Bending the Third Rail
Because We Should, We Can, We Do
Tuesday, June 06, 2006
Refined Market Strategy
Want to understand the economics of high gas prices?

A big part of it is the decline in refining capacity. Unlike any other business, refiners actually benefit from declining capacity and loss of refining capacity. The New Yorker has a very concise and brief explanation of how these economics work. It's well worth the read.

I would add that the fact that oil companies have not built a new refinery since 1976 is not just the result of environmentalist, NIMBY, and regulations. The oil companies, despite their public presenatation, are not stupid. They recognize that peak oil is upon us. To spend $2 Billion per refinery to increase refining capacity on a declining commodity is not a good business strategy. Why take that risk when maintaining a tight refining market results in such positive shareholder gains?
Blogger mikevotes said...
That's an interesting point about not building in the face of peak oil. I hadn't thought about that.

My first reaction on reading that was a skeptical "yeah, but that presumes a pretty sharp peak," but then I thought

You figure the workable lifetime of a refinery is around 40 years, there are some older here, but that's the rule of thumb as inefficiency puts them out.

If you look at the bell curve 40 years would get you a fair bit down the backside.

(Oh, and you didn't mention that a good part of the profits are coming from the extraction portion of the business. Even if refinery profit is kept fixed per barrel, the increase in price is free money on the production balance sheet. I don't know what the math is currently, but back in the oil glut (Remember the Clinton years?) all the profit calculations on extraction were based on $20-22/barrel, and everything after that was pure profit.)