Experts Blame Gas Prices on Refineries Not Meeting Demand

by Alexander Coolidge
The Enquirer

Why are gas prices stuck around $3 a gallon? Experts blame supplies.

Not enough refineries are churning out enough fuel to meet a steady rise in demand, industry watchers say. That’s because big oil companies aren’t piping their profits into radically expanding operations.

So where is Big Oil spending its money? On an investment with a quicker return: stock buybacks. Last year, Exxon Mobil - the world’s largest integrated oil company - increased its capital expenditures by 11.7 percent to nearly $15.5 billion but increased its stock repurchasing activity by nearly two-thirds to $29.6 billion.

Other major oil companies with refining operations also have boosted buybacks.

Marathon Oil spent $1.7 billion on its own stock in 2006 - sharply higher than the $7 million it spent on shares in the previous year - compared with the $3.4 billion it spent on capital expenses, which increased 18.8 percent.

Sunoco more than doubled its stock repurchased in 2006 to $871 million while increasing capital spending by 5 percent to $1 billion. In 2006, Chevron boosted capital expenditures by 58.8 percent to $13.8 billion but hiked stock buybacks by 72.9 percent to $4.5 billion.

“Clearly capacity is an issue contributing to rising prices,” said Raj Manglik, a professor of mechanical engineering and member of the University of Cincinnati’s Emerging Energy Initiative. “There’s not enough capacity to provide a cushion (from lower gas supplies). Some corporate citizenship should come into play.”

While a new U.S. refinery has not opened since 1976, industry officials say they’ve added the equivalent of 10 refineries over the last decade with expansions at existing facilities.

“It’s a lot less expensive to expand versus building new,” said Cindy Schild, a spokeswoman for the American Petroleum Institute, the industry’s trade group.

Constructing a new refinery would take an estimated six to 10 years from the planning and permitting through construction process, whereas an expansion takes about three years, she said. A new refinery doesn’t yield a return on investment for seven to 10 years.

Because expanding capacity takes so long, it’s not a fix to this summer’s prices, Schild added.

“These are long-term investments that require you to think 15 years out,” she said.

This year, API has revised a 2006 forecast that predicted faster expansion of refining capacity. Last year, the group forecast the industry would add enough capacity to produce an extra 1.5 million barrels per day by 2012. The institute now believes the industry will continue its expansion rate, adding two-thirds of their previous estimate of 1 million barrels per day.

There’s another fact that’s made oil companies reluctant to expand or build new refineries: The push by Congress and the White House to develop alternative fuels - both to make the U.S. more energy independent and to curb the carbon emissions that cause global warming.

Uncertainty about the future, coupled with the delayed payoff, entices oil companies to repurchase shares instead.

“Companies are not being rewarded for R&D right now,” said Matthew McCormick, a portfolio manager with Bahl & Gaynor in Cincinnati. “What if it takes billions to expand but it doesn’t work out?”

Yet it’s easy to boost future profit and stock performance by buying back shares. Even if profits don’t increase, fewer shares outstanding means increased earnings per share, which in turn likely boosts the stock price, McCormick said.

While the S&P 500 is setting records for buyback activity, analysts say big oil’s participation is eye-catching because its capital expenditures are so demanding.

“Wall Street is very short-sighted,” McCormick said. If companies add refining capacity “based on projections that oil will stay at $60 per barrel and it falls, they’ll get hammered for not seeing it coming.”

Meanwhile, sticker-shocked Talonda Long, a 27-year-old bank technical administrator, is adjusting to the new price reality. She tries to minimize weekend trips in her Toyota Rav4 SUV from her Westwood home.

“I try to shop closer - I don’t go to Tri-County Mall as much,” she said.

Editor’s Note: The above article appeared in The Enquirer, June 17, 2007, edition.