Consolidation of Oil-Refining Business


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Consolidation of Oil-Refining Business

  1. 1. Consolidation of Oil-Refining Business Is Likely to Lead to Spike in Gas Prices By ALEXEI BARRIONUEVO Staff Reporter of THE WALL STREET JOURNAL Remember the roller-coaster ride gasoline prices took last year? In the spring, some Midwestern prices spiked by half, to more than $2 a gallon, in just two months before falling back. Meanwhile, the average pump price in California leapt by 15%, peaking in May at $1.95. Since then the Sept. 11 attacks and the broader recession have pushed down prices. But here's unsettling news for drivers: Sweeping changes in the oil-refining business are aligning to make gas prices more volatile than ever. Control over refining -- which changes oil into fuel -- has consolidated in fewer and fewer hands in recent years, as already-large companies merge and form joint ventures. Most of the resulting behemoths have also gained greater dominance over retail gas stations in certain areas. Growing More Unstable As with cable-television rates and business-class airfares, concentration of power has pushed gas prices higher in regional markets where competition has dwindled. Yet rather than becoming more steady, gas prices also have grown more unstable. That's mostly because the giant energy companies are deploying largely unseen new technology and cost-cutting strategies to reduce the amount of oil and gas they have to keep on hand. With supplies tighter, modest disruptions, such as plant fires, new environmental regulations or surges in demand, can lead to sudden price jumps in affected regions. On other occasions, some dominant companies are simply exploiting greater market power at the expense of smaller independent gas-station operators that traditionally have sold discount unbranded fuel and kept prices in check. The net effect for big refiners: more opportunities to benefit from abrupt price hikes and fatter overall profits. Oil moves from earth to car in three basic stages. Producers pull crude oil from the ground in places such as Saudi Arabia and south Texas. Refiners boil the crude oil and add chemicals to turn it into gasoline and other fuels. Gas then moves by pipeline and truck to retail stations. Increasingly, a shrinking roster of companies are performing two, or all three, of these roles -- and on a larger scale. After a wave of mergers, the nation's top six refiners now control 59% of that business in the U.S., up from 41% in 1990, according to government
  2. 2. and industry figures. When all of the mergers are completed, a similar group of six companies will own or franchise 55% of the nation's 175,000 gasoline stations, compared with 30% in 1991, according to National Petroleum News, a trade publication. Recent Deals Among the deals in recent months advancing this trend were Phillips Petroleum Co.'s $7.36 billion acquisition of the big independent refiner Tosco Corp. Phillips, based in Bartlesville, Okla., then agreed to merge with Houston-based Conoco Inc., which operates four U.S. refineries. Conoco will add about 5,000 gasoline stations to Phillips, leaving the combined entity with 17,400 stations. And Valero Energy Corp., a San Antonio-based refiner, paid $3.7 billion to acquire rival Ultramar Diamond Shamrock Corp., a refiner and major marketer also based in San Antonio. UDS will bring six refineries and about 5,000 gasoline stations to Valero. The combined entity will have 12 refineries and 5,350 stations, after required divestitures. During the 1990s, energy companies seeking to slash costs closed some 50 refining plants. About half of these could make auto gasoline. The companies often said they couldn't afford to pay for upgrades required by state and federal environmental rules. Overall, however, U.S. refining capacity has increased slightly since 1990 because many of the remaining plants have been expanded. The net effect is that some markets now rely more heavily on fewer plants controlled by fewer owners. When one of those plants suddenly shuts down for a while, supplies in the region drop drastically and prices shoot up. A Costly Fire Last summer, for instance, a fire badly damaged a Citgo Petroleum Corp. refinery near Chicago, cutting the gas supply to Illinois by 16%. That helped push prices in the Midwest above the national average for seven weeks, while retailers had to use gasoline shipped from as far away as Europe. In running newly merged refineries, pipelines and gas stations, the energy giants say they are increasing efficiency by using innovative technology and "just-in-time" inventory- management techniques pioneered by the likes of Dell Computer Corp. New software in use at most major energy companies allows employees to keep closer watch over how much oil or gas is sitting in tank farms, vast pipelines and neighborhood gas stations. By squeezing inventories to the minimum, the companies reduce storage costs and improve cash flow. Exxon Mobil Corp., the product of a 1999 merger, says it is "on target" to reduce by nearly 30 million barrels, or about 15%, the crude oil and refined products it keeps on hand, although the company won't say when it expects to hit that target. Industry analysts estimate the company's total potential savings over a period of years at $500 million.
