United States
Environmental Protection
Agency
Office of Air Quality
Planning and Standards
Research Triangle Park, NC 27711
EPA-453O-94-052
July 1994
Air
Economic Impact Analysis for the
Petroleum Refineries NESHAP
DRAFT
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CONTENTS
Page
TABLES VI
FIGURES viii
ACRONYMS AND ABBREVIATIONS ix
EXECUTIVE SUMMARY - . ES-1
ES.l ECONOMIC IMPACT ANALYSIS OBJECTIVES ES-1
ES.2 INDUSTRY CHARACTERIZATION ES-2
ES.3 CONTROL COSTS AND COST-EFFECTIVENESS ES-3
ES.4 MONITORING, RECORDKEEPING, AND REPORTING COSTS . ES-5
ES.5 ECONOMIC METHODOLOGY OVERVIEW .'.... ES-5
ES.6 PRIMARY REGULATORY IMPACTS AND SOCIAL COSTS . . . ES-6
ES.7 SECONDARY REGULATORY IMPACTS . ES-9
ES.8 ECONOMIC COST ES-11
ES.9 POTENTIAL SMALL BUSINESS IMPACTS ES-12
1.0 INTRODUCTION AND SUMMARY OF CHOSEN REGULATORY ALTERNATIVE 1
1.1 INTRODUCTION - . 1
1.2 SUMMARY OF CHOSEN REGULATORY ALTERNATIVE 2
2.0 INDUSTRY PROFILE 3
2.1 INTRODUCTION 3
2.2 PROFILE OF AFFECTED FACILITIES 4
2.2.1 General Process Description 4
2.2.2 Product Description and Differentiation .... 5
2.2.3 Distinct Market Characteristics 6
2.2.4 Affected Refineries, Employment, and Location . 10
2.2.5 Capacity and Capacity Utilization 13
2.2.6 Refinery Complexity 15
2.3 MARKET STRUCTURE , 15
2.3.1 Market Concentration • 17
2.3.2 Industry Integration and Diversification .... 19
2.3.3 Financial Profile 21
2.4 MARKET SUPPLY CHARACTERISTICS . . 27
2.4.1 Past and Present Production 27
2.4.2 Supply Determinants 27
2.4.3 Exports of Petroleum Products- 29
2.5 MARKET DEMAND CHARACTERISTICS 29
2.5.1 End-Use Markets for Refined Products 31
2.5.2 Demand Determinants 33
2.5.3 Past and Present Consumption 34
2.5.4- Imports of Refined Petroleum Products 36
2.5.5 Pri cing • • • • -^6
2.6 MARKET OUTLOOK ' . . . . 40
2.6.1 Supply Outlook (Production and Capacity) .... 40
2.6.2 Demand Outlook 43
2.6.3 Price Outlook 44
111
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CONTENTS (continued)
Page
3.0 ECONOMIC METHODOLOGY , 51
3.1" " INTRODUCTION 51
3.2 MARKET MODEL . 51
3.2.1 Partial Equilibrium Analysis 51
3.2.2 Market Demand and Supply 52
3.2.3 Market Supply Shift 53
3.2.4 Impact of Supply Shift on Market Price and
Quantity 55
3.2.5 Trade Impacts 55
3.2.6 Plant Closures ....... 58
3.2.7 Changes in Economic Welfare 58
. 3.2.8 Labor Input and Energy Input Impacts 61
3.2.9 Baseline Inputs 62
3 .3 INDUSTRY SUPPLY AND DEMAND ELASTICITIES 64
3.3.1 Price Elasticity of Demand 64
3.3.2 Price Elasticity of Supply 65
3 .4 CAPITAL AVAILABILITY ANALYSIS .74
4.0 CONTROL COSTS, ENVIRONMENTAL IMPACTS, COST-EFFECTIVENESS 79
4.1 INTRODUCTION 79
4.2 CONTROL COST ESTIMATES 79
4.3 MONITORING, RECORDKEEPING, AND REPORTING COSTS . . 82
4.4 ESTIMATES OF ECONOMIC COSTS 84
4.5 ESTIMATED ENVIRONMENTAL IMPACTS 89
