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Thursday, October 19, 2017

Hurricanes Aren’t the Only Reason Gas Prices Are High

While some of the rise in gas prices can be blamed on hurricane-related supply disruption, regulatory burdens play an even bigger role.

Hurricanes Harvey, Irma, and Nate highlighted the exposure to life and property all along the Gulf Coast. Of the critical national assets that took a hit, the crux of the U.S. refining industry suffered dramatically. As a result of Harvey alone, twenty refineries in the 300 miles between Corpus Christi and Beaumont were forced to shut down or dramatically reduce rates. The spot price of ultra-low sulfur diesel (ULSD) promptly increased by 10%, while that for gasoline and jet fuel increased by 25%. All three prices remain about 10% higher than before the hurricanes, in part due to regulatory constraints that extend the duration of such price disturbances and highlight the challenges facing the aging American refinery fleet.

In 1982, there were 301 operational U.S. refineries. There are 141 today, and several of them were first commissioned in the 19th Century. Over the same period, domestic operating capacity has increased slightly, from 17.9 to 18.6 million barrels per day. Today, forced-shutdown events like that from a Harvey constitute more than 10% of domestic refining capacity. The remaining mega-refineries involve multiple processing units that are highly integrated, which makes it challenging to come to a coordinated, complete stop. The same can be said of re-starting, with an intermediate period on both sides where off-spec material is generated. How did we get here?

Regulatory Burdens

As a result, the weekly average price of retail gasoline was 20% higher as compared to the same period last year. Both the paucity and the complexity of the American refinery fleet are largely the result of the increasing regulatory stringency placed on motors and motor fuels. Take sulfur, for just one example. In 2000, the Tier 2 Gasoline Sulfur program placed limits on the sulfur content in gasoline. This was done so that by 2004 additional requirements could be placed on vehicles to use advanced emission control systems, the catalyst for which the sulfur would deactivate. Like for the gasoline vehicle fleet, the sulfur content of diesel has been gradually reduced, and reached 15 parts per million (ppm) in 2007, such that newer-model diesel engines are now required to have emissions-reduction technology. Most recently, the implementation of the Tier 3 program at the beginning of this year has seen the sulfur content of gasoline drop to a maximum of 10 ppm. As a result, while the price of oil has been stable, even before Harvey, the weekly average price of retail gasoline was 20% higher as compared to the same period last year.

Of course, this is because sulfur does not remove itself, and meeting ever-more stringent fuel specifications is becoming increasingly difficult. First, equipment that was already old is now cold, and bringing it back into service is an effort fraught with unsteady performance that breeds equipment failure. And, with its content now severely limited in all major refinery products, process units that remove sulfur have become a tremendous bottleneck to refinery start-up and operation. Also, the extended time required to meet fuel specifications on start-up means more off-spec material is generated that must be re-processed, which lowers overall refinery efficiency and fuel yield.  

Supply Chain Problems

Some refineries will continue to run sub-optimally until international supply chains normalize. Hurricane Harvey also exposed supply vulnerabilities that come with our relatively old and fixed refinery fleet. First promulgated under the Clean Air Act in 1980, the New Source Review (NSR) process is a major source of regulatory uncertainty that prevents new refineries from coming on-stream. Then, in 1996, the Clinton administration interpreted NSR to include routine maintenance projects, hampering the ability of refiners to replace old, inefficient equipment. For example, in 2001 Marathon Ashland Petroleum was one of five companies to settle with the EPA on alleged violations of the revised NSR interpretation. In addition to paying a $3.6 million civil penalty and installing $263 million in emissions control systems, the agreement included the donation of an island in the Rouge River to Wayne County, Michigan. Subsequent administrations have further tweaked NSR, adding still more regulatory uncertainty to lengthy projects that often span the four-year election cycle. Add in the impact of a Harvey on the viability of installed equipment, and the ingredients are there for further deterioration of the fleet going forward.

Furthermore, because the capital upgrades pursued by refiners since 1980 have largely been to satisfy each increment of regulatory oversight, many refineries are limited to using those crudes that have compositions commensurate with the installed equipment. This explains why increased domestic oil production has only partially offset the amount of oil imported by the U.S. Even though oil production has increased by more than 4 million barrels per day since 2011, U.S. imports have only decreased by 1 million barrels per day. This suggests that U.S. refineries are not configured to process significant amounts of the crude oils being extracted in Texas and North Dakota. And, because oil is not truly fungible, disruptions in the supply chains of international crudes disproportionately affect those refineries most geared for its distillation and sulfur removal. This mismatch in domestic capacities is, therefore, another contributor to the lag in fuel price recovery, as some refineries will continue to run sub-optimally until international supply chains normalize.   

Gulf Coast refiners continue to recover from the severe, if short-term, impacts of Hurricane Harvey. Some refineries in Harvey’s path suffered considerable flood damage and remain shut, and the regulatory uncertainty on capital projects will continue to hamper their ability to return to full operation. Even then, refiners will be restarting units that are not fully suited to the crude oils increasingly being extracted just up the road, leaving some of our most critical national infrastructure exposed to international supply chains. The sum of these regulatory hurdles means that pump prices are increasingly dependent on conversion and supply constraints, rather than the underlying price of oil. Fully unlocking the potential of domestic energy, therefore, means peeling back multiple layers of regulatory burden.  

  • Dr. Jacob R. Borden is assistant professor of chemical engineering at McNeese State University.