RF Winter p38/39.ps - 2/9/2006 2:41 PM Bottleneck What the Fifth District’s only major oil refinery explains about high gas prices in

the wake of Hurricanes Katrina and Rita BY DOUG CAMPBELL

f you want to understand why regulation, and competitive markets. The site employs about 300 workers, gas prices shot up past $3 a gal- “Whoever has control of a including contractors. Much of the Ilon immediately after Hurricane resource that suddenly becomes area is under construction as the refin- Katrina hit the Gulf Coast, consider scarce — in this case, refinery capac- ery is upgraded to meet new clean fuel looking at ’s sole oil refinery ity — those people will experience a laws. Charley Yonker, vice president of — in fact, the only refinery of any substantial increase in profits,” says administrative services with Giant in significance in the Fifth District. Stephen Brown, director of energy Yorktown, says the cost of the Almost everything you need to know economics at the Federal Reserve improvements is almost equal to the about gas prices can be explained, at Bank of Dallas. “This is a normal plant’s acquisition price three years ago. least indirectly, with a visit to Giant market phenomenon, much the same The Yorktown facility receives Industries’ refinery in Yorktown, Va. as owning a piece of land that sud- ships loaded with crude oil from The 570-acre facility is dotted by denly becomes valuable.” around the world but lately has gotten mammoth storage tanks, soaring dis- Of course, there are other things a lot of North Sea traffic. After arriv- tillation towers, and miles of pipes. going on as well. Oil prices, as the ing in Yorktown, crude oil is pumped The plant churns out upward of Energy Information Administration from the ships via pipes to storage 60,000 oil barrels a day, which may points out, “are a result of thousands tanks. There it waits just hours sound like a lot but is actually just a of transactions taking place simulta- or a few days until going through a drop in the national bucket of refin- neously around the world, at all levels de-salting process and then being ery capacity; in fact, it is less than a of the distribution chain from crude “charged to the unit,” or moved into half percent of the total U.S. daily oil producer to individual consumer.” distillation towers. refinery output. If the Yorktown At the same time, the hub of much of These towers — there are 20 of refinery was shut down — as it tem- this interaction takes place at them on the Yorktown site — are porarily was in 2003 with Hurricane refineries like the one at the mouth where the main refining process Isabel and then again this fall after a of the York River. happens. Refining crude oil is all about fire — national gas prices wouldn’t heating and cooling, pressuring and even blip. But the way Yorktown The Refining Process depressuring to separate crude operated in the aftermath of Katrina Yorktown is about 10 miles southeast oil’s main chemical components — provides a vivid picture of how price of Williamsburg. Inc. gasolines, diesels, greases, and changes are a function of economic bought the 1954-built refinery in 2002 asphalts. When it enters the tower, rules about supply and demand, from BP p.l.c. for about $170 million. crude oil is heated to upward of

Giant Industries owns and operates Virginia’s only oil refinery, which sits on 570 acres and churns out about 60,000 barrels a day. RF Winter2006 v6.ps - 2/8/2006 12:16 PM

800 degrees Fahrenheit, causing it to For a short time, Hurricanes decided not to stay in the business. It’s vaporize. As the vapor rises along the Katrina and Rita knocked out many very capital intensive,” says Leroy tower’s 10-or-so stories, it condenses refineries in the Gulf Coast, cutting Crow, chief of refinery operations at and collects at different vertical the nation’s refining capacity by about Giant. “We spend $80 [million] to $90 points. Gasoline components, for 25 percent. Even well into October million in 2005 at our refineries [on example, are lighter in molecular about 18 percent of U.S. refining mandated upgrades] and those weight and rise high in the tower capacity remained idle because of the improvements have no payback, no before condensing. Catalysts can storms. So even though the United return on investment.” be added in the process as well to States opened its strategic oil reserve, The Yorktown refinery’s relative promote certain chemical reactions. easing the shortage of crude oil, there isolation illustrates the capacity The resulting products are pulled off remained a shortage of refinery capac- problem. Building new refineries the tower via pipes at ascending ity. That’s where the bottleneck requires hard-to-find qualities like vast heights. The parts that don’t vaporize happened. Meanwhile, demand for gas acreage, port access, and ample water make tar and asphalt. The whole remained relatively stable. From there, and power supplies, not to mention process can take as little as eight all you need is to look at a simple chart compliance with increasing environ- hours. of supply and demand to see why mental rules. With Yorktown as the Yorktown makes three grades of prices rose as quantity dropped. only refinery in the Mid-Atlantic, the gasoline, two grades of diesel, The Yorktown refinery dealt with gas supply problem was particularly kerosene, fuel oil, propane, and coke the supply disruption by allocating acute in this region. For a time after (a high-carbon reside that can be used products to its customers based on Katrina, endured the as a boiler fuel to make steam or their average “lifting” levels over the highest gas prices in the nation electric power). Giant Industries sells past six months. Instead of being able because the Colonial Pipeline running to a wide variety of fuel companies, to collect a full order, customers took up and down the Mid-Atlantic was ranging from major oil brands to 80 percent or so. virtually dry when four major Gulf independents like The storms hurt refinery capacity refineries serving it were shut down chain Royal Farms, which is based more than production capacity. with the storm. And when new crude in Baltimore. Which means there was crude oil began hitting the East Coast, it went For gas products, Yorktown sends ready to be refined — but with no first to New York ports. out most of its output via barges that place to go. If there was more refinery Brown, at the Dallas Fed, said it dock at its pier and usually head north capacity in the United States, the price would take sustained prices of more to . There, the gas is hikes might not have been so steep. than $2.50 a gallon at the pump to pumped into storage tanks where the Although existing refineries have make building a new refinery gas firms add the final additives before expanded in recent years, there has profitable under current regulations. trucking them to the pumps. A smaller been no new refinery built in the Even then, it takes at least five years to portion of Yorktown’s gas is picked up United States since 1976. In addition, go through a permitting process. That by trucks, whose travel radius is about some have shut their doors. There sharply limits the number of possible 150 miles. Additives in this case are were 324 refineries in 1981 but just 144 new entrants. added on-site. today. Over the same time, the volume of crude oil refined in this nation has Price Gouging? Maxed Out also dropped from 18.6 million to 16.9 Stock in Giant shot up 45 percent in Yorktown is running at maximum out- million barrels. Meanwhile, demand the wake of Hurricane Katrina. put almost every day. That is why this has grown about 25 percent over the Net earnings jumped from $6 million summer’s hurricanes made such a siz- past two decades. in the third quarter of 2004 to able — and positive — impact on Refinery companies blame envi- $46.6 million in the same 2005 period. Giant Industries’ bottom line. ronmental regulations. “A lot have Jacques Rousseau, oil industry analyst PHOTOGRAPHY: GIANT INDUSTRIES PHOTOGRAPHY: RF Winter2006 v6.ps - 2/8/2006 12:16 PM

