelines have grown longer, thinning return on capital.
West Coast refiner Tesoro Corp. (TSO) has canceled and Sunoco Inc. (SUN) and Valero have delayed multimillion-dollar additions and expansions of processing units at refineries, citing rising costs for construction and engineering.
(MORE) Dow Jones Newswires Vastly more expensive plans for expanded crude-processing capacity, announced with much fanfare in 2006 or earlier, have stalled.
There are plans for three new refineries in the U.S. and another three in Canada, but they are tentative at best. If they fail to materialize, it would prolong the time the U.S. has gone without a new refinery. The last one was built in 1976.
One new plant, planned to go up in Yuma, Ariz., has been in the works since 1989. The project has obtained key federal and state permits several years ago but has failed to secure commitments from investors. A project in Louisiana exists only as a memorandum of understanding between the state and Kuwait to study the construction of a refinery. Backers of a just-announced third project in the upper Plains region haven't disclosed financial details or a final location. The three Canadian plans have been floated as proposals, but haven't yet progressed further.
Foreign Sources Forge Ahead
Meanwhile, investors in other countries, including national oil companies, are forging ahead.
Saudi Arabia is gearing up to start four refineries with throughput of 400,000 barrels a day. A 615,000-barrel-a-day plant is set to come on line in Kuwait, and a 580,000-barrel-a-day facility will soon be processing in India.
"It will be difficult to build a new refinery in the United States," said Lehman's Mr. Robinson. "There are significant investments coming on line in the world that will, in addition to this whole ethanol craze, continue to de-incentivize building new refineries in the U.S."
Jack Rafuse, a former energy policy advisor for the Nixon Administration who now heads an energy consulting firm, said imports are good for both the U.S. and the world markets.
"As world energy demand grows 50% from now until 2030, our major energy sources will continue to be oil, natural gas and coal," said Rafuse. "To meet this growing demand, the U.S. needs to play a major role in the global market so we must tap into every possible source, both domestic and imported."
Gasoline imports have helped to balance U.S. supply and provide lower prices to consumers during supply crunches. Retail gasoline's recent drop below a record $3.22 a gallon in May was due mostly to a swell in U.S.-bound foreign barrels.
Sources: Ian Talley, Dow Jones Newswires; 202-862-9285; ian.talley@dowjones.com, Beth Heinsohn, Dow Jones Newswires; 201-938-4435; beth.heinsohn@dowjones.com