Refining incapacity: Politicians have hurt as much a s hurricanes

Midway through his press appearance Monday, we wondered if President Bush was going to don a cardigan. He was waxing on about energy "conservation," a la Jimmy Carter, and at one point he even said Americans should "curtail nonessential travel." Maybe they should turn down their thermostats and let their kids tap their keyboards with gloves on, too.

Only belatedly did Mr. Bush get around to the real energy problem that Hurricanes Katrina and Rita revealed for all Americans to see: the degree to which government policy has limited energy production so that a single big storm can deliver a supply shock that sends prices through the roof. Exhibit A is the oil refining industry, which hasn't built a new refinery in America since ... before Jimmy Carter was in office (1976).

Rita shuttered 27 percent of the nation's capacity to refine crude oil into gasoline, heating oil and other products. This followed Katrina, which shut down 10 percent of capacity, sending the average price of gasoline up to $3.07 a gallon. Things are now slowly getting back to "normal," though normal is not a synonym for good.

In 1981, there were 325 refineries in the U.S. with a capacity of 18.6 million barrels per day. Today, there are 148, with a capacity of about 17 million barrels -- though U.S. demand for gasoline has increased more than 20 percent. From 1993 to 2002, the average return on investment in the refining industry was 5.5 percent, or less than half the S&P industrials average of 12.7 percent.

One explanation for this performance is the historically low gas prices over much of the past 20 years; there has often been little incentive to build new capacity.

But just as big a problem are onerous and costly regulatory burdens that have sucked profits from the industry. This includes a permitting process that is subject to endless bureaucratic delay and court challenges. The one company that is even considering building a new refinery -- Arizona Clean Fuels Yuma -- has been trying to obtain its necessary air permits for nearly seven years.

Refiners have also had to spend some $47 billion in the past 12 years to meet the demands of, among other laws, the Clean Air Act, the Clean Water Act, the Toxic Substances Control Act, the Safe Drinking Water Act, the Oil Pollution Act, the Resource Conservation and Recovery Act, and the Comprehensive Environmental Response, Compensation and Liability Act. And from 2006 to 2012, refiners will be forced to comply with 14 new major environmental programs.

One of those is a rule to reduce sulfur in gasoline, which will go into its final stage next year. The U.S. refining industry will spend $8 billion to comply, and should be able to meet federal deadlines. But the rule further limits the ability to import extra gasoline, since many foreign firms are unable or unwilling to meet the new standards.

Ditto a new low-sulfur diesel mandate, which carries another $8 billion price tag. Refiners are understandably worried that low-sulfur diesel, which must go through the same pipes as higher-sulfur products, will ultimately fail to meet specifications and will have to be reprocessed -- potentially causing a major diesel-fuel crunch.

The recent energy bill only makes things worse. Its new ethanol mandate, a payoff to Midwest farming interests, will involve complicated refinery changes. And Congress's failure to pass liability protection for makers of MTBE, a fuel additive, will make it difficult for refiners to keep using that product next year. MTBE currently makes up a significant 1.6 percent of the nation's gasoline supply (more in certain areas), and refiners will have to find something to replace it. Good luck.

Refining companies have actually supported many of these environmental programs. The industry's complaint is that policymakers have put little thought into the timing or cumulative impact of these rules. At the Department of Energy's request, the National Petroleum Council performed two studies of the refining industry (in 2000 and 2004) and among its top recommendations was that regulators sequence environmental programs to give refiners some breathing room. Congress hasn't lifted a finger in response.

Meanwhile, America's energy supply crunch is only going to get worse. Demand for petroleum products is expected to rise by 1.6 percent annually for the next 25 years.

Yet America's refineries are already operating at 95 percent capacity, while imports are both costly and limited. Assuming the basic law of supply and demand, Americans are looking at sustained Katrina-like gas prices and shortages for years to come.

Congressional Republicans are mulling several ideas, including bills that would speed up refinery permitting or convert old military bases into refinery sites.

These are good first steps, but at some point the political class is going to have to find the backbone to ease the rules that it has imposed and that are creating today's energy shortages.