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The Wall Street Journal: Rising Costs for Refiners Delay Expansion Projects

Wall Street Journal Chart

Limited Capacity
Could Lift Prices
At Pump for Years
By ANA CAMPOY and RUSSELL GOLD
June 12, 2007; Page A12

The cost of building or expanding oil refineries is rising rapidly, contributing to delays in increasing the U.S. gasoline supply at a time of near-record prices.

Under Scrutiny: Refiners, flush with profits, face political pressure to add capacity.The oil industry is blaming cost escalation — driven by shortages of skilled labor and construction services, along with higher materials prices — for a spate of pushed-back or scrapped expansion projects. Valero Energy Corp., the U.S.’s largest refiner in terms of the amount of crude it can refine, has delayed expansions in Quebec, Canada, and in Texas. ConocoPhillips has put off projects at refineries in Texas and in Louisiana, while Tesoro Corp. canceled the installation of new equipment to process cheaper crude at a facility in Anacortes, Wash.

The decision to rethink construction comes as the industry, flush with profits from high gasoline prices, is under fire from Congress and consumer groups in the U.S. for not doing enough to build capacity. Delays could expose the industry to additional criticism and unwanted oversight.

The average price of regular gasoline in the U.S. was $3.08 a gallon yesterday, up about three cents from a month ago and up from $2.90 a year ago, according to AAA, formerly the American Automobile Association.

Years of industry underinvestment have contributed to the current rise. Refiners in past years blamed low fuel prices and poor returns, as well as environmental opposition to major expansion efforts and the cost of keeping up with fuel regulations. In the U.S., no new refinery has been built since 1976.

Even today, with prices high, refiners are loath to build new facilities for those environmental and regulatory reasons, as well as concerns that fuel prices might moderate long term. Instead, the industry has invested in expanding or modernizing existing facilities, resulting in gradual output increases.

Meanwhile, the big push for new refineries has been in the Middle East and Asia, where demand for fuels is rising much more rapidly than in the U.S. Some of these refineries plan to ship part of their output to the U.S.

Refiners say escalating costs threaten projects outside the U.S., as well. ConocoPhillips might back out of participating in a massive 500,000-barrel-a-day refinery in the United Arab Emirates with International Petroleum Investment Co. of Abu Dhabi. In April, ConocoPhillips Chief Executive James Mulva said the refinery’s costs were “challenging,” and he questioned whether the Houston company would participate.

The swiftly rising costs compound the industry’s trouble in keeping pace with growing fuel demand world-wide. With demand soaring again, the industry’s attempts to catch up are overwhelming the engineering and construction capacities to build refineries, as well as the global market for specialized refining equipment.

This couldn’t come at a worse time for global consumers, and it could keep transportation-fuel prices high for years to come. Today, despite high pump prices, global consumption of gasoline and other refined petroleum products is rising, paced by rapidly growing demand in China and other developing economies as well as continuing growth in the U.S.

The energy industry already had been dealing with runaway costs for projects that extract oil and natural gas from the earth. The causes were a scarcity of engineers as well as high prices for steel, concrete and other basic materials. This inflationary environment is now hitting the rest of the energy industry.

“All of you who cover our industry certainly are well aware of the rapid escalation in costs in the exploration and production segment in particular, but it has spilled over into refining and chemicals,” said Rex Tillerson, Exxon Mobil Corp.’s chairman and chief executive, at a news conference following the company’s annual shareholder meeting in late May.

U.S. refiners say costs started rising in 2004 and jumped after the hurricane season in 2005 as the Gulf of Mexico region absorbed much of the available labor, materials and construction services for the repair of hurricane damage. Moreover, refining companies are competing for resources globally.

“A lot of the skilled labor has moved on to other industries or other areas,” Valero President Greg King said. Valero’s costs for steel have gone up 74% since 2004, while the cost of Gulf Coast skilled labor has risen 60%, Mr. King said. The competition for labor and construction services has also resulted in a productivity drop of 35% as the most skilled contractors take jobs elsewhere, he added.
 
In recent years, refining projects have sprouted all over the world amid growing demand for fuels. The refinery-related backlog of Foster Wheeler Ltd., an international engineering and construction firm, almost doubled in 2006 from the year before to $1.74 billion. The Bermuda-based company warned investors in its annual report that as costs rise and “the delivery schedule of engineering and construction services lengthens, clients may elect to cancel or delay investments until the market slows.”

Still, many projects are going forward. “Not every project is unaffordable,” Valero’s Mr. King said. This year, the company finished an expansion of the crude unit at its Port Arthur, Texas, refinery that increased capacity to 325,000 barrels a day from 295,000. Valero is discussing plans to expand its refinery capacity in Delaware City, Del., by 20,000 barrels a day.

Marathon Oil Corp. stuck to its plans to expand its Garyville, La., refinery even though the price tag will be much higher than originally anticipated. At the beginning of 2006, the company had expected the expansion to cost $2.2 billion, but it raised its projection to $3.2 billion by the time the project was approved in November that year.

To deal with the global scramble for labor and materials, Marathon is looking to the future. This year, the Houston-based company organized a job fair to start recruiting and training people to build and operate its expanded facilities. In 2006, before the ground in its construction site had been cleared, the company ordered some of the massive equipment that will run the refinery earlier than usual.

“It’s a big project,” said Chris Fox, spokeswoman for Marathon. “You can’t leave anything to chance.”

BUILDING BLOCK
 
Higher Tab: Rising labor and material costs are slowing projects that would add refining capacity in the U.S.

Cross Borders: Higher costs are also hurting construction of new refineries abroad.

Write to Ana Campoy at [email protected] and Russell Gold at [email protected]

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