A Barrel Full's  Instablog

More news from a battered refining sector. Sunoco is to close a refinery for an indefinite period.

Sunoco, Inc. (NYSE:SUN) announced today it is indefinitely idling all process units at its Eagle Point refinery located in Westville, New Jersey in an effort to reduce losses in its refining business at a time when a recessionary economy, weak demand for refined products, and increased global refining capacity have created margin pressure on the entire refining industry. 

 

They were obviously operating at below capacity as they claim to be able to maintain volumes despite the shutdown.
 

Sunoco will shift current Eagle Point production to its two nearby refineries in Marcus Hook and Philadelphia, Pennsylvania, which will now operate at higher capacity utilization. The company will be able to produce essentially the same amount of refined products in two facilities that it currently produces in three while continuing to meet customer demand.  

 

This fact is important for two reasons, one, the company will actually be better off, as their revenues will be the same, whilst costs fall. Two, the impact on the sector will be zero, if output really doesn’t fall.

It is unclear when or even if, the refinery will come onstream again.
 

The company intends to idle Eagle Point until market conditions improve and will evaluate this decision and other options on an ongoing basis, including the feasibility of using the facility to produce alternative fuels in the future. 

 

Interestingly, Moody’s have reduced their outlook to negative following this announcement. I say interestingly because the news should be positive for the company, as it shows that they are able to reduce their cost base, without loosing market share. On the other hand, it is another sign of how difficult the sector is, so it should be seen as a negative for the sector.

We should also expect such news to continue.

Algae that attaches itself to a surface is extremely difficult to manage. Once the algae has reached a certain thickness, it cuts out the light and slows down the process. For this reason, researchers have focused on types of algae that live in suspension.  Origin Oil have come up with a solution.

OriginOil, Inc. has today announced an innovative production system using a type of algae that attaches itself to growth surfaces. The new system helps pursue clean water goals while generating algae for fuel and other valuable products in wastewater treatment plants.  

 

The system is designed for use in waste water systems, so it provides benefits other than just growing algae.
 

OriginOil’s Attached Growth System uses types of algae that will attach to surfaces rotating in and out of the water, exposing the algae to sunlight or artificial light. At harvest time, the algae is scraped off as a sludge.

 

This idea seems to me to offer one big advantage and one disadvantage (not sure how big). Separating an algae sludge from water has to be a lot easier than filtering out microscopic particles. On the downside, a lot of energy would be needed to provide the moving surfaces, and water loss by evaporation would be greater.

The Baker Institute for Public Policy has a new paper (pdf) published, called “Who is in the Oil Futures Market and How Has It Changed?” It takes a look at the growing role of “speculators” in the oil markets.

The market has changed much since it was deregulated in 2001.

First who is in the markets:
 

Non commercial players now constitute about 50% of those holding outstanding positions in the US oil futures market, compared to an average of 20% prior to 2002.

 

By non commercial they mean financial firms with no interest in the physical commodity.

There is a rather startling change that happened at the same time.
 

The correlation between the movements in oil prices and trhe value of the dollar against a trade weighted index of currencies of foriegn countries has increased to -0.82 (a significant measure) for the period between 2001 and the present day, compared to a previously insignificant correlation of only -0.08 between 1986 and 2000.

 

So the dollar/oil correlation that everyone talks about is very new, and is being connected here to changes in the market participants.

There is mention of the positive aspects of speculation, which are all too often ignored.
 

Growth in the use of financial instruments explicitly linked to oil has aided in price discovery by bringing openly accessible, readily available informations about current and expected future market conditions into the market price.

 

Seeing as the oil market is an opaque one, dominated by huge state owned monopolies, the importance of the increased transparency should not be understated.

The size of the markets worries some though.
 

Today, total NYMEX oil futures trading activity represents the equivalent of 600 million barrels, which is about seven times global daily demand.

 

So we can see clearly that the tail is indeed wagging the dog.

The report goes on to conclude that position limits could go some way toward stopping speculative action driving oil prices. It also suggests using strategic stocks to stabilise prices. Like many others, I think this analysis misses a few important points.

1) The period where there was no correlation between oil prices and the dollar, was one where the supply side of the market had a major problem. OPEC discipline had broken down and any increase in demand was met by new supply. It took $10 a barrel oil in 1999 to change all that. When demand is tight, a correlation between the world’s reserve currency and its primary source of energy is not completely unexpected. When excess supply exists however, the chance of a correlation is much less, as other factors become much more important.  

2) Oil prices are driven by Brent, a market that is relatively easy to manipulate.

3) Prices can only depart from fundamentals for short periods of time. Speculators cannot keep oil prices artificially high for extended perios of time. You cannot buck the market.

4) The USA’s trade deficit, is caused by over usage of oil, not by oil speculators. There is no god given right to unlimited access to cheap oil.

5) Price elasticity of oil demand is extremely low in the short term, so prices can be very volatile.

Only if regulators accept these points will they be able to design a regulatory system that is effective. I will not hold my breath.