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Refiners' inventory strategies make gas prices more volatile

Brad Foss Associated Press Thursday, May 17, 2001

PAULSBORO, N.J. -- The Valero Energy Corp. refinery on the Delaware River is producing more gasoline than ever -- upward of 3 million gallons a day -- and at the same time it has less on hand. Some storage tanks have been demolished; others are standing empty.

The Valero situation is hardly unique. Nationwide, companies that refine crude oil into gasoline and heating fuel are selling their products as soon as they make them.

The real-time efficiency is good for the refiners because it cuts their inventory costs. But there's a downside for consumers: It increases the risk of a shortage, which inflates pump prices.

When pressed to explain recent gas price increases, oil and refining companies cite government regulation and environmental concerns that they say have discouraged construction of refineries and required new, cleaner-burning types of gasoline.

Largely unrevealed is their own systematic reduction in the amount of refined fuel they keep in storage, which experts say has played an important role in keeping prices high.

U.S. gasoline inventories are 26 percent lower than two decades ago. So scant is the margin for error, in fact, that a temporary refinery shutdown or other production snag creates fear that there might not be enough product to go around.

The United States is suffering from "petro-noia," said Tom Klozo, director of Oil Pricing Information Service, a Lakewood, N.J., publisher of oil industry data and news.

"We don't have shortages, but the worry about something going wrong is what drives prices higher," he said.

Not too much

Paul Brochu, general manager of Valero's refinery in Paulsboro, said his goal is to "manage inventory such that you can always meet supply, but without having too much."

For Brochu and other refinery managers, inventory isn't only a current expense, it can be a future money-loser as well, especially with today's crude oil prices at more than $28 a barrel.

If crude prices go down, and most analysts believe they will, "any gasoline inventory that you hold loses value over time," said Ed Silliere, vice president of risk management at Energy Merchant in New York. "The market penalizes you for holding inventory."

This market phenomenon has led big integrated oil companies and independent refiners to scale back their surpluses.

"We're putting a lot more emphasis on it," said Ken Abrahams, who oversees refining for a joint venture between Shell Oil Co. and Texaco Inc. "We watch inventories, as all industries do."

In this age of computerized operations and real-time market data, refiners are putting more emphasis on rapid response to profit-boosting opportunities.

With 24 hours' notice, operators at the Valero refinery can use just a few keystrokes to increase output of gasoline if there is a run-up in prices on spot markets. Volume of any one product can be adjusted by up to 5 percent, Brochu said.

From his commodities trading desk in New York, John Kilduff of Fimat USA watches the interplay of supply, demand and prices. When prices spike for refined products, inventories grow as refiners begin "rushing product to market, looking to cash in," he said.

Industrywide trend

Refiners won't give precise figures on how much inventory has been trimmed at individual refineries since 1999, when crude prices started to rise, but government data serve as a guide to understanding this industrywide trend.

About 200 million barrels of gasoline in pipelines, storage terminals and refineries are waiting to be delivered to U.S. service stations. That amount is about 15 percent less than what was available in January 1999, the federal Energy Information Administration said. During the same period, demand rose almost 9 percent.

Events of the past two years followed a cost-cutting binge by refiners, part of which focused on storing just enough gas and heating oil to meet demand. Inventories have been further trimmed through a series of industry mergers.

Last week, Valero agreed to buy Ultramar Diamond Shamrock for $4 billion in a deal that would create the nation's second-largest refiner, while Phillips Petroleum Co. has a pending acquisition of Tosco Corp. for $7 billion that would produce the No. 3 refiner. Analysts say the mergers will probably result in even tighter inventories.

Even before the Ultramar deal, Valero had reduced inventories at Paulsboro by 50,000 barrels, or 15 percent, in the past few years, said John Schields, a refinery manager.

The strategy has paid off. Stock prices of independent refiners like Valero, Tosco and Tesoro Petroleum Co. all rose about 50 percent in the past year as profit margins have nearly doubled from their historic average of 5 percent.

Refiners have boosted their output by improving the productivity of their plants. Valero, for example, said it has increased capacity at its six U.S. refineries by a total of 185,000 barrels a day in the past four years.

Yet even as capacity has kept pace with demand -- albeit barely -- industry representatives and analysts say petro-noia will last as long as refiners are forced to produce 14 varieties of low-emission, reformulated gasoline (RFG) and deliver them to different parts of the country. These small-batch blends are more difficult to distribute, requiring separate storage and pipelines.

'Balkanized the system'

"It has balkanized the system and taken away the flexibility and the responsiveness of the market," said Red Cavaney, president of the American Petroleum Institute, a trade group based in Washington, D.C.

A number of refiners, including ExxonMobil Corp., this summer have refused to make the product after a recent Supreme Court ruling that upheld a Unocal Corp. patent on the recipe for RFG. Some refiners pay a patent fee to Unocal, while others say they can produce without violating Unocal's proprietary formula.

Imports from Europe have helped pick up the slack, but as countries there implement their clean-air rules, certain blends of RFG are less available in the United States this summer, causing regional price spikes.

With foreign supplies of RFG drying up, refining capacity tight and inventories dwindling, "the safety valves that used to be there are gone," said Larry Goldstein, president of the Petroleum Industry Research Foundation in New York City.

"People who want gasoline can buy it," he said. "The question is: [How much] do you want to pay for it?"

Copyright 2001 Star Tribune. All rights reserved.

-- Martin Thompson (, May 16, 2001

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