The D Factor – Downstream's Role in The New Energy Equation
Patricia A. Woertz, Executive Vice President, Global Downstream
Gastech 2005 Conference and Exhibition
San Francisco, California, March 14, 2005
I am delighted to be here this morning, and to welcome you to San Francisco, ChevronTexaco's historic hometown. It was here that Chevron's oldest predecessor company began operations 125 years ago.
Since we are here in our hometown, I thought I might introduce you to a practice that is part of our corporate culture. It's called a "safety moment." We never begin a meeting or other large gathering without first taking a moment to talk about safety. We share ideas and information that helps us create an environment where every colleague goes home safely, every shift, every day. You can visit any of our facilities in 180 countries where we do business and one common denominator you will find is the safety moment. I know that most of you are from out of town, so as our safety moment today, I would like to encourage you to be particularly cautious as you drive or walk about town. San Francisco has a significant problem with motorists who run red lights. City traffic officials estimate that more than 1,300 injuries a year are caused by red-light violators; that's three a day. So, please be careful. We want you to return home safely to your family, too.
I mentioned that San Francisco is our hometown and, indeed, if you go up to the 46th floor here and look east, you can see across the bay to Alameda, where our first refinery was built in 1880. It was California's largest and most modern refinery, capable of processing 600 barrels a day. And of course, at that time refining meant distilling oil into kerosene for lamps, heating and cooking, and figuring out what to do with the tar.
I wonder what those early refiners would think of our modern facilities, some of which process 1,000 times that amount? Would they be fascinated to learn how we distill the whole barrel into hundreds of products, from transportation fuels to chemical feedstocks, nylons, and plastic cups. Would they marvel at the global energy network that sees crude from central Africa shipped to European refineries ending up in California vehicles and all in the course of a few weeks?
The progress in our industry has evolved in step with global human progress. Every movement, from the field to the city and, literally, from darkness into light has been enabled by the energy we provide. It is this inexorable human progress that continues to make progress in our industry imperative if we're going to continue to meet the energy needs of a growing world market.
As our industry looks at the changing global demand for energy, many of us see new realities emerging. They are part of what we and ChevronTexaco's chairman Dave O'Reilly has called "The New Energy Equation." Today, I'm going to delve into the "D Factor," or downstream factor in the new equation and look at the challenges facing our sector.
But first, let's put those challenges in perspective by taking a broader look at the new equation.
While the new, global energy equation remains one of supply and demand, we think it encompasses a number of recent trends: challenging new resource locations, shifting balances in supply and demand, a complex geopolitical environment, and a changing competitive landscape. We also believe that, taken together, these new trends call for new thinking and new action on the part of industry, government, and society.
On the demand side, the key questions surround growth, and more specifically: where we're seeing that growth and what it means for our industry.
The International Energy Agency tells us that, in 2004, global oil demand, including both crude oil and products, was approximately 82.5 million barrels a day, and has grown an average of roughly 2% per year over the last four years.
By itself, that level of growth does not suggest a "new" equation. And, indeed, in Europe, the U.S., and in many developed countries growth is oscillating between 1 and 2 percent a year. Looking farther ahead, demand growth in these countries is actually expected to slow over the next 15 years.
In many developing countries--in Africa, the Middle East, and Latin America – total demand is growing at a slightly faster pace, averaging around 3 percent per year, yet is not large enough to signal an inflection point.
However, if we look at Asia, it's a totally different story. In China alone, demand growth in 2004 was nearly 16%. And the majority of this growth is in the transportation sector. China is adding 4 million cars and trucks a year to its roads.
It's this growth that leads some, such as the Energy Information Agency, to project that global oil demand growth will increase by about 46 percent in the next 20 years, reaching 120 million barrels a day by 2025.
And it's these projections, combined with projections that see supply growth flattening and in some areas declining, which lead some to fret that we will soon run out of oil.
