As crude oil production in the United States continues to grow, the back-ups it is creating for domestic refineries are becoming more apparent.
Booming production in new plays, like the Bakken Shale in North Dakota, have led to record storage at Cushing, Ok., one of the major hubs for crude oil.
Crude oil production increased almost 14 percent in the last year alone, according to the American Petroleum Institute. But domestic demand is dropping and US crude cannot be shipped to foreign refineries because of an export ban.
While many are calling for more pipelines to solve the storage issue, the best long-term solution is to build new refineries, said Bernard Weinstein, associate director of Maguire Energy Institute, at a Thursday morning breakfast.
“I think the ultimate solution to Cushing is to build more refining capacity,” Weinstein said, noting that there has not yet been a major new refinery built in the US since the 1960s.
The challenge for new refineries is both political and economic Weinstein said, listing a range of local, state and federal regulatory requirements a new refinery must meet in order to operate, from air emissions to required use of biofuels to water quality issues.
Finding a location is another difficulty, given community opposition to new refineries, Weinstein noted.
“It’s the whole not-in-my-backyard phenomenon,” Weinstein said. “The challenge is finding a place where the community is accepting and you meet all the refinery standards. It probably is easier in Texas or Louisiana, where you have a 100 year history of refining, than in New Jersey or Massachusetts.”
These problems have led many major refiners to expand current facilities rather than attempt building new ones.
For example, CHS Inc., a Minnesota-based refining company, announced in mid-March that will increase refining capacity of its McPherson, KS site by 100,000 barrels per day by 2016.
Some smaller companies, however, are looking into building smaller facilities near the new plays, hoping to capitalize on insufficient infrastructure to move crude to the larger refineries.
MDU Resources Group Inc, is one such company. The North Dakota-based energy services company is working to get final approval for a small diesel refinery in southwestern North Dakota that could process 20,000 barrels a day of Bakken crude oil. But Weinstein noted that these kinds of small refineries will only process small amounts crude that does not need to be transported, which will not solve the issue of the Cushing gult.
One of the biggest challenges for refineries is how to make sure they will be profitable enough to justify the cost to build a new site, and for that, a huge refinery is required.
“They have to be large in order to bring the unit cost down to the point htat the refinery can be economically viable,” Weinstein said, explaining that subsidies for refineries after the OPEC crisis led to the construction of many ‘tea kettle refineries’ which turned out not to be economically viable.
“Once the subsidies went away they couldn’t compete because they couldn’t get the economies of scale,” he said.
The refining business is legendary for both its high risk and low profit margins, making a huge upfront capital investment for a new facility unappealing for many companies.
The last year has been a good one for refineries, whose profits helped the major integrated companies mitigate mediocre performances in the exploration and production sectors.
But it is difficult to know if last year was an anomaly, and the financial history of refineries does not help make the case for a new one.
“The pure economics of trying to build a refinery just doesn’t make any sense,” said Bruce Bullock, director of the Maguire Energy Institute, explaining that refineries are only considered profitable when they earn enough to cover their cost of capital, typically about a 10 to 15 percent return, on top of operating costs. “Refining has only returned its cost of capital three years out of the last 15.”