Get Used to Gas Price Run-Ups

In addition to flowers and picnics, big hikes at the gas pump will be an annual spring tradition. Refiners won't catch up with booming demand for years.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

June 8, 2007

The good news: Gasoline's steep price rise is finally coming to an end.

The bad news: Sharp jumps at the pump will be annual spring events for a number of years. The traditional pattern for motor fuels, in which spring brought fairly gradual price advances ahead of the peak summer driving season, is fast becoming a pleasant memory in relative terms.

Oil's not the culprit. Blame a lack of oil refining capacity. In theory, refiners should be expanding briskly in response to explosive growth in demand for gasoline and fat profit margins. Refiners are currently clearing a whopping $30 on every barrel of oil they buy and turn into gasoline.

Refiners are expanding, but at a fairly modest pace, not fast enough to keep up with the global surge in the number of drivers as car markets in China, India, eastern Europe and other emerging economic regions take off. The U.S. thus faces much stiffer competition for imported gasoline, which now accounts for about 10% of domestic supplies.

What's holding refiners back? For one thing, they're wary of overinvesting, given the volatile nature of the energy markets. Refiners have seen margins suddenly shrink in reaction to oil price spikes or unexpected dips in gasoline use. That creates a general fear of commitment when it comes to building large, capital-intensive refineries. The proliferation of environmental regulations around the country, requiring different fuel mixes in different regions, also has made refinery building more complicated.

Coaxing by Congress to boost refinery construction won't do much good, at least in the short term. Lawmakers have eased some restrictions, reducing the federal paperwork required to obtain permits to build and operate new refineries. But refiners still have to slog through the state and local permitting process and deal with possible legal challenges by local governments and citizens. Refiners also are bracing for a host of new regulations aimed at cutting emissions of greenhouse gases, and operators don't want to commit funds before they know what to expect.

Jason Schenker, an economist with Wachovia Bank who follows the energy sector, notes that refiners generally are limiting themselves to small add-on projects at existing facilities that have already gone through the permitting process. Refinery operators also are seeking expansion through acquisitions, but this doesn't boost overall gasoline supply.

One much-touted government initiative has been to allow refineries to be built on properties formerly occupied by military bases. The Army is closing dozens of bases as part of a broad reorganization of military resources. But these properties are simply going to be turned over to local communities, whose residents will surely raise plenty of "not in my backyard" concerns when refinery projects are proposed.

Refineries are also prone to more-frequent outages as they age. The average U.S. refinery was built 30 years ago and, even with careful maintenance, is vulnerable to outages. Indeed, refinery accidents have been epidemic in the U.S. and Europe this year, adding to tightness in the gasoline and diesel markets.

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