4 .6 COST EFFECTIVENESS 90
5.0 PRIMARY ECONOMIC IMPACTS AND CAPITAL AVAILABILITY
ANALYSIS • '.-.... ..:•'• 92
^5". 1 INTRODUCTION 92
5.2 ESTIMATES OF PRIMARY IMPACTS '....' 92
5.3 CAPITAL AVAILABILITY ANALYSIS 95
5.4 LIMITATIONS 96
5.5 SUMMARY . .." 97
6.0 SECONDARY ECONOMIC IMPACTS 98
6.1 INTRODUCTION .- 98
6.2 LABOR MARKET IMPACTS ....... 98
6.3 ENERGY INPUT MARKET 100
6.4 FOREIGN TRADE . ' 100
6.5 REGIONAL IMPACTS 100
6.6 LIMITATIONS '. . 102
6.7 SUMMARY . . .' . 102
7.0 POTENTIAL SMALL BUSINESS IMPACTS ... 103
7.1 INTRODUCTION 103
7.2 METHODOLOGY . . . 104
7.3 SMALL BUSINESS CATEGORIZATION 104
7.4 SMALL BUSINESS IMPACTS 104
IV
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CONTENTS (continued)
APPENDIX-A - PRODUCTION CAPACITY OF OPERABLE PETROLEUM
REFINERIES BY FIRM AND REFINERY (AS OF JANUARY 1, 1991)
APPENDIX B - SENSITIVITY ANALYSES
Page
. A-l
. B-l
v
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TABLES
Page
TABLE ES-1 SUMMARY OF COSTS IN THE FIFTH YEAR BY EMISSION
• " POINT ...... ES-4
TABLE ES-2 SUMMARY OF PRIMARY ECONOMIC IMPACTS OF PETROLEUM
REFINERY NESHAP ES-8
TABLE ES-3 SUMMARY OF SECONDARY REGULATORY IMPACTS . . . ES-10
TABLE ES-4 ANNUAL SOCIAL COST ESTIMATES FOR THE PETROLEUM
REFINING REGULATION ..... ES-12
TABLE 2-1 PRODUCTION CAPACITY OF OPERABLE PETROLEUM
REFINERIES 8
TABLE 2-2 EMPLOYMENT IN THE PETROLEUM REFINING INDUSTRY . 11
TABLE 2-3 1990 EMPLOYMENT FOR SELECTED REFINING FIRMS . . 12
TABLE 2-4 AVERAGE ANNUAL OPERABLE AND CAPACITY UTILIZATION
RATES 14
TABLE 2-5 1990 REFINERY COMPLEXITY DISTRIBUTION: OPERABLE
CAPACITY 16
TABLE 2-6 CONCENTRATION IN REFINING CAPACITY 18
TABLE 2-7 MAJOR ENERGY FIRMS WITH REFINING CAPACITY ... 20
TABLE 2-8 FIRMS IN SAMPLE FOR REFINERY-SPECIFIC FINANCIAL
DATA 22
TABLE 2-9 OPERATING STATISTICS OF REFINERY SAMPLE 1987-1991 23
TABLE 2-10 REFINED PRODUCT MARGINS 1977-1988 24
TABLE 2-11 CAPITAL EXPENDITURES BY DOMESTIC PETROLEUM
REFINERS 1977-1988 ' 26
TABLE 2-12 U.S. PETROLEUM PRODUCTS SUPPLIED, 1980-1992 . . 28
TABLE 2-13 EXPORTS AND DOMESTIC REFINERY OUTPUT .- 30
TABLE 2-14 PETROLEUM PRODUCTS SUPPLIED* TO THE U.S. MARKET
BY TYPE 1970-1992 35
TABLE 2-15 IMPORTS AND DOMESTIC CONSUMPTION OF REFINED
PETROLEUM PRODUCTS 37
TABLE 2-16 U.S. PETROLEUM PRODUCT IMPORTS AND EXPORTS ... 38
TABLE 2-17 PETROLEUM PRODUCT PRICE LEVELS, 1978-1992 , . . .39
TABLE 2-18 PROJECTED CONSUMPTION OF PETROLEUM PRODUCTS . . • 45
TABLE 2-19 PROJECTED PRICES OF PETROLEUM PRICES 46
TABLE 3-1 PRODUCT-SPECIFIC BASELINE DATA INPUTS ..... 63
TABLE 3-2 BASELINE INPUTS FOR THE PETROLEUM REFINING
INDUSTRY 63
TABLE 3-3 ESTIMATES OF PRICE ELASTICITY OF DEMAND .... 65
TABLE 3-4 PRODUCTION FUNCTION DATA INPUTS 71
TABLE 3-5 ESTIMATED PRODUCTION FUNCTION COEFFICIENTS ... 72
TABLE 4-1 SUMMARY OF COSTS IN THE FIFTH YEAR BY EMISSION
