Globalization hits the refinery sector

Refinery operators from Hawaii to Germany are weighing plans to close or sell plants due to the biggest drop in oil and refined product demand in almost three decades, according to Bloomberg News.

Companies that may close refineries include U.S.-based Chevron (CVX) and Valero (VLO), as well as Royal Dutch Shell (RDS.A), Petroplus Holdings AG, and Total SA.
Globalization hits the refinery sector

Shutting refineries may seem irrational or even the stuff of a collusion to American drivers, who have seen average U.S. gasoline prices rise about $1 per gallon over the past six months, to an average of about $2.20-2.55 per gallon for unleaded regular. But the cost structure of the global economy is driving the industry changes almost as much as lower demand for refined products due to the U.S. and global recessions.

Clearly, the key short-term factor in refinery closures has been weaker gasoline and refined product demand. But the long-term factor is one Americans and other high-cost developed nations have had to deal with for decades: globalization. Newer, more efficient refineries in emerging market economies -- India, China, Brazil, Russia, and the Middle East -- are opening, displacing the higher-cost refineries in the developed world.

Further, weak margins, and the Obama administration's push for carbon reductions and increased energy efficiency (which should decrease oil product demand), are hastening the trend.

"We can see how weak margins are right now, and with inventories where they are and no real indication of any type of demand . . . it's hard to see any kind of rebound in refining margins at all through the end of the year," Chris Barber, an oil market analyst at Energy Security Analysis Inc., told Reuters Monday. The margin from making fuel in the U.S., known as the 'crack spread' in the industry, is at $8.97, near a three-month low.

U.S. refineries operated at 87.0 percent of capacity last week, according to U.S. Energy Information Administration data. "The industry is going to have to go back to running at 80 percent or lower," said Ann Kohler, a New York-based analyst with Caris & Co., told Bloomberg News.

Energy analysis: Shipping gasoline and other refined products half-way around the world goes against the recent 'localization' trend -- which, ironically, has been propelled by high oil prices. Still, at least until refined product demand picks up in the West, thereby improving margins for U.S. refiners, the trend toward importing refined products from emerging market countries is likely to continue.

For investors, the new, cheaper emerging market refineries will likely hurt the bottom lines of integrated oil companies, whose downstream margins will be hurt.

For U.S. drivers, it's another bitter pill to swallow. Despite flat or declining gasoline demand due to belt-tightening and more than 6.5 million job losses, the closure of high-cost U.S. refineries will likely keep gasoline prices higher than they would be, at least short-term, due to decreased supply. Longer-term, prices should drop, due to the importation of those lower oil-cost, emerging market refined products. Still, the importation of that fuel increases the U.S. trade deficit, a major negative for the U.S. economy. One solution: a tax law change and an easing of environmental regulations to encourage oil companies to build refineries in the United States.

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