  3. 3. BP, which acquired Atlantic Richfield Co. and Amoco Corp. in the late 1990s, says it has shaved its inventories by 7% since 1997, saving a total of $1.7 billion since then as a result. And even before it merged with Texaco Inc. last fall, Chevron Corp. had reduced the levels of mid- and premium-grade gas in its stations' tanks by up to two-thirds over the previous decade, says Victoria Hobbs, Chevron's manager for delivery coordination. As companies trim inventory, overall supply in certain regions decreases, making sudden price increases more likely. Refiners are "all trying to manage a fine line," says Mike Mears, vice president of transportation and fuels at Williams Cos., owner of a 9,000-mile Midwest pipeline system. "When you have these blow-ups in prices, [refiners] have probably miscalculated," he says. Consumer advocates see something more purposeful than miscalculation. "The combination of this technology and the growing market share these companies are developing through mergers is emboldening them" to take advantage of tight supplies by periodically hiking prices, says Tyson Slocum, a senior researcher at Public Citizen, a Washington, D.C.-based consumer-rights groups. Worried about accelerating concentration in California, the Federal Trade Commission forced Valero to agree to shed a refinery and some gasoline stations in that state after it acquired Ultramar. But federal and state antitrust investigators who have looked into the volatility of gas prices around the country have never found any illegal collusion. Oil executives agree that improved efficiency and tighter supplies can lead to price spikes, but they say these same developments ultimately reduce their costs and help keep prices down. Since 1990, U.S. gasoline inventories have dropped by 10%, to 202 million barrels, or 24 days of supply, even as gasoline use has grown by 16%, according to the Department of Energy. In some regions, the inventory drop was much more pronounced. Midwest gasoline supplies fell 22% over the same period, while California inventories dropped by about 20%. The national average retail price of gas remained relatively stable during the 1990s, after adjustment for inflation.
  4. 4. With lower inventories, "if things go wrong, you may have a spike," says John Manzoni, formerly BP's U.S. president and now chief executive for natural gas and power. BP recognizes that consumers find volatile gasoline prices "unbelievably irritating," he adds, but drivers would pay more if companies held larger stocks. Nevertheless, the spikes have also contributed to bigger profits for refiners. Last year, gross profit margins in the U.S. refining business soared to an average of $11.43 a barrel through October, up from an average of $7.95 during the previous decade, after adjustment for inflation, according to the Department of Energy. BP, which is strong in both California and the Midwest, says it booked combined U.S. refining-and-retailing pretax profits of $2.8 billion, about triple that of 1999. The trends roiling the refining business are most visible in California, where gasoline prices often ring up 30 cents a gallon higher than in the rest of the country -- and stay higher longer. That gap ballooned in the late 1990s, partly because of new California requirements for low-emission gasoline that the industry says is more expensive to produce. But consolidation and corporate behavior also play a role. Tosco, a refiner and gas-station owner, acquired Unocal Corp.'s refining and marketing assets in 1997. Tosco promptly began shifting supplies to Unocal's 1,350 "76"-brand stations, and away from the independents that competed with Unocal. That move alone helped push up wholesale gas prices across California in 1997 and 1998, as independents scrambled for new suppliers, according to a study released last July by the University of California at Berkeley. The study estimates that the Tosco-Unocal combination, and its aftereffects, pushed up prices in Los Angeles by 3.7 cents a gallon and in San Jose by 2.9 cents. A spokeswoman for Tosco, now a part of Phillips, declines to comment on the study.