POINT ' - 81
TABLE 4-2 MISCELLANEOUS PROCESS VENTS - MONITORING,
RECORDKEEPING, AND REPORTING REQUIREMENTS FOR
COMPLYING WITH 98 WEIGHT-PERCENT REDUCTION OF
TOTAL ORGANIC HAP EMISSIONS OR A LIMIT OF
20 'PARTS PER MILLION BY VOLUME 85
TABLE 4-3 ESTIMATES OF THE ANNUALIZED ECONOMIC COSTS
ASSOCIATED WITH ALTERNATIVE NESHAPS BY PETROLEUM
PRODUCT MARKET ..... 89
VI
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TABLES (continued)
TABLE 4-4
TABLE 5-1
TABLE 5-2
TABLE 6-1
TABLE 6-2
Page
ESTIMATED ANNUAL REDUCTIONS IN EMISSIONS AND
COST-EFFECTIVENESS ASSOCIATED WITH THE SELECTED
REGULATORY ALTERNATIVE 90
SUMMARY OF PRIMARY IMPACTS 94
ANALYSIS OF FINANCIAL RATIOS 96
SUMMARY OF SECONDARY REGULATORY IMPACTS .... 99
FOREIGN TRADE (NET EXPORTS) IMPACTS 101
VI1
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FIGURES
Page
ES-1. MODEL DEVELOPMENT FOR ECONOMIC IMPACT ANALYSIS ... ES-7
2-1. - ' PETROLEUM ADMINISTRATION' FOR DEFENSE (PAD) DISTRICTS 7
2-2. PETROLEUM CONSUMPTION BY END-USE SECTOR, 1970-1990 32
2-3. PROJECTED SUPPLY OF PETROLEUM PRODUCTS ...... 42
3-1. ILLUSTRATION OF POST-NESHAP MARKET MODEL 56
Vlll
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ACRONYMS AND ABBREVIATIONS
API
ASM
bbl
bbl/d
BCA
BWON
CAA
CERA
DOC
DOE/EIA
EIA
EPA
HAP
HON
LPGs
MACT
Mg
MRR
MTBE
NAAQS
NESHAP
NSPS
-v
0&3
OMB
PADD
RFA
RIA
SIC
S02
VOC
American Petroleum Institute
Annual Survey of Manufactures
One barrel; equal to 42 gallons
Barrels per day
Benefit Cost Analysis
Benzene Waste Operations NESHAP (NESHAP is
defined below)
Clean Air Act
Cambridge Energy Research Associates
Department of Commerce
Department of Energy/Energy Information
Administration
Economic Impac Analysis
Environmental Protection Agency
Hazardous Air Pollutant
Hazardous Organic NESHAP (NESHAP is defined
below)
Liquefied Petroleum Gases
Maximum Achievable Control Technology
Megagram
Monitoring, reporting, and recordkeeping
Methyl tertiary butyl ether
National Ambient Air Quality Standard
National Emission Standard for Hazardous Air
Pollutants
New Source Performance Standard
Nitrogen oxide
Oil and Gas Journal ,
Office of Management and Budget
Petroleum Administration for Defense District
Regulatory Flexibility Act; also Regulatory
Flexibility Analysis
Regulatory Impact Analysis
Standard Industrial Classification
Sulfur dioxide
Volatile Organic Compound
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EXJsCUJ-iViS
SUMMARY
ES.l. ECONOMIC IMPACT ANALYSIS OBJECTIVES
. • The purpose , of .this. economic impact analysis (EIA) is to
Devaluate- the.; effect' df the: control costs associated with the
Petroleum Refining National Emission Standard for Hazardous Air
Pollutants (NESHAP) on the behavior of the regulated petroleum
refiners. The EIA was conducted based on the cost estimates for.
