Oil and Gas:

Tesoro's Westfall gives refinery industry's take on gas prices, demand for alternatives

With the summer driving season in full swing, will consumers continue to experience high gas prices at the pump? How much of an effect is the United States' refining capacity having on the price of gas? During today's OnPoint, Lynn Westfall, chief economist of Tesoro Corp., explains why he believes maintenance issues at U.S. refineries have been at the core of this season's high gas prices. Westfall discusses the importance of reaching out internationally in order to meet our refining needs. He explains why the refining industry believes it is not economically viable to build more refineries in the United States to support increasing energy demands. Westfall also discusses how a possible cap on emissions could affect his industry and discusses how the demand for alternative fuel is affecting the oil and refining industries.

Transcript

Monica Trauzzi: Welcome to OnPoint. I'm Monica Trauzzi. Joining me today is Lynn Westfall, chief economist of the Tesoro Corp., a refining company based in San Antonio. Lynn thanks for coming on the show.

Lynn Westfall: Thank you for having me.

Monica Trauzzi: Lynn, we're in the middle of the summer driving season. Prices skyrocketed in May and they've since come down slightly. Critics have consistently pointed fingers at your industry, the refining industry, saying that you guys are causing the high gas prices. How much of that can be attributed to the refining industry?

Lynn Westfall: Well, right now in the world the refining industry is the bottleneck in the entire system. So, to the extent that we had a lot more maintenance work on refineries this year I guess we're to blame. There was about twice as much refining capacity taken off-line this year to do routine maintenance than normal. So we had a lot less refineries operating. So, in that sense, that really drove most of the price increases. As they've come back from maintenance though the exact opposite is happening we've seen inventories grow. We've seen gasoline production grow and, as should be happening, prices are now falling. So when all of the refineries are running well prices should be stable and lower than they are now.

Monica Trauzzi: How do you manage the decreased refining capacity? Do you reach out internationally?

Lynn Westfall: Yes, as a matter of fact, even when refineries run full today we still have to import about 13 percent of our gasoline requirements. And when I checked last year that came from over 43 different countries. So, you can imagine that our supply lines in the business are stretched literally worldwide and there's not a whole lot of give in that system if something unexpectedly happens. There is no short term, quick volumes ready for us to fill ready for us to fill a gap in supply and demand.

Monica Trauzzi: So, if you have to go overseas to meet refining demands, wouldn't the obvious thing be to build more refineries in the U.S.?

Lynn Westfall: It seems like that would be the obvious thing to do, but it hasn't made economic sense in the past and it still doesn't make economic sense. If you're asking someone to build a refinery you're asking them basically to spend about seven or eight years, which is how long it would take to build a refinery. So, during that time period you're spending billions of dollars and getting no income for seven to eight years. And after that, even at today's high refining margins, it would take another 10 to 12 years to pay off that investment. So asking someone to build a new refinery is basically asking them to take a 20 year bet that refining margins are going to stay high. And, at the same time, most developed countries in the world are doing their best to lower demand for our major product, which is gasoline. So that's a very unclear investment decision for most companies.

Monica Trauzzi: Isn't that part of the risk of being part of the refining industry though? Isn't that a risk that you have to take?

Lynn Westfall: That's a risk that in the past we were willing to take when you could build a new refinery in three or four years. And before there was even any talk about gasoline has issues with global warming, we want more ethanol, no renewables. So I think, in the past when it was a less risky proposition, it was a level we were willing to take. But now it's just not really - it's gone above our risk tolerance.

Monica Trauzzi: In order to keep up with demands how many refineries would need to be built domestically?

Lynn Westfall: In the last nine months demand in the U.S. has been going up at the rate of about 2 1/2 new refineries every year. And that's a rate at which the industry has never been able to build. And we are, not just our industry, but any infrastructure industry, is in tremendous constraints these days. The price of cement has doubled in the last two years. The price of steel has doubled. Fabrication shops are working overtime. And probably one of the most long-lasting problems we're facing is that during the 80s we had a big drop in engineering enrollment. So, the engineers with 20 years experience we should be turning to right now to do these sorts of projects really out there. You have older guys, such as myself with 30 years experience, and you have some with 10 years experience, but you can't throw enough money to make suddenly an engineer have 10 years more experience.

Monica Trauzzi: What is Tesoro doing at existing refineries to increase refining capacity?

