The US experiences periodic gasoline price shocks, and we’re often told it’s less to do with constrained crude supply than with constrained refinement capacity. Many oil-rich countries actually import the majority of their gasoline because of constrained refinement capacity (Iran, Kuwait, Mexico, I’m sure many others)
How can this be? Oil refinement, complex though it certainly must be, is not nuclear energy or rocket science or anything like that. There’s no quantum mechanics. There aren’t any military secrets involved. It boils down to distillation (no pun intended), the principles of which have been known for centuries. If it’s all machines and engineers, what is the big obstacle to adding capacity? I get that environmental obstructionism is an issue in the US, but surely that’s not a problem in Iran or Kuwait.
Your typical Joe Average oil refinery costs about $5 Billion to build (if the numbers I found on google are accurate). You could build a smaller refinery, but it isn’t going to be cost effective and wouldn’t help significantly when one of the big refineries goes offline for some reason.
When all of the refineries are operating, there is plenty of supply for everyone.
So, all you need to do is convince investors to shell out $5 Billion for something that is only going to be needed once in a while (when a major refinery goes offline) and otherwise will be wasted capacity, which means it’s going to be hard to make a profit with it. Yeah, that will be an easy sale. Good luck with that!
Okay, so it costs 5 billion. It sounds like a large number, but the US spends that much in a month in Iraq. Isn’t that chump change for a country like Iran that needs it, can afford it, and has lots of local petroleum supply to exploit? Isn’t that a good bargain for a country like the US that is actually being harmed by insufficient capacity?
In the US, I believe the construction of refineries is not funded by the government; they are built, owned, and operated at the expense (and for the profit) of companies like BP.
Are refineries in Iran national assets, or are they corporate owned/operated? If the latter, then the business case for building one in Iran is no different than the business case for building one in the US.
Also refineries are not very popular things to locate near people’s homes and businesses. So I imagine that getting permission to build one is going to be a long, hard process. (There’s a reason that so many of them are in New Jersey.)
Price fluctuations are not due to limited refining capacity. Even though new ones are not being built, upgrades to existing refineries are more than keeping up with demand.
Fluctuating oil prices are caused by speculation in the market.
It is quite complicated though, because crude oil varies wildly in contents, and you want to get more than just gasoline and throw away the rest. So it’s not like you build a refinery in the middle of nowhere, and let the next illiterate goat herder throw a switch to start the automatic process. You need engineers there, which want pay.
This is a major reason why there aren’t more refineries. Another reason is that there are is no great shortage of refineries, so building a new one is no guarantee of profit. BTW: Most existing refineries are constantly being rebuilt to for greater efficiency and to accomodate the changing oil sources and output demands.
So, let’s say you open your $5 billion refinery. Will it be profitable? Nope, so why do it? As for the US government, it doesn’t really operate businesses. We prefer it that way. Especially out of businesses with low margins where the oil companies occasionally take losses to move product. I can’t imagine Americans getting behind a federally owned refinery.
Beyond that, there’s the NIMBY problem. Everybody wants new refineries. Few people want that refinery in plain sight (“how about over in that town? It’s not like that’s a nice place”). So, we make up for it by expanding capacity at existing refineries. This mostly works. We pretty much can refine what we need. Shocks come because we suddenly don’t have enough crude, not refining capacity.
Also, while refining is not rocket science, not all crude oil is the same. For example, the US is pretty much the only country that can handle that heavy sulfur-rich sludge coming from Venezuela. And anybody can handle West Texas Intermediate (light, low sulfur).
As for Iran, it IS boosting its refining capacity. But, as mentioned earlier, it takes time (a lot of time) to bring additional capacity online (and they spent billions doing it). I believe they claimed they had no gasoline imports this year. If they keep adding new capacity, they could be exporting refined petroleum in another few years.
Yeah, it’s plenty hard! And the public are scared to death of them and don’t want them in their state.
From someone that spent 32 years in the petrochemical industry.
Our company had a gasoline refinery across the street that we sent our side streams. They later sold it to Shell. In the early 90’s Shell tore it down and it was moved overseas.
maybe Iran is afraid to make investments in big localized facilities for fear of destructive bombing during the next war? Let’s say if the refinery ought to pay for itself in 10 years and they figure that the war will happen within 10 years from now, they will end up with a pile of rubble before the investment fully pays off.
Admittedly, I also wonder why spare refineries are not built by non-crazy countries that are not threatened by war, e.g. Russia, China, Indonesia, Brazil etc.
