There was no news yesterday at President Bush’s ranch in Crawford, Texas, but there was plenty of talk when the head of the world’s biggest oil-consuming country chatted with his counterpart from the world’s biggest supplier.

After playing host to Prince Abdullah, the working leader of Saudi Arabia, the President explained that “a high oil price will damage markets and he knows that,” according to AP via Bush also observed that “one thing is for certain: The price of crude is driving the price of gasoline. The price of crude is up because not only is our economy growing, but economies such as India and China’s economies are growing.”
Growth, it seems, is a challenge as much as an opportunity to the global economy. Not to worry, though; the Saudis have a plan. What is it? Well, they plan to pump more oil, at first by squeezing their ever-thinning spare capacity down to the nub. In the longer term, they’ll invest billions to bring new fields online is the silver bullet. Promises, promises.
In any case, all of this has been widely discussed before the prince set foot in the Lone Star State, but “the plan” nevertheless impressed White House National Security Adviser Stephen Hadley. “Clearly, the news that came out of the meeting today ought to be good news for the markets and we would hope that and other factors would result in some positive news, in terms of the price fronts,” Hadley said of the Bush-Abdullah meeting in a briefing to reporters on Monday.
But for all the optimism, there seems to be some disagreement as to whether Saudi Arabia is pumping as much as it could in the spring of 2005. “The problem in the oil markets now is a perception that there is inadequate capacity…” Hadley told said. Meanwhile, Reuters reports that Prince Abdullah’s Foreign Policy Adviser Adel al-Jubeir said that the oil markets are adequately supplied. Someone it seems needs a perception adjustment.
Oil traders, however, are going with the Saudi’s viewpoint. Consider that when the nearby oil futures contract closed in New York last week, a barrel of crude changed hands for well over $55. By the end of today’s session, the price was roughly $54.
Tomorrow, next month, next year, and beyond, however, is another matter. Indeed, while much of the world, along with Wall Street, is focused on where the price of oil is headed in the short run, strategic thinkers in the energy business are casting their votes on the long haul in the here and now.
The smoking guns can be found in recent decisions of big oil (ChevronTexaco’s purchase of Unocal) as well as in the domestic refinery business, as witnessed by Monday’s news that Valero Energy Corp. plans to buy oil refiner Premcor Corp.
Valero is already the nation’s biggest refiner, and the deal promises to further consolidate Valero’s leading presence in the industry. Consolidation and economies of scale, in other words, is the name of the game from here on out.
Indeed, the acquisition news sent the remaining refinery stocks higher on the reasoning that additional takeovers are coming. Shares of Tesoro Corp., for instance, temporarily shot up in the wake of the Valero announcement on Monday before pulling back today.
But for all the bullish anticipation about refinery stocks, there’s still skepticism about Valero’s decision to buy Premcor. The Street, as if you needed another reminder, still isn’t sure about the notion of oil as a scarce commodity in the long haul. The Wall Street Journal (subscription required) today suggests as much by pointing out that the string of profits in recent years in running a refinery is temporary and therefore due for a correction a la the 1980s. Jay Saunders, a Deutsche Bank analyst, is quoted as saying that Valero’s acquisition of Premcor represents a “significant risk.” Why? Valero’s paying a 19% premium for Premcor shares.
Indeed, refinery stocks are a recent arrival to the halls of optimism. As recently as 2002, shares of Valero were trading at below book value. No more: the top indy refiner now trades at two-and-a-half-times book.
Risk or not, Saunders still rates Valero a “buy,” the Journal notes, suggesting that some on the Street are torn by this energy bull market. Ok, so why the “buy”? Reviewing the nation’s refinery capacity of late may yield a clue. Echoing the Saudi output situation, there is little spare capacity at the moment in U.S. refineries. In January, for example, refinery capacity was running at 91.3%; for December 2004, it was 95%, the Energy Department reports.
Ninety-percent-plus capacity is nothing new in the refinery game of late, but it wasn’t always so. In the early to mid-1980s, refinery capacity was around 70% for a number of years.
But the economy has since grown, and is growing. The bottom line: demand for gasoline and other refined oil products ascends too. Yet new refineries have become an extinct species, prompting the Energy Department to warn, as it did last year, that surplus U.S. refinery capacity is disappearing. No wonder that gasoline imports have been trending higher. This past January, gasoline imports were running at the equivalent of 803,000 barrels a day, up by a third from a year earlier.
Yes, there are risks to Valero’s purchase of Premcor, just as there were risks when Sunoco purchased a large refinery from El Paso Corp. last year. But in a world of rising gasoline demand and dim prospects for building new refineries any time soon, buying is the only game left in town.
Indeed, buying rather than developing seems to be a theme throughout the energy business of late. A number of large oil companies have been buying existing production in addition to developing it from scratch. Why? A clue comes from a Reuters story about declining production at BP.
The dearth of new refineries in the United States is a self-imposed limitation courtesy of NIMBY (not in my backyard) while the reportedly declining opportunities to develop large, new oil fields globally is a byproduct of geological constraint. In either case, the path of least resistance leads to a common conclusion: buy up the competition. In fact, the buying game has only just begun.
But don’t confuse consolidation of refineries with increasing production output. The dwindling number of players is no short cut to increasing supply. Only God can make a tree, and only a new refinery can materially expand gasoline production.
Lower prices from refinery consolidation probably aren’t imminent either. Or so Senator Ron Wyden (D-Oregon) tells The Deal today. “We know that concentration of the oil industry is already squeezing consumers at the pump, and this proposed acquisition by Valero of Premcor would create the biggest U.S. refiner and tighter concentration in a number of areas.”
Wyden is an outspoken critic of mergers in the refinery business, but does he realize that the government has been instrumental in driving consolidation. As Lynne Kiesling of Knowledge Problem writes today of the Valero/Premcor deal, “I continue to think that this merger pattern is consistent with the fact that environmental regulation has broken apart the economies of scale in petroleum refining, making it more costly, and that the mergers are a way to recapture those economies of scale.”
Perhaps when the refinery industry devolves into a true state of oligopoly (if it’s not there already), the government will promote the development of the nation’s first new, major refinery since 1976. Either that or hand out bicycles. Till then, the refinery stocks are in play.