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Capitalist Reform to Reduce International Oil Demand: Getting World Refiners to Price at Market

A market-driven revitalization of the world oil refining sector is the best and fastest way to reduce both oil demand and related air emissions, including CO2. A combination of market-based pricing–absent from foreign refineries (most politically owned and/or managed)– and new investment brought forth by the improved profitability of such pricing, could reduce the demand for crude oil by between eight and twelve million barrels per day, or about 10–15 percent.

A Bold Hypothesis

This rather astounding assertion can be educed as follows:

  • Most countries subsidize refined oil product consumption, usually middle distillates (diesel and kerosene) at the expense of gasoline and other products;
  • Owing to the price controls on heavily used middle distillate products, most oil refiners outside the U.S. and a few other countries lose money;
  • The subsidies to middle distillate users, at the expense of gasoline and LPG consumers, creates an “unbalanced” demand barrel – one that defies both economics and chemistry;
  • Refiners lose money and avoid investing in modern refining technology; instead refiners build more simple refineries and use up crude oil to meet the unbalanced demand barrel, which creates more heavy fuel oil (HFO);
  • The U.S., with its sophisticated refineries and market-based pricing of oil products, creates virtually no net HFO, using it as a feedstock instead. In fact, the U.S. is a net importer of HFO from Europe and the Caribbean, a less expensive feedstock for refining than crude oil;
  • Most of this HFO created outside the U.S. is used to generate electricity, creating significant greenhouse gas emissions;
  • Right-pricing refined oil products would (1) reduce the demand for middle distillates; (2) make refining a going business without subsidies; and (3) induce investment in better refining technology;
  • The excess HFO now created as a artifact of middle distillate subsidies would be absorbed within the refining system as a feedstock, reducing the demand for crude oil by at least 8 million barrels per day, perhaps 12-13 million b/d;
  • Replacement of this HFO in power generation by natural gas would, on balance, reduce the output of CO2 by an amount greater than the CO2 generated by all natural gas flaring worldwide, or, equivalently, taking 20% of U.S. electricity generating capacity out of service.

Subsidizing Middle Distillate Is Like Fighting Chemistry And Economics At The Same Time

The Government giveaways of gasoline in a number of oil exporting countries, especially Venezuela and the Persian Gulf nations, are well known. But while these subsidies are considerable, the far greater player in the subsidy game is the encouragement of middle distillate over-consumption in country-after-country in the developing world.

In many countries, including China, India, Indonesia, Thailand and other leading developing countries, prices of diesel and kerosene are maintained at 70–85% of the energy equivalent price of gasoline. These price ratios, unlike those in the real world, which are generally within 5-6% of one another on an energy basis, give energy consumers every reason to use more of the middle distillates and less of the more expensive products.

Moreover, since the low prices for middle distillates are below the cost of supplying such products, the funds to supply the induced demand must come from somewhere – either taxpayers or the consumers of the non-subsidized oil products (gasoline, HFO, LPG) must foot the bill. Although increasing numbers of taxpayers have become alarmed (rightly) about the subsidization of renewable energy, the harm to the economy of the world that is created by subsidies for refined oil products, especially middle distillates, currently dwarfs the resource misallocation created by renewable energy policies. In 2007, middle distillate subsidies cost Indonesia about $9.8 billion, more than 2% of that country’s GDP.

At worst, subsidies can so promote demand for the subsidized product, while simultaneously retarding the efficient supply of that product that vast financial and economic imbalances in the energy sector may occur. Worldwide, the demand for middle distillates in recent years has increased from about 35 to 38% of the crude oil barrel. In the countries cited above, as in many other subsidizers, the middle distillate proportion in the demand barrel can range from 50–60%.

Countries import middle distillates at market prices and sell them for less; or worse, they build expensive refinery add-ons solely to meet middle distillate demand and then sell the products for less than the cost of production. By rendering the oil refining sector less profitable than would otherwise be the case, subsidies stunt the investment in new technology and clean fuels needed to meet increasingly stringent environmental demands for reducing plain old pollution (lead additives for gasoline, volatile organic compounds, CO, sulphur).

Simply put, where middle distillate subsidies are present, the country’s approach to meeting refined oil product demand is tantamount to fighting chemistry. There is almost no way to make a barrel of oil produce a 50–60% yield of diesel, jet fuel and kerosene at a reasonable cost (yes, it can be done at an unreasonable cost, just as you can grow bananas in Alaska – that doesn’t make it a good investment). Pressure, heat and catalysts will almost always generate other products, gasoline and LPGs, as well as (some) HFO.

Ending Oil-Product Subsidies Offers an Environmental Upside

A country with refined-product subsidies will tend to consume more oil products than it might without below-market pricing. At the same time, as long as refiners lack the financial capability (or even the desire) to invest in better yields of light products, they will try to meet demand in the least expensive way, either importing middle distillate products or refining more crude in simple refineries. (Note: Countries without any oil refineries tend not to subsidize the consumption of these products).

