As one of the larger independent refiners in the United States, Tesoro Corp. has met and overcome its challenges and enjoyed success. With today’s advances in alternative energy development, the company has strategic plans to further adapt to and embrace those changes and to continue its position as a leading refiner. Chairman, President and CEO Bruce Smith emphasizes that collaboration is the key to achieving those future goals.

The big picture

“We always thought we had clear messages, but recently, we were surprised to learn that the general public, the media, our elected officials and even our own employees actually had little understanding of the fundamentals in our industry,” Smith said. “The issue that started the discovery process was when Hawaiian lawmakers passed legislation that capped gasoline prices because some policymakers believed that Hawaii’s gasoline prices were artificially inflated because they were in an isolated market.”

Tesoro, which has a refinery in Kapolei, Hawaii, opposed the law for two reasons.

“Price controls have never worked,” Smith said. “They are not an effective way to allocate resources, and two, we did not want to find ourselves in a position where our responsibility to shareholders forced us to move product out of Hawaii to other markets with higher netbacks.”

To be proactive, Tesoro developed an education program for its employees and an awareness program for the general public. As Smith explained to an audience at NPRA’s recent annual meeting in San Antonio, this was when the misunderstanding was discovered.

U.S. refineries rely on foreign crude sources for almost two-thirds of their feedstocks. Those refineries are virtually running at full capacity, but the country still imports about 14 percent of its gasoline needs to meet total demand.

“The popular suggestion that we should decrease our reliance on foreign crudes reflects a misunderstanding about the resulting tradeoff,” Smith said. “If we reduce crude, we limit the throughput of U.S. refineries, and then America would import even more refined product. In fact, there is a call for us to build more refining capacity, which means we would need to import more foreign crude.”

The development of new natural resources takes massive amounts of capital and decades to achieve. New refining capacity takes less time, approximately four to five years, but after that, a margin environment that is somewhat stable for another four to five years is needed to see the return on this investment.

“Unfortunately, this nine- to 10-year investment cycle is longer than the average term of our elected officials,” Smith explained. “When you factor in the uncertainty about the future capital required to address climate change, the possible negative margin impact of renewable fuel supply combined with the current project cost explosion, it makes it extremely difficult for refiners to commit large amounts of capital to long lead time projects. So the idea of building significant new capacity in the United States is unrealistic.”

Smith said another overlooked fact is that about 45 percent of the refining capacity in the United States is owned by independent refiners that compete in the global markets with National Oil Companies and with integrated majors. 

“We produce gasoline so we get lumped together with the integrated companies in many legislative and regulatory matters, but we do not produce, nor profit from, the production of oil,” Smith explained. 

A better understanding of the supply and demand relationship is needed.

“The price of crude does impact the absolute price of gasoline, but profit is driven by the balance of global demand for refined products and their supply, which has become the global bottleneck,” Smith said. “The global shortage of product has caused refining margins to increase, which has nothing to do with the cost of crude.”

Another common misconception is that industry has vast amounts of storage, which gives it the ability to control gasoline supply. But, according to Smith, refinery production must find a market-clearing price in order to make room for the next day’s production.   

“We buy crude at a world price, facilitate the conversion of that commodity into products and move them into the marketplace to meet demand,” he said. “The fact that global markets are efficient and that products find the highest available clearing price is the paradigm that the state of Hawaii failed to appreciate when they passed the gasoline cap legislation, which has now been suspended.”

Tesoro is a West Coast refiner, but similar to the rest of the United States, the West Coast now imports gasoline. 

“In our opinion, the cost of imports has become the price-setting mechanism in the United States since there must be sufficient economic inducements for foreign refiners to produce and ship fuels that meet our product specifications,” Smith said. “We learned that the global scale and complexity of our business makes it very difficult to develop an effective communication message if we assume that the listener has very little detailed knowledge about the fundamentals of our business.”

Future energy

Tesoro is greatly concerned about making the right choices in the fundamental changes that are currently underway — What will be the most dependable, cost-effective and environmentally responsible source of energy in the future?

“It’s a tough question,” Smith said. “The general expectation is that with global prosperity the demand for energy will increase by an estimated 40 percent over the next 25 years. The only reasonable answer is that it is highly unlikely that a single source of energy will be able to satisfy the expected growth.

“As a consequence, the United States will find it very difficult to achieve ‘energy independence.’ With globalization, we are in fact economically dependent on others. I believe we should strive to have energy security by ensuring that we have a healthy economy and that our industries are able to compete in the global marketplace.”

Today and in the coming years, how America reacts to the energy challenges will be critical.

“The issues that are dominating the political agenda today are global warming and the call for alternative fuel development,” Smith said. “Some people smiled when former Vice President Gore received an Academy Award for his documentary on global warming.  However, the concern is a serious matter. Quite candidly, I think it’s time to demonstrate some leadership and forward thinking on this issue.”

Several states have been proactive, passing legislation to reduce CO2 emissions, paving the way for other states to do the same.

“Although a federal solution may not happen for several years, we believe it will happen,” Smith said. “The ball is rolling, and even the automakers are beginning to talk about making changes as long as they are not disproportionately disadvantaged. We believe this is not a bad position for our industry. We should not agree to any unacceptable solution that isn’t fair and equitable, but it’s unrealistic to assume that an equitable solution won’t require some no- or low-return capital investments.”

Renewable energy

“While oil will meet some of the future needs for transportation fuels, alternatives will supply an increasingly larger portion of the world’s future incremental energy demands,” Smith said. “We support efforts to develop renewables and believe our industry must work together to craft an energy strategy that balances fossil fuels and renewable energy.”

The Energy Act of 2005 included mandates for renewable fuels that escalate to 7.5 billion gallons a year by 2012.

“There is an effort by some people in Washington to substantially expand that requirement over the next decade,” Smith explained. “However, as the production of ethanol has grown, a number of potentially unintended consequences are surfacing such as the evolving ‘food vs. fuel’ debate.”

Smith believes that the economic viability of domestic renewables lies in protective tariffs and subsidies.

“Our country needs to consider the ramifications that additional mandates could have on the dependability of renewable fuels if its infrastructure is unable to compete in the global marketplace,” he said. “I am not suggesting that we throw in the renewables towel. We need to develop new technologies that have the potential to deliver cost-effective energy such as cellulosic ethanol.”

Smith encourages action and collaboration on the renewable fuels front.

“We realize there will be many voices in the debate about emissions and renewables. However, it is vital that our voice be heard. We need to reach out and listen to those interests that may have a different opinion to understand their point of view,” Smith said. “It is through this dialogue that we can seek to establish mutual respect and develop an effective communication message.”

Smith proposes three factors that will guide success:

• More consistent and realistic long-term planning, with industry’s participation “at the policy table to ensure that its unique concerns are not lumped with companies having broader agendas.”
• Petroleum will continue to be the principal component of our energy supply for years to come. The role of renewable energy “can’t be based on policies founded on hope or false economics, nor should we have an unrealistic expectation for its role as an energy source.”
• Industry must expand its community engagement, and reach out to interest groups with which it does not agree in order to find common ground on difficult issues. 

“At the end of the day, people make the difference between where we were, where we are and what we can achieve,” Smith said.