Plight of the U.S. Refiner: Climate Bill, Stagnant Demand and Weak Margins

The latest doomsday report about proposed climate change legislation centers on the plight of U.S. refiners, essentially predicting the ultimate downfall of the industry as costs become too high and production shifts overseas.

U.S. refiners and their bottom lines have already been punished by a recession that has curbed demand for oil and gas and pushed its margins down sharply.

So what will be the industry's ultimate undoing? Will it be climate change legislation? Or will it be due to continued slowing demand for gasoline in the U.S., aided by an increase in the biofuels mandate and stricter fuel economy standards?

Let's set aside for a moment that the study, conducted by global consulting firm EnSys Energy, was commissioned by oil industry group American Petroleum Institute. Plenty of folks already have. The Houston Chronicle's guest blogger Victor Flatt, dives into the report's shortcomings including that it seems to ignore restrictions placed on imports of fuel coming into the U.S. from refineries abroad.

Much of the strife surrounding climate change legislation, passed by the House in June, centers on what many feel is the unequal doling out of "free allowances."

The legislation, known as the Waxman-Markey bill, mandates a 17 percent reduction in greenhouse gas emissions by 2020 from 2005 levels. Under the cap-and-trade system outlined in the bill, a price is placed on greenhouse gas emissions and the number of allowances for these emissions is restricted. A company must buy credits if they emit more pollution than is allowed.

In an effort to soften the transition, the bill distributes free allowances or credits -- with some industries like utilities and coal receiving the vast amount. Refiners, on the other hand, are responsible for 44 percent of emissions and are given 2.25 percent of allowances.

And that's where API's beef lies: on the unfair burden placed on the U.S. oil industry. The Ensys report argues, as a result of the legislation, costs would rise dramatically and by 2030 U.S. refining production could fall as much as 25 percent. U.S. investment would drop off and jobs would be lost.

To meet demand, foreign refiners -- who would presumably not have the same strict guidelines -- would import their products to the U.S. In the end, global emissions would not decrease nearly as much because reductions in the U.S. would be offset by polluters elsewhere, according to the report.

There is no doubt that U.S. refiners have been given the short-end of the stick under the House legislation compared to say, the coal industry. Of course, there are plenty of people cheering this type of scenario.

The Senate has an opportunity to rectify the unfair distribution of free allowances as it works through its own version of climate change legislation.

But even if proposed legislation settles some of the fairness issues, the industry still must grapple with stagnant demand and the rising cost of refining as more producers turn to unconventional sources of crude.