Christopher Helman, 11.13.09, 12:20 AM EST Forbes Magazine dated November 30, 2009 Valero Energy's Bill Klesse says a carbon permit system will hasten the demise of America's oil refiners. It sure won't help any.
William Klesse, chief executive of oil refiner Valero Energy, is riled up. "I think cap-and-trade is ludicrous," he says. "The whole bill is a hidden tax." The so-called climate bill wending its way through the Senate aims to create a cap-and-trade regime covering emissions of carbon dioxide and other greenhouse gases. If it passes in anything close to its current form, the bill would milk more carbon cash (payments to the government for the right to pollute) out of refiners than any other industry--somewhere between $30 billion and $110 billion a year. Valero, as America's biggest refiner (2.4 million barrels a day), would pay on the order of $7 billion a year.
The numbers are massive because the bill would hit refiners twice. First they would have to pay for allocations covering the carbon emissions from their factories (roughly 5% of total U.S. emissions). Then they would also be responsible for the tailpipe emissions from the combustion of all the automotive fuels they sell (roughly 40% of U.S. emissions). Klesse, 62, moans that politicians are "picking winners and losers" in figuring emissions allocations.
One problem with this analysis: It's motorists who will pay, as refiners simply tack carbon costs onto the price of gasoline. Valero Energy ( VLO - news - people ) admits as much: Placards posted atop each pump at Valero's 5,800 branded gas stations feature the iconic illustration of a finger-pointing Uncle Sam and the words, "You will pay the price." The sign says that cap-and-trade "will cost you 77 cents or more a gallon."
One thing Klesse does not need is yet another reason for people to buy less of his product. Even though rising fuel costs and taxes can mostly be passed along, they depress demand for refining. That causes refining margins to implode.
The U.S. will not in the near future (or maybe ever) use as much gasoline and diesel as the 580 million gallons a day sold in 2007. The recession has cut demand 10%, forcing the industry to cancel or put on hold expansion plans that would have added 900,000 barrels per day of new capacity. Valero, which owns no gas or oil fields, lost $500 million in the third quarter on $19.5 billion in sales, while reducing runs at its 16 plants and shuttering its refinery in Aruba. Competitor Sunoco ( SUN - news - people ) has idled its Eagle Point, N.J. refinery.
It will get worse. The litany of grief starts with congressional mandates to blend more ethanol into gasoline, further reducing demand for Valero's distillation towers. A federal mandate will have the average new car getting 35.5mpg by 2016. General Motors is set to introduce the Volt, while Ford, Nissan ( NSANY - news - people ) and Tesla have received $8 billion in government incentives to build electric cars. "Economic recovery will not solve the problems faced by the refining industry," says Roger Ihne, an analyst with Deloitte Consulting.
In five years the U.S. will have the plants to produce some 70 million more gallons of fuel a day than it needs, figures Deutsche Bank ( DB - news - people )'s Paul Sankey. Under cap-and-trade that extra fuel wouldn't be exported because it couldn't compete with new refineries, unburdened with carbon regulations, in India, Saudi Arabia, Vietnam and China. Though imported gasoline would be subject to carbon tariffs covering tailpipe emissions, it wouldn't be subject to regulations on plant emissions, giving imports a giant 5-cents-per-gallon cost advantage, even after shipping costs, according to Deloitte's Ihne. He figures that under cap-and-trade, imports, which now account for 16% of refined petroleum products, could easily return to the 25% share they held in 2006 when the dollar and demand were strong.
Ihne predicts that at least 15 of the current 150 plants, capable of processing roughly 2 million barrels of oil a day, will close, eliminating 5,000 jobs. Sankey suggests that U.S. refiners push lawmakers to pass protectionist tariffs on imported fuel, on the grounds that U.S. refineries are more environmentally friendly than their overseas competitors.
In the past decade Valero adjusted many of its plants to take heavy, sulfurous oil that historically sells at a discount to light, sweet crude. In early 2008 that discount was as wide as $30 a barrel, leaving plenty of profit potential despite the added costs of heating and boiling the gunk. This year, however, the discount has shrunk to less than $5 a barrel; heavy crude is the first grade that quota-constrained OPEC producers shut in when prices plunge. The heavy crude also produces more carbon dioxide. "What looked like a cheap feedstock may now mean a costly carbon footprint," says Ihne.
So who wins and loses in the shakeout? Winners: the small players in isolated, landlocked markets, like Holly Corp. ( HOC - news - people ) and Frontier Oil ( FTO - news - people ) in the Rocky Mountains. Survivors: the globally integrated petroleum producers. ExxonMobil ( XOM - news - people ) lost $200 million on U.S. refining operations in the third quarter but has ample profits from oil and gas fields to absorb refinery losses until weaker players fall out of the U.S. market. No wonder Shell and BP are backing cap-and-trade (Exxon still prefers the certainty of a flat carbon tax).
Losers: companies like Valero, Sunoco and Tesoro ( TSO - news - people ), which are refiners only and own plants in coastal areas that are thick with both refineries and import tankers. Klesse says he'd like to find a buyer for Valero's two East Coast plants. Daniel Weiss, senior fellow at the Center for American Progress, says the refiners should stop whining. He insists that the requirement to buy emissions credits will spur refiners to look for new ways to cut emissions. "Once we take the debate away from the lobbyists and hand it over to the engineers, there's no telling how many efficiencies we'll find," he says.
Last year Valero bought seven ethanol plants from bankrupt Verasun for $480 million, 30% of replacement cost. The plants make 51,000 barrels of ethanol a day, roughly a third of what Valero needs to blend with its gasoline. This year Klesse christened a 33-turbine wind farm on the grounds of Valero's McKee refinery in the Texas Panhandle. It generates 50 megawatts, enough to cover most of the plant's power needs and pay for itself in ten years. "We're not opposed to renewable energy," he says. "But these things should have to compete in the market."
He's also thinking about replacing old oil boilers, which convert energy to heat with 82% efficiency, with new ones that are 92% efficient. "But it's hard to invest in any upgrades when you don't know what the price of carbon is going to be."
Klesse can't change what Valero is. It's unlikely he'll find a buyer for the plant in Aruba or the two on the East Coast he wants to sell. And don't hold your breath for a congressional oil refiner bailout.