one hybrid regulatory option above the maximum achievable control
technology (MACT) "floor" (or minimum standard). This analysis
compares the quantitative economic impacts of regulation to
baseline industry conditions which would occur in the absence of
regulation. The economic impacts of regulation are estimated for
the industry, using costs which were supplied on both a national
and a refinery level.
Section'-112'of'the Clean Air Act''(CAA) contains a list of
hazardous air pollutants (HAPs) for which the U.S. Environmental
Protection Agency (EPA)- has published a list of source categories
that must be regulated. To further meet this requirement, EPA is
evaluating NESHAP alternatives for the regulation of the
petroleum refining industry, based on different control options
for the emission points within refineries which emit HAPs.' This
EIA was completed to fulfill CAA requirements and an Executive
Order. Section 317 of the CAA requires EPA to evaluate
regulatory alternatives through an EIA. Executive Order 12866
' requires EPA to" assess major regulations through a regulatory
impact analysis (RIA). In addition to other analyses, an RIA
must include an EIA. Accordingly, this EIA has been prepared to
ES-1
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satisfy the requirements of the CAA and to partially fulfill the
requirements of Executive Order 12866.
The objective of this EIA is to quantify the impacts of NESHAP
control costs on petroleum refinery output, price, employment,
and trade. The probability of refinery closure is also
estimated, in addition to potential effects on the financial
conditions of affected firms. To comply with the requirements of
the Regulatory Flexibility Act (RFA), special attention is
focused on the potential effects of control costs on smaller
refineries.
ES.2 INDUSTRY CHARACTERIZATION
The firms affected by the Petroleum Refinery NESHAP are
classified in SIC code 2911. The U.S. refining industry uses
crude oil as an input to refine petroleum products for use as
fuels, lubricants, waxes, asphalt materials, and other
miscellaneous products. The five main refinery output categories
are (1) motor gasoline, (2) jet fuel, (3) residual fuel oil, (4)
distillate fuel oil, and (5) liquefied petroleum gases (LPGs).
These five products accounted for 93 percent of total refinery-
output in 1992. The economic model used for this analysis
focuses on these five product categories. The four economic
sectors which are the source of demand for these five petroleum
product categories are (1) residential and commercial,
(2) industrial, (3) transportation, and (4) electric utilities.
During the past decade, the number of operating refineries in
the United States has declined by 40 percent. As of January 1,
1992, there were 192 operable petroleum refineries in the United
States owned by 109 firms. Firms that operate petroleum
refineries are characterized as vertically integrated if they own
and operate segments responsible both for exploration and
production of crude oil (which supplies the input for refineries)
and for marketing the finished petroleum products after refining
occurs. The crude capacity of the major, vertically integrated
firms in the petroleum refining industry represents almost 70
percent of nationwide production. Of the 109 firms in the
industry, 73 operate only one refinery each. These are the
ES-2
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newly constructed emission points, which were prepared by the
engineering contractor for use in the EIA. All costs are in
first quarter 1992 dollars. Costs are provided by emission point
for the MACT floor level of control and Option 1 for equipment
leaks. " The total national annualized cost for the chosen option
is approximately $81.0 million (excluding monitoring, reporting,
and recordkeeping costs).