Indeed, there is something of a cottage industry publishing books with titles like "The End of Oil," "Out of Gas," and "The Party's Over." And if you "google" 'Are we running out of oil?' you'll get 6 ½ million entries in less than half a second if you have a really fast computer. If the first 20 entries are any indication, most people believe the answer to this question is: "yes...we're running out of oil."
The world is not, however, running out of oil Global proved reserves are estimated to be 1.26 trillion barrels. That represents a 75 percent increase, in just the last 20 years.
However, a significant percentage of those reserves are in areas marked by geopolitical uncertainty and strife. A little over 2/3 of those reserves are controlled by OPEC countries, over half of which are in the Middle East.
By comparison, the United States has less than 2% of the world's conventional oil reserves.
So, while the world has oil, industry's ability to develop these reserves and supply refineries, and the ability of refineries to supply products, is becoming constrained.
Let me put some historical perspective around that: In 1983, when world demand was about 58 million barrels a day, OPEC had about 9 million barrels a day of spare production capacity.
Today, when world demand is above 80 million barrels a day, spare OPEC capacity is only around 2 million barrels a day.
It's important to note that this major drop in spare production capacity has coincided with a one-third reduction in spare refinery capacity worldwide.
As I am sure you realize, refineries in the U.S. and Europe are running at or near full capacity, with average utilization rates above 90%, and even in Japan and most of Asia they're running above 85%.
The implications are clear: Looking out over the next two decades, we can see the potential for this new global energy equation: growing demand, combined with constrained upstream and downstream supply, challenging industry's ability to supply oil to markets and to refine that oil to make finished products to meet the world's energy needs.
Against this global picture, let me delve more deeply into the challenges here in the U.S.
Today, U.S. oil demand is roughly 21 million barrels a day and, as I said, is growing about 1-2 percent a year. We are importing about 62% of that oil. In addition, we are importing about 10% of refined products.
In 20 years, U.S. oil demand is projected to be nearly 28 million barrels a day.
With U.S. refineries running at full capacity already, we may be hard pressed to supply all of that growth. And, with demand in international markets absorbing utilization gains generated by non-U.S. refineries, our ability to import more finished product may become more limited over time.
There are, of course, factors that could mitigate this demand. Ours is a cyclical business. We have seen this in the past. Geopolitical and economic factors can put the brakes on accelerating demand and can do so very quickly.
There are also emerging technologies that could serve to contain the demand for finished products, such as the introduction of more fuel-efficient vehicles, a marked increase in the number of hybrid vehicles, or the development and marketing of alternative fuels. However, fossil fuels will remain the principal energy source fueling our economy for decades to come. And therefore, it is clearly in our national interest, as well as the industry's, to seek supply solutions that will enable sound economic growth and effective environmental policies.
Expansion of the nation's refining infrastructure would seem to be an obvious part of these supply solutions. However, a study by the National Petroleum Council highlights many reasons why the obvious solution may be far from the easy or perhaps even feasible one.
While recent returns have been stronger, NPC studies over the years show that the historical refinery rate of investment return has trailed other manufacturing sectors: five to eight percent versus 12 percent. These are not exactly the levels of return that motivate robust capital investment. Significant investments over the last 20 years have focused on meeting new fuel and environmental requirements, and while those investments have changed operations and improved environmental performance, they have not necessarily added significant new capacity.
Even if you believe the investment economics have become more favorable, other discouragements remain. You would be hard pressed to find a community that would welcome a new refinery. The last new refinery in the U.S. was built almost 30 years ago. And, sometimes, it feels like permit delays can take just as long--even when the request is, for instance, to build a tank to hold ethanol to meet the RFG requirement, as we experienced here in California in 2003.
There is no simple solution that will unravel the complexity of balancing supply and demand needs in the U.S. or in the world. Indeed, the complexity of our industry would seem to be surpassed only by the importance of the energy we provide. So, it is critical that we work in concert with governments and communities to create an environment that will enable continued plentiful, reliable fuel supplies.
There are actions that our legislators can take, and I would like to recognize NPRA and Bob Slaughter for the important role they play as advocates for our industry. In this time when energy is a top public policy issue, we should push hard for an energy policy that reflects the importance of supply and for alignment of that policy with our other national imperatives.
