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Gasoline Prices Affected By Oil Refinery Operations, Supply Demand Factors

Posted on: Tuesday, 10 July 2007, 15:15 CDT

By LAURA BOBAK

TORONTO (CP) - Another summer of mercurial gasoline prices is here, thanks in no small part to the Achilles' heel of the petroleum market - a tight supply chain vulnerable to the slightest of oil refinery hiccups.

Hurricanes, refinery fires, shipping troubles, local strikes and unexpected shifts in demand all contribute to shortages and volatile swings in wholesale fuel prices, which determine the price drivers pay at the pump.

It also doesn't help ease the supply crunch when there hasn't been a new refinery built in decades because of environmental and other reasons.

Ontario, Canada's largest fuel market, felt the sting of refinery troubles in February when Imperial Oil's (TSX:IMO) Nanticoke refinery on the shores of Lake Erie was shut down after a fire.

Coupled with a cold snap, a month-long US$10 per barrel runup in the price of crude oil and a strike by CN Rail workers - which kept Imperial's trucks busy and unavailable to help transport fuel - a provincewide gas shortage ensued, affecting hundreds of stations.

Predictably, prices to the consumer rose. A litre of gas hovered on average around $1 across the province and for the most part has stayed at or above that level.

On Tuesday, the average price of self-service unleaded gas was about $1.05 in Toronto, $1.14 in Vancouver, $1.15 in Montreal, under $1.10 in Edmonton and between $1.12 and $1.16 in the regulated Nova Scotia market and about $1.17 in Newfoundland.

Refineries are the crucial middlemen in the process by which viscous black sludge is processed into the clear, flammable liquid consumers depend upon to get to work, run errands, transport children and visit family and friends.

"Gasoline markets continue to be vulnerable to short-term refinery outages or other supply disruptions and can be expected to remain volatile throughout the summer," Natural Resources Canada said its June 8 "Fuel Focus" report.

Meanwhile, federal statistics show profit margins for refiners are up, as wholesale prices soar as a result of the supply disruptions. But don't be too quick to blame all of the price hikes on the refiners: their profits represent only one small portion of the price of a litre of gas and they don't always control the factors that lead to price increases.

After oil arrives at a refinery, it is broken down into basic components using complex metallic tangles where heavy hydrocarbon molecules are transformed using large vessels, piping and other equipment.

The convoluted process uses heat, pressure and chemical reactions to create end products such as gasoline, heating oil, jet fuel and diesel fuel.

The process is further complicated by the fact that refiners must blend, purify and fine-tune gasoline so it will meet vehicle manufacturers' specifications and government emissions and other standards.

Operating a refinery costs millions of dollars, while building one can cost billions, one of many reasons - environment and health concerns are among the others - why these massive shiny jungles of piping are few and far between. Canada has only 20 refineries.

Refining crude involves heating the oil in furnaces. The resulting liquids and vapours are then released into distillation towers, the skyscraper-like towers that are a hallmark of refineries.

After these are separated and purified of contaminant and impurities, they can be revamped into other products.

The exact cost of refining oil is competitive information, but Ted Stoner, a vice-president with the Canadian Petroleum Products Institute, said a major component, after the capital cost of the refinery and paying workers' wages, is the energy costs to fuel the large furnaces.

"Refineries are continuously seeking out energy conversation ideas to keep their energy bills at a minimum," Stoner said.

When refineries encounter fires or equipment failures that disrupt production, the shutdown has a ripple effect through the downstream supply chain. Uncertainty about future supplies can add a risk premium to prices, notes Canada's Competition Bureau.

"Seasonal variations in demand also contribute to price fluctuations as prices tend to rise in connection with the increasing demand for gasoline in summer," the agency states in its consumer gas prices primer.

Shortages have resulted in increased wholesale prices from refiners over the last three years by about six cents per litre in eastern markets and 10 to 12 cents per litre in Western Canada, according to Natural Resources Canada.

"Refining margins continue to increase, reflecting the supply/demand imbalance for gasoline across North America this spring," the report states, noting there have been more than 30 distinct events so far this year that have reduced refining capacity use in North America.

"In the face of robust demand, gasoline inventories have been drawn down and wholesale prices have been driven up as markets try to rebalance. These increases reflect the higher costs associated with new fuel specifications, the tighter supply in the west and improved returns for refiners."

In the United States, a spring punctuated by a higher than usual number of refinery outages caused a gasoline supply crunch, leading to May's record U.S. gasoline prices.

But gas prices have moderated in the U.S. recently as refineries have come back on line and started producing more gas, bringing inventory levels back up and helping keep gasoline prices stable.

Gas price benchmarks are ultimately set by buying and selling in the North American marketplace, reflected in the so-called New York Harbour price. That wholesale price is influenced by speculators, who buy large amounts of wholesale gas to resell later when prices rise.

Other factors include the impact of North American as well as regional and local supply and demand.

Shell Canada says about 60 per cent of its refineries are independently owned and set their own prices depending on local competition among gas retailers.

When gasoline prices suddenly jump, says the Competition Bureau of Canada, the hikes are often linked with the world price of oil, since crude makes up nearly half the final retail price.

