A: Refining Challenge
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A: Refining Challenge

In thinking about global oil supplies, the problem of refining capacity is at least as important as that of production capacity. This is because all crude oil must be refined before it can be used as a fuel. A shortage of refining capacity, particularly acute in the United States but also prevalent in many nations throughout the world, is a key cause of the global supply crunch. It has also caused many to wonder whether an energy crisis might not be looming just over the horizon.

Globalization and increased investment have brought into play new or previously unavailable sources of oil, many of which require sophisticated refining techniques to exploit because of their low quality. At the same time, a comparable investment in capacity to refine this diverse array of raw materials—particularly for production of high-demand, labor-intensive fuels such as diesel and gasoline—has been absent (Pirog, 2005).

A cheaply constructed simple refinery, for example, might be capable of producing a mix of 20 percent gasoline, 30 percent “middle distillates”, and 50 percent “heavy residuals,” while a more complex and expensive one might be capable of producing 60 percent gasoline, 35 percent middle distillates, and 5 percent heavy residuals (Pirog, 2005). Since only 20 percent of crude oil is of the light or sweet variety, significant investment is required to build advanced facilities capable of transforming an increasingly wide variety of crude stocks from around the world into the fuels that consumers demand (Maugeri, 2006).

The Refining Process

Source: http://www.eia.doe.gov/kids/energyfacts/sources/non-renewable/oil.html

Capacity versus Utilization

In the United States, by far the world’s leading oil consumer, no new refineries have been built in more than 30 years and refining capacity has been stagnant since 1981 (Pirog, 2005)(Maugeri, 2006). In the 1970s, generous government incentives extended through the Emergency Petroleum Allocation Act of 1973 encouraged the construction of many small refineries. Over time, it became clear that an excess of capacity was hurting utilization rates and making many refineries unprofitable. Over the last 20 years, the industry has undergone a wave of consolidation, to address this problem.

As a result, while the net capacity decreased by nine percent during this period, average utilization rates jumped from a low of seventy percent in 1981 to record highs of ninety percent or greater from the 1990s to 2004 (Pirog, 2005). The trend has begun to reverse, though, as utilization rates drop below 85 percent due to massive decreases in demand in 2008, 2009, and 2010 (The American Oil Refinery Shortage Myth, 2008).In 2012, utilization rates began to rise again, reaching 92.6 percent in the last week of June 2012, the highest levels since 2007 (Zhou, 2012).

The shift from excess capacity to higher utilization rates has important consequences for energy consumers everywhere. Although refineries might be more efficient and profitable, many believe that “high capacity utilization rates leave a slim margin available to meet any increase in demand, raising, at least the potential, of market disruptions, either shortages or price spikes, in the retail market” (Pirog, 2005). The smaller number of refineries means that the risk of a supply disruption is now greater than ever before. More and more, damage or disruption to any one refinery can have a devastating impact on overall refining capacity.

The risk of a supply disruption is increased by the localized nature of consumer demand for petroleum products. Whether the tailored nature of demand is the result of national preferences (e.g. diesel engines in Europe vs. gasoline engines in the United States) or the fragmented markets that have been created by different local standards (see “Demand Imperfections: Boutique Gasoline Regulations”), it is undeniable that oil refining is a very local affair. More than ever before, local events can have disproportionate effect on a nation’s overall refining capacity. This was evidenced when American refining capacity in the Gulf of Mexico was crippled in the aftermath of Hurricanes Katrina and Rita.

Bridging Supply and Demand

To ensure the efficient operation of the global oil market, it is vital to have the right amount and mix of refining capacity so that supply can adequately meet the wide range of consumer demand. Regardless of how much oil is produced, if flexible refining capacity is not in place the prospect of a supply shortage can become very real.

Daniel Yergin, Chairman of Cambridge Energy Research Associates, has highlighted this point:

What additional oil might be produced cannot be easily sold because it would not be of sufficiently good quality to be used in the world’s available oil refineries. Refining capacity is a major constraint on supply because there is a significant mismatch between the product requirements of the world’s consumers and refineries’ capabilities. Although often presented solely as a U.S. problem, inadequate refining capacity is in fact a global phenomenon(Yergin, 2006).

Further Reading

For more information about refining, see “Adventures in Energy,” American Petroleum Institute, <http://www.adventuresinenergy.com/main.html>.


Next: Appendix B. Demand Imperfections: Boutique Gasoline Regulations