Lower-Atlantic Gas Prices near future, then it behooves him to Prices spiked following the hurricanes, but then moved back to pre-storm levels. raise prices. In this way, he replaces 350 inventory in a cost-effective manner. Hurricane KatrinaHurricane makes Katrina makes 300 landfall on Augustlandfall 29, 2005 on August 29, 2005 Meanwhile, the higher price signals 250 that the resource is growing scarce

ALLON 200 and dampens demand. In any case, /G 150 retailers ended up with no profit ENTS C 100 advantage because of the hurricanes, 50 industry participants say. 0 “If anything, we did worse than a normal year,” says Rob Rinehart, chief 7/21/04 1/21/05 4/21/05 1/21/06 7/21/05 10/21/04 10/21/05 of gas operations at Royal Farms. NOTE: The Lower Atlantic region: Florida, Georgia, South Carolina, North Carolina, Virginia, and West Virginia. and the District of Columbia are considered part of the Central Atlantic region. Rinehart notes that the states of SOURCE: Energy Information Administration and Maryland, among others, are subpoenaing records of at Friedman Billings Ramsey in crude oil. The next highest portion of convenience retailers. “I believe they Arlington, Va., uniformly raised stock gas prices comes in the form of federal will find cries of price gouging to be price estimates on the companies he and state taxes, about 27 cents of every unfounded in the retail sector,” he says. follows after the hurricanes and dollar. Refining accounts for roughly But that didn’t stop lawmakers in predicted that the impact would be 15 percent. And the smallest portion, Washington from holding hearings to long term. “It is important to keep in about 14 percent, is for the so-called question oil company executives about mind that the hurricane’s impact on “downstream” activities of marketing their post-hurricane profits. With con- inventories should have a long-lasting and distribution. Baltimore-based sumers complaining about spiking gas effect, and refiners are likely to have Royal Farms is a typical midsize gas prices, politicians responded by difficulty replenishing gasoline and retailer. But unlike big oil companies proposing taxes on oil firm “windfall distillate stocks in 2006,” Rousseau that have their own refining opera- profits” and warned against what they wrote in a note to investors. He also tions, retailers like Royal Farms were termed “price gouging.” cited refinery downtime for regulatory largely left out of the Katrina bonus. It is true that many oil firms profit- upgrades and removal of the contro- In general, the wholesale cost of fuel ed handsomely in the wake of the versial component MTBE from the increased faster than retail prices. The hurricanes. Whether that’s something gasoline pool as factors that will supply disruption drove prices up at that should be legislated away, though, continue to dampen supply. the pump in large part because is not so obvious. Many energy econo- Oil companies like Giant are retailers like Royal Farms paid higher mists believe the market should be unapologetic about the windfall, prices for their wholesale products to largely left alone. describing it is part of the up and ensure they had enough for their “I guess there’s a political defini- down industry cycle. “This works both customers, and enough to pay for tion [of price gouging] — that if the ways,” Crow says. “In 2002, you “future, more expensive gasoline deliv- change in prices is high enough that couldn’t give gasoline away. The eries,” says the American Petroleum constituents call and complain,” market is what the market will be.” Institute, an industry trade group. Brown says. “But as an economist, I An economist would put it this have a hard time defining what price Downstream way: Even if the retailer bought gas at gouging is. Prices are signals that About 44 percent of the price of gaso- $2 a gallon today, if he knows that he there’s scarcity. They tell people to be line is determined by the price of will be buying it at $3 a gallon in the using less gas.” RF

R EADINGS Brown, Stephen P.A., and Mine K. Yücel. “Gasoline and Crude “Oil Market Basics.” Energy Information Administration, U.S. Oil Prices: Why the Asymmetry?” Federal Reserve Bank of Dallas Department of Energy. Economic and Financial Review, Third Quarter 2000, pp. 23-29. “Virginia Energy Patterns and Trends.” Virginia Department of Conaway, Charles F. The Petroleum Industry: A Nontechnical Guide. Mines, Minerals, and Energy. Tulsa, Okla.: PennWell Books, 1999.

Peltzman, Sam. “Prices Rise Faster than They Fall.” Journal of Political Economy, June 2000, vol. 108, no. 3, pp. 466-502.

40 Region Focus • winter 2006