  5. 5. There is a force that potentially could cut against the consolidation trend and spur new price competition in some places: large retailers making inroads into gasoline sales, including Costco Wholesale Corp. and Wal-Mart Stores Inc. Costco, for example, has opened 45 stations in California. Because they are well capitalized and tend to deal in huge volumes, they command more power in the marketplace than smaller chains. Greater consolidation and tighter supplies are also roiling Midwestern markets, such as Michigan. Through most of the 1990s, Marathon Oil Co. and Ashland Inc. competed as big refiners in the state. In January 1998, they combined their refining and gas-station operations into a joint venture. The venture bought more stations, terminals and pipelines. Today it controls the state's only refinery, in Detroit, as well as 26% of the retail stations. On top of all that, the venture shares control of a critical storage-tank farm with Exxon Mobil, Citgo Petroleum Corp. and a separate joint venture that Shell is taking over. In the late 1990s, independent gas-station owners began complaining that the tank farm, in Niles, Mich., 90 miles east of Chicago, had become a choke point, making it difficult to get competitively priced gas, especially in northwest Michigan. The major companies control not just the storage facility, but also 69% of Wolverine Pipe Line Co., which brings in one-third of Michigan's gasoline, mostly from the Chicago area. Alleging that Wolverine was charging exorbitant pipeline rates for any company that didn't own storage space in Niles, Quality Oil Co., a family-owned independent retailer based in Holland, Mich., filed a protest with the Federal Energy Regulatory Commission in August 1999. In May 2000, a Marathon Ashland official told Michael D. Swan, Quality Oil's general manager, that the joint venture had "no need, want or desire" to allow Quality to use its tanks at Niles, according to testimony by Mr. Swan in March 2001 in the FERC case. Chuck Rice, a Marathon Ashland spokesman, says that "if that comment was made," it reflected only the joint venture's interest in long-term agreements with retailers, rather than short-term ones. A spokesman for Wolverine says the pipeline hadn't been aware of the storage issue and that Quality Oil never requested tank space. Michigan state officials became concerned last year about the lack of access to storage at Niles, especially after seeing gasoline prices in Michigan towns such as Ferrysberg and Muskegon increase to as much as a dime a gallon above those in Chicago. In a further demonstration of the effects of consolidation, a June 2000 break in the Wolverine pipeline sent Midwest retail gasoline prices soaring to above $2 a gallon in some cities for nearly three weeks. As is typical in such situations, major refiners -- now all the more powerful because of mergers and acquisitions -- cut off independent retailers to ensure their own supply. Some independents drove trucks as far as Canada and New York, scrounging for supplies.
  6. 6. Later that same month, the FTC and the Michigan attorney general's office announced they would formally investigate the price spikes. Marathon Ashland struck a one-year agreement beginning in August 2000 to supply gasoline to Quality Oil. After probing price increases in Chicago and Milwaukee for nine months, the FTC concluded last March that an unnamed company had held back gasoline in the Midwest to prop up prices. Marathon Ashland later confirmed it was the company. But the FTC said it didn't find any antitrust violations and didn't seek any punishment. Quality Oil and five other independent retailers have since built their own 2.5 million- gallon storage tank at Niles. Last summer, Wolverine's owners agreed to connect their pipeline to the new tank and open additional tank space for Quality Oil at Niles. For some, though, it was too late. At the end of July, Ken Gillette, owner of Four Star Service Stations in Grand Rapids, Mich., shut his seven outlets, blaming shrinking supply for independents. Mergers had whittled his suppliers from five companies to two, he says. "We won't be the last" to go under, he predicts. Write to Alexei Barrionuevo at Updated January 24, 2002 12:01 a.m. EST Copyright © 2002 Dow Jones & Company, Inc. All Rights Reserved