It is a good question why the oil rich countries haven’t built a petrochemical industry as well as refineries. Most likely it is because so much is controlled by the government with wrong priorities.
Why has China recently become such an economic threat? New thinking by their government.
Perhaps the oil-rich countries haven’t built much refining capacity (beyond what’s needed for domestic use) because it’s a low-margin business. Also, isn’t it more cost-effective to ship crude oil overseas rather than gasoline or some other petroleum product?
There was one about 10 miles from where I grew up. Refinery was in Commerce City, I grew up in Thornton, CO. It was a stinky thing, but not as bad as the stock yards and sewage treatment plants that were also down that way…but worse than the coal fired power plant.
One day I was getting ready for school and the house shook with a big boom. There had been an explosion at the refinery that killed several workers and broke windows for a couple mile radius. This would have been late 70’s…78 if I had to guess.
ETA:www3.gendisasters.com/node/16440
october 78 from the google preview, but I can’t open the link from here.
my figures may be slightly off but they’re enough i think. to the OP, refining cost is only around 10%-15% of the cost you pay for your diesel or petrol. 85% to 90% is cost of crude oil. on the question of refining capacity, you somewhat got it right: it is easy but you need a really big scale of refining to make it efficient (bring it down to 10% of total cost or even less.) that’s why for third world countries, it makes a lot more sense to import finished petroleum products than to build their own refinery. that’s because their refining potential cannot match the scale and efficiency of developed countries’.
as to the price of crude oil, it’s subject to futures speculative trading. how much is a barrel doing now, $94? do you know that most oil companies produce a barrel of crude for less than $25? maybe an expert in futures tradign can explain this.
Speculation accounts for some of the price, but certainly not 2/3 of the price.
The way it was explained to me is that various sources of oil cost different amounts to extract, and the price of oil doesn’t depend on the average cost of production, but instead on the cost of production of the most expensive barrel of oil produced.
For example, suppose we lived in a world where there were two sources of oil:
[ul]
[li]Source A: Costs $25 to produce a barrel of oil. Can produce 100000 barrels per day.[/li][li]Source B: Costs $94 to produce a barrel of oil. Can produce an arbitrary amount per day.[/li][/ul]
Assume also that oil is freely traded on an open market, and there are many non-colluding producers extracting from each source.
So long as demand stays below 100000 barrels per day, the price of oil will hover a little above $25, and only producers extracting from source A will do anything. At that price, extracting oil is a money-losing proposition for anyone extracting for source B, so they’ll shut down production. Conversely, if any producer on source A tries to raise the price, they’ll immediately be undercut by some of the other A producers and have to lower their price back to the market price.
But as soon as demand hits 100001 barrels per day, the price on the market will rise until one of two things happens.
[ol]
[li]Someone on the demand side says, “I can’t afford to pay that for oil”, and stops demanding oil.[/li][li]The price hits $94 and a source B producer can make a profit on filling the demand by producing one barrel per day.[/li][/ol]
Oil being the foundation of modern industry that it is, the first scenario is less likely than the second, so the price goes up to $94. It doesn’t matter that nearly all of the oil is extracted at a much lower cost, that last barrel drives the price up to its cost, and the producers from source A get a $69/barrel windfall.
Even if one of the producers from source A was willing to give up its windfall (out of the goodness of its heart) and still sell its oil for $25, someone would jump in and buy the oil for $25 and sell it into the market for $94 and pocket the windfall for himself.
Moral: Yes the Saudis are making a killing, but it’s not entirely because of speculators and price gougers – the market kind of works that way.
leahcim did a great job of explaining it…that’s the way I understand how it works as well:
My guess is you made that figure up or whoever told you made it up, but another factor in the cost that goes into speculation is transport. You have to actually deliver the oil from where the wells are to where the refinery is, and that tacks additional costs onto every barrel of oil. If the oil producer’s costs are $25/barrel (in labor and capital costs for the original exploration, test wells and initial drilling and well production), you still have to actually get the oil to where it’s needed. Speculators have to factor those costs in, as well as other factors such as ‘will the oil actually be delivered, how much might the price change during my contract period, what geo-political thingies might impact delivery or fulfillment of said contract 6 months or a year or 5 years down the road’, etc etc.
Seriously…if you think speculation is such a winning game and they are all out there fleecing the public for 2/3rds of the costs then you should jump into the game and make millions.