In a simple refining configuration, about one third of the output is heavy fuel oil, assuming a light crude is used. Heavier crudes may yield more than 40% HFO from simple distillation. The proportion of middle distillates and gasolines are about equal, at roughly 30–35%, depending on cut points and the specifics of the crude oil used. Such a refinery cannot produce a demand barrel that is more than 50% middle distillates. So the refiner will export some of the unwanted gasoline and HFO and import middle distillates. If this is done at the margin, then there is little or no impact on prices and product availability, but if it is general practice, then the prices for the exported gasoline, naphtha and HFO products will tend to be depressed. The financial impacts on a refiner of selling middle distillates below cost and other products at depressed prices virtually guarantees continuous financial stress for such companies.

If a refining company could recoup its investments in upgrading low quality feeds and avoid selling unfinished gasolines and HFO at distressed prices, then they might be able to build a better refinery. In a highly complex refinery, with full reduction of heavy byproducts, middle distillate yields rarely rise above 40%. With a mix of various unappetizing heavy, high sulphur crudes and HFO, Valero Energy’s Delaware City refinery produces 40% middle distillates, 53% gasolines, 3% HFO, and precious little else. Even the petroleum coke, about 1% of output, is recycled to generate electric power.

The roughly 155,000 b/d of light products produced in Valero’s complex refinery requires just 170,000 b/d of low quality feed. A simple refinery will need roughly 240,000 b/d to produce the same yield of light products. If rest of the world were able to replicate the efficiency of the U.S. refining sector, then current demand for gasoline and middle distillates, LPGs and chemical feedstocks could be met with 10–15% less (lower quality) crude oil each day, even allowing for lags in adoption.

Shifting the HFO now used to generate electricity to natural gas, where feasible, would result in a substantial reduction in CO2 emissions. Worldwide, the consumption of HFO for power generation and industry is about 10 million b/d, 12% of total oil demand. Reducing the crude oil distillation that is rendered unnecessary with modern technology, and replacing current industrial and utility consumption of HFO with natural gas, an excellent financial option for most countries, could result in a net annual reduction in CO2 emissions of more than 500 million tonnes, more than the CO2 emissions from all natural gas flaring worldwide.[1]

The moral of the story is that fighting the market and fighting chemistry is a bad idea – bad for profits, bad for oil reserves and bad for the environment. There is literally no other set of investments in the next 10–15 years that could reduce air pollution (and CO2 emissions) as dramatically as the investments induced by good oil pricing policies. It is literally equivalent to removing 20% of U.S. power generation capacity from service, a feat that is beyond the wildest dreams of any renewable energy advocate.


[1] This reduction is calculated as follows:

Nine million barrels per day (b/d) of HFO, when burned, creates 1.55*109 T/year CO2 – all this HFO could go into fuels production, displacing crude oil, since the demand for the light products is evident.

An equivalent power or industrial output from natural gas creates no more than 1.08*109 T/year CO2. Efficiencies more typical of natural gas use in power would lower this energy equivalence figure to about 560 million T/year CO2.

The differential, about 500-1,000 million T/year CO2, is greater than the known emissions from gas flaring worldwide (see Chapter 6).

3 comments

1 Bill Gathright { 04.23.09 at 7:13 am }

Governmental intervention into the markets is again at the center of this problem. Subsidies and price controls lead to these market distortions.

2 E.M.Smith { 04.24.09 at 1:13 am }

I didn’t see where the article shows that the simple refineries are destroying oil that US refineries do not; the article seems to say that they boil off the easy cuts, then send the HFO to the better refineries. This does not seem to be to be ‘waste’ available to improved efficiency.

The redirection of HFO from electric generation to Diesel would create more, but that is a different question than actual loss of oil from poor refining processes. Is there really 15% burned up in the poor refineries that’s available for recovery? Or is it efficiently refined, but as HFO, and used as generator fuel?

BTW, these folks make a multifuel engine. Perhaps this kind of engine could break the notion that Diesel and Kerosene are good (industrial) and Gasoline is bad (public consumption) and help end the subsidy process…

http://www.flexdi.com/flexdi-solution-multi-fuel.asp

It would be hard to justify subsidy for one fuel over another if either can run the cars…

Did I miss something?

3 Donald Hertzmark { 04.24.09 at 8:41 am }

Dear E.M.,
Virtually all of the savings lie outside the US. We are able to take up only a tiny fraction of the world’s HFO to use as a feedstock. The rest has to be used as a fuel. If that HFO now used around the world as a fuel were refined to lighter cuts as in the US system, then there would be little or no net HFO output, diesel and mogas demand could be met without using excessive distillation capacity and net demand for crude input to stills would fall.

Those of us old enough to remember can recall that bad government policy in the US (The Entitlements Program of the 1970s) encouraged the construction of small, simple refineries. The ending of that program and the subsequent winnowing of the US refining industry led to the more efficient high tech refineries that dominate domestic refining. Such a process or “creative destruction” was not allowed in Europe or most anywhere else, resulting in the excess capacity of low conversion refineries outside this country.

The numbers speak for themselves – in the latest week (Oil and Gas Journal, 13 April), crude inputs of 14.2 million bbl. yielded 13.9 million bbl of non-HFO products, and most of the HFO was used subsequently as feedstock not fuel. No other national refining system in the world is even close to numbers like that.

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