Lynn Westfall: What we're looking at right now -- and I should say that it's only been very recently that Tesoro or other refineries have been able to look to projects to increase capacity. Up until last year we spent a lot of our free cash flow on required projects for required environmental specs. For instance, last year there were three regulations on lowering the sulfur level of gasoline, diesel, and banning the use of MTBE. So, we haven't had that long as an industry to say, hey, I can see a time period coming when I'm going to have cash to spend on throughput increases. But I think all companies are looking at that and they're taking different approaches. At Tesoro right now we're really looking at things that improve the reliability of our refineries. So we're not building things that are bigger, but if that same unit in a refinery can run 360 days a year instead of 340 you've gained output out of.

Monica Trauzzi: So, for the foreseeable future, what trend do you see for gasoline prices?

Lynn Westfall: Well, first you have to ask the question about what are crude prices going to do, because they said the floor and determine a lot of the price of gasoline. Putting that aside, which is a hard thing to put aside, as long as we have stable U.S. refining operations, which I think we'll have through the summer because we just shut down a lot for maintenance work and they're running the best they can. I think we should see drops probably continuing through the middle of July and then stabilizing. That's kind of the short-term picture. In the long-term we're going to continue to be dependent on imports for gasoline. And the difference that that makes is that refineries outside of the United States were not built to make our kind of gasoline very cheaply. They're not very good at it. So, when we have to go to overseas refineries to fill demand growth, which we're continuing to have demand growth, we actually have to pay a refiner there in the price of gasoline to do something he's not very efficient at doing. Plus we have to pay to ship to gasoline over here. So there are cost elements that are now permanently built into the price of gasoline, that we're probably not going to do away with.

Monica Trauzzi: And something that might affect the price of gas in this country, Exxon and ConocoPhillips recently announced that they would be exiting major projects in Venezuela. What impact do you see that decision having on gas prices?

Lynn Westfall: I think it's going to be more of a long-term effect and I think you can see in just about every country that has nationalized their oil supplies, what they're missing are two things. They're missing the best technology in the world because the Exxons and the Conocos of this world have absolutely the best technology for finding oil. They basically say go away with that. Plus they are making it a very unsure environment for the flow of international funds in the fund projects. If they can take away assets from Exxon, why do I want to fund another project when they can nationalize that? So I think what you're going to see is the same trend we see every time a country does this, and this is a slow decline in their oil production.

Monica Trauzzi: So, will the price of gas continue to rise as companies invest in cleaner technologies and focus on alternative fuels instead of increasing refining capacity? I mean how does that push affect your industry and the oil industry?

Lynn Westfall: I think the prices are always going to the volatile, so they're going to fluctuate up and down. There will be times when it will be in the mid two dollar range. There will be times, due to unexpected occurrences that will drive it into the three, three fifty range. So I think that's where it's going to land probably pretty much for the next five to 10 years.

Monica Trauzzi: The Senate energy bill provides a great deal of support for alternative energy and not for fossil fuels. Exxon Mobil CEO Rex Tillerson says, "It defies logical or rational thinking." Is there too much of an emphasis on alternatives?

Lynn Westfall: I think that the energy problem, which has been growing in this country for 20 years, shouldn't be viewed as something that can be solved in 10 years or 15 or 20. So I very much think that policies should look beyond the next election and look into how do you solve this problem 10 or 20 years from now? Renewable fuels are one part of the solution. Biodiesel is one part of the solution. Wind, solar energy, they're all part of it, but none of them is a silver bullet that's going to solve it by the next election.

Monica Trauzzi: The way things look now it looks like there will be a focus on climate change in the future. What kind of impact do you think emissions caps are going to have on your industry?

Lynn Westfall: The basic chemistry of our business, since we produce hydrocarbons that are burned, is that you can't do that without producing CO2. So, when you're attacking global warming you're going to have to look for alternate transportation sources than gasoline. So it's not a matter of finding a different source of energy for a power plant or something like that. You're going to have to find a substitute for gasoline, which today that's really unknown, what can fill that role.

Monica Trauzzi: The issue of giving new tax breaks for renewable fuels and renewable electricity came up during the Senate energy debate. And the proposal was to repeal certain tax breaks or to implement new taxes. Even though it didn't pass, the issue is still alive and well. What are you expecting to happen here? Do you think that the oil industry is going to suffer a blow?

Lynn Westfall: I don't think the oil industry is going to suffer a blow. I mean those technologies are in their nations right now and aren't nearly the size to effect an industry as large as the worldwide energy business. Again, I think this is something that is going to happen slowly over the next 10 to 20 years, nothing that can happen in the immediate future. The technology just really isn't there.

Monica Trauzzi: All right. We're going to end it right there on that note.

Lynn Westfall: Great.

Monica Trauzzi: Thanks coming on the show.

Lynn Westfall: Thank you for having me.

Monica Trauzzi: This is OnPoint. I'm Monica Trauzzi. Thanks for watching.

[End of Audio]

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