"A Case of the Vapors," Feature Article, December 2004

FEATURE FOCUS: Global Fuel Systems

a case of the vapors

An increasing reliance on gasoline imports puts another uncertain link in the U.S. fuel supply chain.

by Jeffrey Winters, Associate Editor

If one machine could symbolize the vulnerability that the United States has to international influences, it would be the supertanker. It is up to a quarter-mile long and capable of holding cargoes weighing up to a half-million tons. The American economy would grind to a halt without a steady stream of these giants delivering crude oil to our ports.

But along the Atlantic Coast and elsewhere, a different petroleum cargo is being imported: gasoline. Instead of refining crude oil in domestic refineries, oil companies are becoming increasingly dependent on imports of finished fuels to meet the growing American thirst for gas.

The arrangement has benefited both sides of the trade. Domestic refiners can keep their overall capacity tight, secure in the knowledge that any demand spikes can be met with imported gasoline. And foreign companies can use the American market opportunistically to sell off excess gasoline production rather than store it at home.

This relationship could be in danger of breaking down. Recent changes in U.S. fuel standards may reduce the number of foreign refineries capable of serving the American market. And demand from China and India is rising fast. We may soon find ourselves more dependent than ever on a handful of nations—and fighting off foreign competitors—in the quest to meet our transportation fuel needs.

The familiar model for the U.S. oil industry has been that crude oil makes its way to American refineries and there is processed into a variety of products. It isn't just gasoline that is produced, although gasoline makes up more than half of American refinery output. Petroleum refineries also turn out jet fuel, heating oil, propane, and other products.

This model has dominated during the era when the United States produced most of its own oil and in the past few decades, when imports have equaled or surpassed domestic production. Ports in New Jersey, Louisiana, California, and elsewhere are ringed with refinery complexes to handle crude brought in by tanker.

Sailor's delight: The new gasoline supply chain begins in overseas refineries with excess capacity, like this one in Germany (above). The gasoline is then loaded onto a tanker to be delivered to U.S. ports.

But while refineries are a critical link in the transportation fuel supply chain, and with American oil consumption rising steadily over the past two decades, something remarkable has happened. "The big problem in gasoline today isn't crude," noted Vice President Richard Cheney in 2001. "It's the lack of refinery capacity. We haven't built any new refineries in this country in over 20 years."

Refinery construction in the United States is close to impossible. In fact, when the possibility of new refineries was mentioned to Joanne Shore of the Energy Information Agency, she quickly dismissed it. "We're not seeing anyone adding grassroots capacity," Shore said.

There are now 104 fewer U.S. refineries in operation today than in 1982, according to the Energy Information Agency. That doesn't mean, however, that domestic refinery production has gone down—quite the opposite. Operations have undergone two revolutions since the last refinery was built in the early 1980s.

The first revolution comes in the form of technological advances that wring greater output from the same refinery footprint. Equally important, a revolution in management helps established refineries operate at an ever-higher percentage of peak capacity. So-called de-bottlenecking enables managers to schedule the production of batches of refined components in such a way that downtime is virtually eliminated.

Even with these steps to make a smaller number of refineries churn out a greater volume of product, there can be some serious shortfalls. Something as simple as an industrial accident or fire can sideline a refinery for months at a time. With individual refineries producing as much as 2 percent of the nation's gasoline, a few simultaneous disruptions can play havoc with the supply line.

Maintenance is another factor that slows down gasoline production: Those efficiency upgrades have to be added sometime. But this past year, many states have begun phasing out the use of methyl tertiary butyl ether, or MTBE, a fuel additive intended to reduce smog-forming emissions. In many cases, refiners are switching to ethanol as a replacement.

Also, new federal standards have instituted a 90 percent cut in the allowable levels of sulfur in gasoline. To meet these new mandates, refineries have had to halt production to install new equipment.

"The industry is putting a lot of money into the low-sulfur fuels program," Shore said. "And the resources needed to do that—monetary resources and a lot of human resources—are constraining. You can only do so many things, so it is distracting from capacity expansion to some degree."

Above all, the industry is faced with meeting the ever-rising demand for gasoline. Gasoline consumption has gone up by 23 percent since 1988 and by 13 percent in the past seven years. The EIA predicts that if current trends hold, American drivers will burn an additional 4.5 million barrels a day by 2025—a staggering 50 percent increase over current demand.

With gas consumption ranging from 8.6 million to 9.4 million barrels a day and refinery capacity under 9 million barrels a day, it's clear that the industry is no longer able to meet domestic demand. Gasoline must be imported from elsewhere.

Gasoline is almost as portable as crude oil on the international market, although gasoline must be transported in smaller, cleaner tankers, which makes transporting it more expensive. As long as gasoline could be imported for less than the cost of refining it domestically, there would be a role for imports. Nations such as Venezuela have, for decades, shipped limited amounts of gasoline as well as crude oil to the United States.

But until the mid-1990s, U.S. refineries were faced with a glut of capacity, and it almost always made more sense to import crude rather than finished fuel.

With domestic refining capacity falling behind domestic demand, imports have taken on a new role: smoothing out any mismatches between gasoline supply and demand. Gasoline is sold on a worldwide spot market, and international refiners know that every gallon of gasoline will be bought by someone, somewhere. "If gasoline importers are well paid by the U.S., gasoline will go to the States," said Jean-Claude Company, vice president of refinery operations for the French oil giant Total. "If it gets a higher price somewhere else, it will go there."

Total provides a perfect example of the opportunistic nature of the global fuel market. The Paris-based oil giant is largely focused on serving European consumers. But there has been a marked trend there in recent years away from gasoline-powered cars and toward diesels, which feature greater fuel economy and produce fewer greenhouse gases per mile.