Table ES-1 also shows the HAP and VOC emission reductions
associated with control at three of the four emission points and
the calculated cost-effectiveness of each control method. The
cost-effectiveness of VOC emission reduction ranges from $63 to
$411 per megagram, and the cost-effectiveness of HAP reductions
ranges from $1,353 to $5,425 per megagram. No control costs or
emission reductions are associated with the control of wastewater
streams.
To allocate the costs among the five petroleum product
categories in the analysis, a national average production mix was
applied to individual refinery production data found in the Oil
and Gas Journal's (OGJ) "Survey of Operating Refineries for
1992." This calculation assumes that all refineries have the
same product mix as the national average. Costs were then
allocated in a two-step process: (1) by assuming that all
storage vessels control costs were associated with the production
of motor gasoline, and (2) costs associated with equipment leaks
and miscellaneous process vents were distributed among the
product categories based on the national product mix ratios.
ES.4 MONITORING, RECORDKEEPING, AND REPORTING COSTS
In addition to provisions for the installation of control
equipment, the proposed regulation includes provisions for
monitoring, recordkeeping, and reporting (MRR). EPA estimates
that the total annual cost for refineries to comply with the MRR
requirements is $30 million. After incorporating MRR costs, the
total cost of compliance of the Chosen Regulatory Alternative is
$111 million.
ES-4
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ES.5 ECONOMIC METHODOLOGY OVERVIEW
In this study, data inputs are used to construct a pre-control
baseline equilibrium market model of the petroleum refining
industry. This baseline model of the petroleum refining market
provides the basic framework necessary to analyze the impact of
proposed control costs on the industry. The Industry Profile for
the Petroleum Refinery NESHAP contained industry data, including
estimates of price elasticities of supply and demand measures
which are inputs to the baseline model. The industry profile
characterizes the market structure of the industry, provides
necessary supply and demand information, and identifies market
trends. Engineering control cost studies provide the final major
data input required to quantify the potential impact of control
measures on the market. These profile and engineering cost data
inputs are evaluated within the context of the market model to
estimate the impacts of regulatory control measures on the
petroleum refining industry and on society as a whole. The
potential impacts include the following:
• Changes in market price and" output.
• Financial impacts on firms.
• Predicted closure of refineries.
• Welfare analysis.
• Small business impacts.
• Labor market impacts.
• Energy use impacts.
• Foreign trade impacts.
• Regional impacts.
The progression of steps in the EIA process is summarized in
Figure ES-1.
ES.6 PRIMARY REGULATORY IMPACTS
Primary regulatory impacts include estimated increases in
the market equilibrium price of refined petroleum products,
decreases in the market equilibrium domestic output or
production, changes in the value of domestic shipments, and plant
closures. The analysis was conducted for the five petroleum
ES-6
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products of interest. The primary regulatory impacts are
summarized in Table ES-2. ~
As shown in Table ES-2, the estimated price increases for the
petroleum products range from an increase of $0.03 per barrel for
residual" fuel oil to $0.14 per barrel for jet fuel. These
predicted price increases represent a less than 1 percent
increase in the price of each product and range from 0.24 percent
for residual fuel oil to 0.53 percent for jet fuel. Domestic
production is expected to fall for the five petroleum products
combined by approximately 12.52 million barrels annually. This
estimated decrease in production for each of the petroleum
products varies from annual decreases of 0.65 million barrels for
jet fuel to 5.67 million barrels annually for motor gasoline.
The predicted change in the dollar value of domestic shipments
or revenue to producers in the industry is actually anticipated
to increase for the five petroleum products combined by
approximately $107.41 million annually ($1992). Annual revenues
for each of the petroleum products are anticipated to increase
with the exception of residual fuel oil. Price increases for
products with inelastic demand generally lead to
ES-7
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TABLE ES-2.
