Wednesday, December 15, 2004

Gas Prices and Crude Oil Prices

Today's Wall Street Journal commented that gasoline prices were not necessarily following the path of crude oil prices, even though over half of the cost of gasoline is represented by the cost of crude oil used to produce it. The major reason was a restriction in the ability of energy firms to refine the crude oil into gasoline. The refining process is a complex and dangerous operation involving explosive chemical unit operations and very expensive equipment.

There has not been a new refinery built in the United States for nearly two decades, because NIMBY (Not In My Back Yard) groups like homeowners associations and neighborhood associations challenge almost all new plant proposals and because a protracted depression in the price of oil discouraged profitable investment in refinery plants. Refinery capacity has been increased by a process called debottlenecking, which involves identifying the choke point in a production process and increasing its capacity selectively, resulting in a much larger output from the plant with minimal (sometimes no) capital outlay. After twenty plus years of this, however, the US refinery industry will need to add new capacity by building plants soon.

Another problem afflicting the industry is environmental regulations, both in terms of product specifications and building restrictions on chemical plants. Add to that endless red tape and fears of terrorist attacks, and you can imagine the difficulty and cost of building a new plant. Regardless of this difficulty, however, as demand for new products increase, the refining industry will have to respond with additional capacity --- if not in the US, then somewhere in the world where regulation and NIMBY concerns aren't as great.