Inventory levels, supply and demand, and grade affect the price of crude, which is sold by the barrel - about 42 U.S. gallons or 159 litres, an amount of liquid that could fill a standard bathtub.

On Tuesday, light, sweet crude for August delivery rose 56 cents to US$72.75 a barrel on the New York Mercantile Exchange on concerns about refinery production after British oil giant BP PLC was forced to shut down a huge oil processing unit for maintenance in Whiting, Ind.

Canada's oil industry currently produces about 2.8 million barrels, about 445.2 million litres, every day and imports one million barrels a day of light crude from the North Sea, Nigeria and Venezuela, says Stephen Rodrigues, a researcher for the Canadian Association of Petroleum Producers.

As conventional oil output drops four to five per cent annually, oilsands production will increase, meaning there'll be less light oil on the market for refiners.

More Canadian oil produced will be of the heavier Bow River Stream variety, which sells for about C$48 per barrel, compared with Edmonton light oil, which refiners would buy for $71 a barrel.

The heavy oil is cheaper for refiners, but "they'll get less gasoline out of it and more pitch," says Rodrigues.

The industry spokesman says prices for heavy oil increase somewhat in the spring, when demand for ashphalt and tar increase as construction and road work season ramps up.

Canadian wholesale prices are also affected by U.S. markets, because this country exports refined fuel, according to the federal Competition Bureau, which has investigated and rejected conspiracy theories about gasoline price fixing.

"Given the commodity characteristics of gasoline, commonly published wholesale prices among competitors is a normal practice and insufficient to raise suspicion of conspiracy," the bureau said in a report.

Each company establishes their own "posted" wholesale prices. These prices can and do move daily as the system is very dynamic, says Stoner of the oil products institute.

"The Mercantile Exchange in New York establishes a price for gasoline and diesel based on what a speculator could purchase a large (boatload) of product in the New York Harbor for," Stoner said.

"Speculators will use information (U.S. product inventories, world crude oil prices, significant world events) on the North American industry to influence their 'bid' levels when attempting to buy a product contract. Any concerns over higher crude prices, higher demands, severe weather, tend to drive the bid price upwards whereas lower crude prices, low demands will have the opposite effect."

Once a wholesale "marker" is established for the next day, the next week and the next month, those price trends are reflected in the so-called wholesale "racks" close to New York, "which in turn impact racks a distance away until the entire North American rack system has been adjusted," Stoner said.

Unlike wholesale prices, retail prices are affected by local market forces.

Retail margins remain relatively stable in markets across the country, "with any minor volatility an indication of local price war activity," says Natural Resources Canada.

Of the five markets studied by the federal department, "only the regulated Halifax market has retail margins consistently above six cents per litre, averaging 7.5 cents per litre through the first five months of this year.

Some facts about Canada's oil refineries:

-Crude oil must be separated into parts and refined before it can be used as a lubricant or to power car and truck engines.

-Fuels include gasoline for cars, diesel for trucks, jet fuel and kerosene.

Other specialty products from refiners include petrochemicals, propane, dyes and detergents, motor oils and greases, wax used in the packaging of frozen foods, sulphur, tar and asphalt.

Facts about crude oil:

-Crude oils range in consistency from a watery liquid to tar-like solids, and in color from clear to black.

-"Average" crude oil contains about 84 per cent carbon, 14 per cent hydrogen, three per cent sulphur and less than one per cent each of nitrogen, oxygen, metals, and salts.

-Refinery crude base stocks usually consist of mixtures of two or more different crude oils.

-Crude oils are also defined in terms of API (American Petroleum Institute) gravity. The higher the API gravity, the lighter the crude.

-Crude oils that contain appreciable quantities of hydrogen sulphide or other reactive sulphur compounds are called "sour." Those with less sulphur are "sweet."

Here's a list of gasoline refineries in Canada and capacity (bpd refers to barrels per day - one barrel is about 159 litres):

East Coast

-Come by Chance, Nfld. (North Atlantic Refining), 105,000 bpd

-Dartmouth, N.S. (Imperial Oil), 89,000 bpd

-Saint John, N.B. (Irving Oil), 300,000 bpd

Central Canada

-Montreal, (Shell Canada), 161,000 bpd

-Montreal, (Petro-Canada TSX:PCA), 160,000 bpd

-Levis, Que. (Ultramar/Valero), 215,000 bpd

-Nanticoke, Ont. (Imperial Oil (TSX:IMO), 112,000 bpd

-Sarnia, Ont. (Imperial Oil), 115,000 bpd

-Sarnia, Ont. (Sunoco TSX:SU), 70,000 bpd

-Corunna, Ont. (Shell Canada), 72,000 bpd

Western Canada

-Lloydminster, Alta. (Husky Energy TSX:HSE), 27,000 bpd (Asphalt/Heavy Oil Refinery)

-Regina (Co-operative Refineries Ltd.), 90,000 bpd

-Edmonton, (Imperial Oil), 195,000 bpd

-Scotford, Alta. (Shell Canada), 100,000 bpd (processes oillands crude)

-Edmonton (Petro-Canada), 135,000 bpd

-Burnaby, B.C. (Chevron), 52,000 bpd

-Prince George, B.C. (Husky Energy), 12,000 bpd

Source: Canadian Press

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