SUMMARY OF PRIMARY ECONOMIC IMPACTS OF
PETROLEUM REFINERY NESHAP
Refined Product
Motor gasoline
Amount
Percentage
Jet fuel
Amount
Percentage
Residual fuel
Amount
Percentage
Distillate fuel
Amount
Percentage
LPGs
Amount
Percentage
Increases1
$0.09
0.29%
$0.14
0;53%
$0.03
0.24%
$0.08
0.29%
$0.07
0.26%
Decreases
(5.67)
(0.22%)
(0.65)
(0.13%)
(1.62)
(0.50%)
(2.78)
(0.26%)
(1.80)
(0.25%)
Shipments-3
$55.63
0.07%
$53.22
0.41%
($11.92)
(0.26%)
$8.06
0.03%
$2.42
0.01%
NOTES: 1 Prices are shown in price per barrel ($1992).
^Annual production quantities are shown in millions of barrels.
^Values of domestic shipments are shown in millions of 1992 dollars.
^Brackets indicate decreases or negative values.
ES-
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revenue increases for producers. This result holds for each of
the petroleum products studied except residual fuel oil. The
resulting decrease in predicted revenues for this product results
from the large quantity of this product that is imported. As the
price of' domestic residual fuel oil rises, greater amounts of
this product are imported leading to revenue decreases for
domestic producers.
Approximately 7 refineries are predicted to close as a result
of the regulation. Plant closure estimates and other regulatory
impacts are likely to be overestimations for the following
reasons:
• The model assumes that all refineries compete in a
national market. In reality, some refineries are
protected from market fluctuations by regional or local
trade barriers and may therefore be less likely to
close.
• It is assumed that the plants with the highest control
cost per unit of production also have the highest
baseline production costs. This is a worst- case
assumption and may not be true in every case.
• Control costs are assigned exclusively to the five
products of interest which collectively represent 93
percent of the total quantity of petroleum products
produced.
• Refineries with the highest per-unit control costs have
compliance costs that are significantly higher than the
average costs. This could be the result of the manner
in which control costs were estimated or the method
used to allocate costs by product category based on
production data.
ES.7 SECONDARY REGULATORY IMPACTS
Secondary impacts of the Petroleum Refinery NESHAP include the
potential effects of the regulation on the labor market, energy
use, foreign trade, and regional effects. The effects on the
labor market, energy use, and foreign trade are summarized in
Table ES-3.
ES-10
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Labor market losses resulting from the NESHAP are estimated to
be approximately 114 jobs for the domestic petroleum refining
industry. This estimate reflects the reductions in jobs
predicted to result from the anticipated reduction in annual
production of refinery products. No effort has been made to
estimate the number of jobs that may be created as a result of
the regulations, however, so this estimate of job losses is
likely to be overstated.
Annual reductions in energy use as a result of the regulation
are expected to amount to a savings of approximately $10.85
million (1992 dollars) annually. Net annual exports are
predicted to decrease by 2.26 million barrels for the five
products, with the range of reductions varying from 0.21 million
barrels for LPGs to 0.91 million barrels for residual fuel oil.
Regional effects are expected to be minimal, since the
predicted plant closures are dispersed throughout the United
States, rather than concentrated in specific geographic regions.
ES.8 ECONOMIC COST
Air quality regulations affect society's economic well-being
by causing -a reallocation of productive resources in the economy.
Resources are allocated away from the production of goods and
services (refined petroleum products) to the production of
cleaner air. Economic cost are associated with the reallocation
of resources.
The economic costs of regulation incorporate costs borne by
all of society for pollution abatement. The social or economic
costs reflect the opportunity cost or economic cost of 'resources
used in emission control. Consumers, producers, and all of
. society bear the costs of pollution controls in the form of
higher prices, lower quantities produced, and possible tax
ES-11
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TABLE ES-3. SUMMARY OF SECONDARY REGULATORY IMPACTS
Estimated Impacts1
Refined Product
Motor gasoline
Amount
Percentage
Jet fuel
Amount
Percentage
Residual fuel
Amount
Percentage
Distillate fuel
Amount
Percentage
LPG
Amount
Percentage
Total five products
Amount
Labor Input ^
(52)
(0.22%)
(6)
(0.13%)
(15)
(0.50%)
(25)
(0.26%)
(16)
(0.25%)
(114)
Energy
Input3
($5.79)
(0.22%)
($0.52)
(0.13%)
($0.71)
(0.50%)
($2.27)
(0.26%)
($1.56)
(0.25%)
($10.85)
Foreign Trade
(net
exports) 4
(0.43)
(0.54%)
(0.23)
(1.41%)
(0.91)
(0.81%)
(0.48)
(40.92%)
(0.21)
(0.54%)
(2.26)
NOTES: ' Brackets indicate decreases or negative values.
