Monday, June 25, 2007

The US Refining Industry: Another Business Where Costs of Production are Key

This is an interesting article from Bloomberg concerning the oil refining industry. It basically states that buying refineries is cheaper than building one. For example, you can buy refinery for $12,000 per processing barrel, where the costs to build the same capacity is $18,000 to $20,000 per processing barrel.

Refining is a difficult business because it cannot control the costs of the input (crude oil) and the refineries ultimately cannot control the price of the output. Therefore, if the refinery does not buy right or the price of the product falls, the margins are squeezed. So even though margins are more generous now, in the future this may not be the case. So trying to re-coup the cost of the refinery from decreasing margins could increase the payback period of the project. This is why so many plans for new refineries or plans for expansion of existing facilities are being shelved.

Refineries are generating record profits of $17 to $24 per barrel, seven times higher than the 1990s average.

Li paid $11,515 for each barrel of refining capacity; Barrack's deal equaled about $12,100. Marathon is spending $17,778 on each barrel of capacity to be added in Louisiana.

A near doubling in engineering costs since 2005 has ended at least 10 new refining projects worldwide, said Fesharaki at FACTS Global.

``For five to six years, you're pouring billions of dollars into a project and getting nothing in return,'' said Lynn Westfall, chief economist at Tesoro. ``Even at today's margins, it's going to take 10 to 15 years to repay that investment.''

Reliance is among the few energy providers ready to complete a new refinery. The 580,000 barrel-a-day plant in Jamnagar, western India, built at a cost of $6.1 billion, in June, 2008 will start making diesel for Europe and gasoline for the U.S.

Each barrel of daily processing capacity will cost Reliance $10,500. Reliance gave final approval for the project in December 2005 and locked in most costs within three months, before they spiraled out of control. Shares of Reliance Petroleum Ltd., the subsidiary that's building the plant, have gained 66 percent since an initial sale in April.

Kuwait Petroleum Corp., the Middle East's biggest exporter of refined products, June 17 invited new bids to design and build a 615,000 barrel a day refinery. A first round of bids at $12 billion, or $19,512 for each barrel of daily capacity, was rejected in February. Kuwait Petroleum originally estimated the construction costs at $6.4 billion.

``Asking anyone to build a brand-new refinery today is asking them to take a 20-year bet that refining margins are going to remain where they are,'' said Tesoro's Westfall.

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