Hitting the limit: When U.S. refineries started operating close to capacity in the mid-1990s, gasoline imports began to increase.

This trend has left Total and other refiners with excess gasoline refining capacity. "The molecules that are dedicated to gasoline are not the same as the ones dedicated to diesel," Company said. Since the mid-1990s, the gasoline glut has been shipped to the United States. Some 40 percent of American gas imports now comes from Western Europe.

European refiners are looking to solve this problem by switching refining technologies. Hydrocracking, which is a high-pressure process that relies on hydrogen to saturate various products, will enable them to make more diesel from a given barrel of petroleum, and less gasoline. Although expensive, hydrocracking technology has been added at some European refineries already, and it is expected that many more will be converted over the next decade.

Until then, however, companies such as Total can produce far more gasoline than their domestic markets can absorb. Rather than shutter some of these refineries, as was done in the United States in the 1980s, Total is producing more gasoline than needed and putting the difference on the international market.

"We are trying to reorient ourselves to making more diesel," Company said. "But while we make that change, the U.S. gives us a good opportunity to sell the gasoline that we make."

While Total's commitment to American consumers will last as long as they can pay the highest price, other companies are more dedicated suppliers. Irving Oil, based in St. John, New Brunswick, has made exports to the United States a centerpiece of its business strategy.

Irving, which serves the Atlantic provinces of Canada, realized in the 1970s that as it expanded and updated its refinery in St. John, it would be able to produce far more gasoline than its local customer base could ever use. Since the late 1980s, Irving has exported a significant volume of gasoline to the United States.

The 280,000-barrel-a-day St. John refinery is in a perfect position to reach customers in New England. It is only 65 miles from the Maine border and about 400 miles from Boston. That's about as close as Montreal, the nearest large market in Canada.

"We ship gasoline from St. John to Boston in 24 hours," said Kevin Scott, director of supply planning and trading for Irving. "And there's other demand all along the way. So over time, it became natural for us to send our product south rather than inland."

What's more, Irving's crude oil terminal in St. John Harbor sits in 128 feet of water. This facility can accommodate 400,000-ton, ultralarge crude carriers, meaning that Irving can transfer oil directly from these behemoths to its crude oil storage facility and on to the refinery.

Irving Oil transports gasoline to the United States in tanker trucks and ships. The company sends 100,000 barrels of gasoline a day, constituting some 80 percent of Canadian gasoline exports to the United States and about 1 percent of total American consumption.

Scott said he expects this supply will remain fairly stable in the near term: Demand in the Atlantic provinces is not growing appreciably, and no refinery expansions are on the horizon.

Even American companies are jumping on the bandwagon. In May, San Antonio-based Valero, which operates 13 U.S. refineries, purchased a 315,000-barrel-a-day facility on the Caribbean island of Aruba. This isn't the first foreign refinery for Valero, which owns one in Quebec, but it is the first it purchased expressly for making products to be imported by the United States.

According to Valero's senior vice president for refining operations, Rich Marcogliese, the Aruba refinery's major product will be feedstock for other Valero refineries along the Gulf Coast. The refinery processes low-grade crude from the Yucatan peninsula that costs much less than benchmark grades. Once the preliminary refining is complete, the feedstock is shipped to the United States in order to be further refined into gasoline.

Rather than seeing it as a foreign asset, Valero "looks at Aruba as part of our Gulf Coast network," Marcogliese said. "It's a good strategic fit."

Different strategies: The Total refinery in Normandy (top) makes more gas than is needed in Europe; the excess in shipped via tanker (middle) to world markets. Valero's refinery in Aruba (above) makes products dedicated to its U.S. refineries.

For Valero, the Aruba refinery project is both a challenge and an opportunity. Marcogliese said he was struck by the antiquated power generation facility at the refinery. Electricity is so expensive on the island that the plant must generate its own. Some of the equipment, he said, dates to the 1940s. On the other hand, the refinery has the potential to more than double in capacity, and its port facilities are top-notch. With the right upgrades and expansion, the Aruba refinery could be a major exporter to the United States.

The change in American fuel standards has tilted the playing field for would-be exporters. In particular, the reduction in sulfur content has taken many refineries in South America out of the running as suppliers of gasoline to the United States.

Until these refineries make the necessary upgrades—whose timing depends on the international spot price and on demand from less stringent countries—imports may be restricted to advanced, First World refineries, such as Total's and Irving's facilities. "The specification in the U.S. is more sophisticated than the rest of the world," Company said. "Because of this, Americans are willing to pay a bit more, and that means we can get more money from our ability to make sophisticated fuels."

The EIA projects that Western Europe will remain a dominant exporter of gasoline to the United States for at least another decade, due to its high-tech refineries and its proximity to East Coast ports.

Analysts expect that domestic refinery capacity will increase over the next several years, as money that recently has been put into meeting new standards will be invested into expansion. But even if this is the case, imports of gasoline are not expected to decrease significantly. Barring an economic slowdown that would reduce driving, gasoline demand should at least keep pace with any refinery expansions, meaning that imported gasoline should retain its 10 percent share of market.

For some refiners, that's part of the business plan. Irving Oil's St. John refinery and Valero's facility in Aruba are dedicated to the U.S. market, and it's hard to envision a situation in which their products won't be sent to the United States. Other refiners, however, may not be as dependable. Total's Jean-Claude Company, for instance, views the American market opportunistically.

Company also pointed out that there is a limit to how much gasoline the United States can import. "The main thing to fear is logistics," Company said. "As you increase the amount of gas that you are importing, the number of tanker ships needed increases. One day, you will hit a roadblock in logistics."

The EIA's Shore is a bit more sanguine. "If you look at the Northeast, the supply chain from the Gulf Coast is almost as long as the supply chain from Western Europe," Shore said. "It's just a different supply chain."