^Indicates estimated reduction in number of jobs.
^Reduction in energy use in millions of 1992 dollars.
^Reduction in net exports (exports less imports) in millions of barrels.
ES-12
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revenues that may be .gained or lost. Annual economic costs of
$132.35 million ($1992) are anticipated for the chosen
alternative and are shown in Table,ES-4. Economic cost are a
more accurate estimate of the cost of the regulation to society
than emission control cost'estimates to the directly affected-
industry.
TABLE ES-4.
ANNUAL ECONOMIC COST ESTIMATES FOR THE PETROLEUM
REFINING REGULATION
(Millions of 1992 dollars)
Social Cost Category
Net Costs-
Surplus Losses for Chosen Alternative:
Change in Consumer Surplus
Change in Producer Surplus
Change in Residual Surplus to Society
Total Social Cost of Alternative3
$ 476.19
$ (242.11)
$ (101.73)
$ 132.35
NOTES: 1 Negative net costs or benefits are shown in brackets
2Residual surplus loss to society includes adjustments necessary to equate the relevant discount rate to the social
cost of capital and to consider appropriate tax effect adjustments.
Srhe Chosen Alternative includes floor controls for all emission points except equipment leaks. Option 1 is
preferred to the floor for equipment leaks because it is a less costly option than the floor.
ES.9 POTENTIAL SMALL BUSINESS IMPACTS
The RFA requires that a determination must be made as to
whether or not the subject regulation would have a significant
economic impact on a substantial number of small entities. (A
significant number .is generally considered to be more than 20
percent of the small entities identified.) There were
approximately 63 small petroleum refineries in the United States
producing less than 50,000 barrels of refined petroleum products
per day in 1992. Although the proposed regulation may result in
the closure of some firms in the industry - with small business
entities at the greatest risk - this study indicates that the
number of closures would be limited to approximately 7, or less
than 20 percent of the small businesses in the industry. This
estimate is likely overstated for reasons previously outlined.
An alternative criterion of determining if small businesses will
be adversely affected by a regulation is to compare control costs
ES-13
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to sales revenues for small businesses relative to all other
firms in the industry. According to the RFA, impacts are
"significant" if costs as a percentage of sales for small
entities is at least '10 percent higher than compliance costs as a
percentage of sales for large entities. The cost to sales ratio
for small refineries for the study period was 0.191 percent,
compared to 0.082 percent for all other refineries in the
industry. Since the differential in these ratios exceeds 10
percent, the conclusion that small domestic petroleum refineries
will experience a significant economic impact as a result of the
proposed emission controls is warranted.
ES-14
-------
1.0 INTRODUCTION AND SUMMARY OF CHOSEN REGULATORY
ALTERNATIVE
1.1 INTRODUCTION
This report evaluates the economic impact of proposed
standards on the petroleum refining industry. Section 112 of the
CAA contains a list of HAPs for which EPA has published a list of
source categories that must be regulated. To further this
requirement, EPA is evaluating alternative NESHAPs for the
petroleum refining industry, because several emission sources
within refineries emit HAPs. Section 317 of the CAA requires EPA
to evaluate regulatory alternatives through an EIA. Executive
Order 12866 requires EPA to assess major regulations through a
Regulatory Impact Analysis (RIA). In addition to other analyses,
an RIA includes an EIA. Accordingly, this EIA has been prepared
to satisfy the requirements of the CAA and to partially fulfill
the requirements of Executive Order 12866.