Such alignment would be an important step toward increasing regulatory certainty and help ensure that our industry can operate within a framework of rules that won't change after major investments have been made.
We need to streamline the inhibitive permitting process that puts up barriers to industry actions to improve the supply situation, and encourage federal, state and local agencies to work together more proactively to expedite permitting.
NPRA has been in the forefront of activity to rationalize litigation exposure and, again, we are grateful for Bob's leadership. NPRA's call for limited liability protection for manufacturers of fuel containing MTBE is fundamentally fair. Congress knew MTBE would be used to meet the oxygenate requirement in the Clean Air Act, and EPA expressly approved it for that purpose.
Back in 1999, I said that mandated additives were not the solution. "Don't tell us the recipe, tell us the end specification." Refiners need flexibility, and a free market process, to create clean fuels our customers like. The same is true today.
Flexibility is particularly important because, quite often, solutions that are imposed on us by government create unintended consequences. For example, here in California MTBE was phased out in 2003, but the federal law for reformulated gasoline still requires the use of an oxygenate. As a result, our industry is forced to use the only state-approved alternate, which is ethanol. Now, research is showing unexpected excess emissions from cars using ethanol-blended gasoline and the California Air Resources Board has concluded that these emissions cannot be offset by further changes to California specs. So California continues to work for a waiver of the oxygenate requirement. But thus far, EPA has been unwilling to grant that waiver. Where does that leave us? With unintended consequences. Again-- flexibility, in the form of performance specifications rather than mandated ingredients, is the key.
We should also look at rationalizing state and local gasoline standards. The proliferation of boutique fuels can contribute to supply pinches and price volatility, which are prime sources of customer ire. Making gasoline more fungible can ease both supply and consumer frustrations, without sacrificing clean air benefits.
While we continue working with government and our communities to address energy security and economic growth issues, there is even more that our industry should do. We should be more open to conservation efforts, encourage the development of energy alternatives, and promote greater innovation within our industry.
We expect improved engine and fuel technologies to drive greater fuel system efficiencies, and we should continue to support these efforts through research and development, and in cooperation with the automakers. Our most advanced technology, combined with their most advanced technology, gives us both the best story to tell and the best future to unfold.
Gas-electric hybrids present a strong future technology alternative and in the longer term, hydrogen fuel-cell vehicles also offer some promise although many technical and economic hurdles remain before the full potential of hydrogen can be realized.
Bottom-line, we think the mix of energy sources will become more diversified over the longer-term, and we will need all the energy we can get, from every available energy stream. My company is focusing on innovation in many of these areas. For example, we are partnering with the auto industry and government to study the performance of extremely low emissions vehicles. We are developing and manufacturing advanced batteries for hybrid vehicles. We are experimenting with hydrogen distribution, building energy centers in Florida and here in California to understand the challenges involved in the practical delivery of hydrogen to vehicles equipped with fuel cells. We are involved in photovoltaics. And we are involved in wind power.
We must also address our role in the public's perception of our industry, particularly as it manifests itself in a reluctance to support new energy facilities. We may wish for government to take more of a leadership role to ensure new facilities are built. But we need to strengthen our relationships with the communities in which we operate.
While each of us defines our role in the new energy equation, and works to carve out our competitive share of the growing demand pie, we can also strengthen our collaboration through organizations such as the NPRA to ensure that our collective voice of reason will benefit our economy and our communities.
As an industry, we have a long history of working constructively on many issues: on fuels regulations; on helping to improve our environmental performance; and on the safety and quality of the products we produce. As NPRA members, many of us here in this room have worked hard, and have won, greater flexibility for our industry.
We will need that flexibility and more to meet the challenges ahead. Downstream's role in the new energy equation must be as masters of our own fate. We have a shared interest in making sure the world has reliable supplies of energy. There are many things that we, and governments, should do--globally, regionally, nationally and closer to home--to advance that mission. Let's work together to accomplish these changes.
Updated: March 2005