Anish Agrawal December 07, 2012 Econ 102: Macroeconomics Dr.

Dong

Oligopoly in Oil Refinery Industry An oil refinery or petroleum refinery is an industrial process plant where crude oil is processed and refined into more useful petroleum products, such as naphtha, gasoline, diesel fuel, asphalt base, heating oil, kerosene, and liquefied petroleum gas. Oil refineries are typically large, sprawling industrial complexes with extensive piping running throughout , carrying streams of fluids between large chemical processing units. In many ways, oil refineries use much of the technology of, and can be thought of, as types of chemical plants. The crude oil feedstock has typically been processed by an oil production plant. There is usually an oil depot (tank farm) at or near an oil refinery for storage of bulk liquid products. The market structure to which the oil refinery industry belongs to is Oligopoly. The Justice Department considers a market with a Herfindahl-Hirschman Index score above 2,500 to be highly concentrated. In 2010, the East Coast refining markets score hit 3,255, against a nationwide one of 680, according to the Federal Trade Commission (A personal Trainer for Delta Air). This suggests that the market is highly concentrated with a few large firms that have large market shares. When Delta Air Lines has agreed to buy and reopen

Phillips 66 refinery in Pennsylvania, there are expected influences on the other firms. If Pennsylvanias Trainer facility had stayed idle rather than be bought by Delta, the score would have surpassed 4,000, according to the American Antitrust Institute. As capacity shrinks and ownership consolidates, the market power of remaining refiners increases suggesting that decisions of one firm influence other firms.

Today, national and state legislation requires refineries to meet stringent air and water cleanliness standards. In fact, oil companies in the U.S. perceive obtaining a permit to build a modern refinery to be so difficult and costly that no new refineries have been built (though many have been expanded) in the U.S. since 1976. More than half the refineries that existed in 1981 are now closed due to low utilization rates and accelerating mergers. As a result of these closures total US refinery capacity fell between 1981 and 1995, though the operating capacity stayed fairly constant in that time period at around 15 ,000,000 barrels per day (2,400,000 m3/d). Increases in facility size and improvements in efficiencies have offset much of the lost physical capacity of the industry. In 1982 (the earliest data provided), the United States operate 301 refineries with a combined capacity of 17.9 million barrels (2,850,000 m3) of crude oil each calendar day. In 2009 through 2010, as revenue streams in the oil business dried up and profitability of oil refineries fell due to lower demand for product and high reserves of supply preceding the economic recession, oil companies began to close or sell refineries. In 2010, there were 149 operable U.S. refineries with a combined capacity of 17.6 million barrels

(2,800,000 m3) per calendar day. A few large producers who are present in the industry are Valero Corp., Phillips 66 Co., Tesoro and Sunoco. Since, there are a few large producers who are present in the industry accounting for most of the output in the industry, and dominate the many small firms and, have concentrated market shares, the market structure to which the oil refinery industry belongs to is Oligopoly.

There are a big amount of fixed costs involved in the oil refining industry. In the short run, oligopolies are able to earn abnormal profit, but in the long run as well they are able to sustain abnormal profits due to the barriers to entry and exit . Similarly, high fixed costs in the oil refining industry act as a strong deterrent to firms that want to come into the industry and " eat into" the abnormal profits and, then exit the industry. Cycles in the industry have been historically related to movements in the price of oil, which is the primary cost element in refinery operations, and this will likely remain true in the future. More urgently, the refining industry faces structural challenges from recent government regulations that aim at directly reducing the demand for the industrys output. Higher gas mileage standards for automobiles, increased ethanol content in gasoline blends, and the expansion in the use of pure bio-fuels suggest that even if economic conditions encourage a period of increasing demand for transportation fuels, the need for refined petroleum products will not necessarily increase proportionately. Electric vehicles, if adopted on a large-scale basis, could reduce the demand for liquid transportation fuels of all types. These policies were intended, in part, to

accommodate the growing demand for refined petroleum products. Now, though, the prospect of declining motor-fuel demand means that the use of more renewable fuels could influence operators to idle, consolidate, or permanently close refineries. This possibility may help explain why some refiners do not see a need to expand, or even maintain, production capacity in the United States.

However, the poor share-price performance of independents Valero and Tesoro, both down around 13% over the past year and 60% over five years, reflects too much pessimism (Refiners Catch a Whiff of Investor Interest). One of the major reasons of the firms increasing profits is their booming exports of diesel fuel and gasoline. Phillip 66 currently exports about 100,000 barrels per day of refined products such as gasoline and diesel to overseas market . By 2014 the company aims to hit 200,000 to 220,000 barrels a day, with products going to Europe and Latin America, where they will get higher prices than U.S. markets. The companys plans to expand exports are similar to those of other U.S. refiners; overall fuel exports are likely to double by 2015, according to energy research firm Wood Mackenzie (Phillips 66 To Double Fuel Exports). Last year was the first since 1949 that the U.S exported more gasoline, diesel and other fuels than it imported, at about 439,000 barrels per day, according to the U.S Energy Information Administration. Therefore, the booming exports help the firms increase their supply even when the demand is controlled due to different government regulations. And, hence even in the long run, firms can earn abnormal profits.

An important element to notice is that oil companies have exploited their strong market position to intentionally restrict refining capacity by driving smaller, independent refiners out of business. The government needs to treat these companies in such a way that it can protect the consumers. The most effective way to protect consumers is to restore competitive markets. As the exports are making both consumers and producers better off , the government needs to make a policy to increase exports. The best policy is to promote free trade and not just concentrate on increasing exports. The firms need cheap imports to produce exports that can compete in the world market. It is tempting to have high tariffs on imports to protect domestic producers but this is self-defeating. It not only raises the cost of goods for everyone but also encourages domestic producers to be lazy. Low tariffs on imports also encourage trading partners to lower tariffs. Hence, when exports are increased the domestic consumers are better off as the prices go down and, the producers are better off as well because they can compete in the international market increasing their supply.

Works Cited
Jakab, Spencer. "Refiners Catch a Whiff of Investor Interest." Wall Street Journal 2 May 2012. Fowler, Tom. "Phillips 66 To Double Fuel Exports." Wall Street Journal 2 May 2012 Denning, Liam. "A Personal Trainer For Delta Air." Wall Street Journal 2 May 2012