This chapter presents a discussion of the -NESHAP alternative
under analysis in this report. Chapter 2 of this report is a
compilation of economic and financial data on the petroleum
refining industry. Included in this profile are an
identification of affected refineries, a characterization of
market structure, separate discussions of the factors which
affect supply and demand, a discussion of foreign trade, a
financial profile, and the quantitative data.inputs for the EIA
model. Chapter 3 outlines the economic methodology used in this
analysis, the structure of the market model, and the process used
to estimate industry supply elasticities.
1-1
-------
Chapter 4 presents the control costs used in the model, the
estimated" emission reductions expected as a result of regulation,
and the cost-effectiveness of the regulatory option. Also
included is a quantitative estimate of economic costs and a
qualitative discussion of conceptual issues associated with the
estimation of economic costs of emission controls. Chapter 5
presents the estimates of the primary impacts determined by the
model, which include estimates of price, output, and employment
impacts. A capital availability analysis is included as well as
a discussion of the limitations of the model. Chapter 6 presents
the secondary economic impacts, which are the estimated
quantitative impacts on the industry's labor market, energy use,
foreign trade, and regional markets. Lastly, Chapter 7
specifically addresses the potential impacts of regulation on
small refineries.
1.2 SUMMARY OF CHOSEN REGULATORY ALTERNATIVE
The CAA stipulates that HAP emission standards for existing
sources must at least match the percentage reduction of HAPs
achieved by either (1) the best performing 12 percent of existing
sources, or (2) the best five sources in a category or
subcategory consisting of fewer than 30 sources. For new
sources, the CAA stipulates that, at a minimum, the emission
standard must be set at the highest level of control achieved by
any similar source. This minimum level of control for both
existing and new sources is referred to as the MACT floor.
A source within a refinery is defined as "the collection of
emission points in HAP-emitting petroleum refining processes
within the source category. The source comprises several .. . •
emission points. The definition of source is an important
element of this -NESHAP because it describes the specific grouping
of emission points within the source category to which this
standard appJLies. An emission point is a piece of equipment or
component of production which produces HAPs. Based on Section
112(c) of the CAA, controls are required on the following
emission points in refineries: storage vessels, equipment leaks,
miscellaneous process vents, wastewater collection and treatment
1-2
-------
systems, and catalytic reformer process vents. EPA chose one
regulatory alternative for detailed economic impact analysis
which combines MACT floor level controls for storage vessels,
wastewater collection and treatment systems, and miscellaneous
process vents, with an option more stringent than the MACT floor
for equipment leaks.
1-3
-------
2.0 INDUSTRY PROFILE
2 .1 INTRODUCTION
The petroleum industry can be divided into five distinct
sectors: (1) exploration, (2) production, (3) refining, (4)
transportation, and (5) marketing. Refining, the process subject
to this NESHAP, is the process which converts crude oil into
useful fuels and other products for consumers and industrial
users. All affected facilities are classified under Standard
Industrial Classification (SIC) code 2911. Although petroleum
refineries produce a diverse slate of products, the five primary
output categories are (1) motor gasoline, (2) jet fuel, (3)
residual fuel', (4) distillate fuel, and (5) liquefied petroleum
gases (LPGs), which in total accounted for 93 percent of all
domestically refined petroleum- products in 1992. This analysis
focuses on the markets for these five main product categories.
Section 2.2 through Section 2.6 of this chapter provide an
overview of the activities of the petroleum refining industry.
The economic and financial information in this chapter
characterizes the conditions in the refining industry which are
likely to determine the nature of economic impacts associated
with the implementation of the alternative NESHAPs. The
information contained in this chapter represents the inputs to
the economic model (presented in Chapter 3) which were used to
conduct the economic impact analysis. The general outlook for
the industry is also discussed in this chapter.'
2-1
-------
Section 2.2 describes the refining process and refined
petroleum products, and identifies the unique market
characteristics of each product. Section 2.2 also identifies
affected refineries, presents trends in refining capacity, and
addresses the range in complexity among refineries. Section 2.3
characterizes the industry structure in terms of market
concentration, integration, and product differentiation. Also
included in Section 2.3 is a financial profile of a sample of
firms. Section 2.4 characterizes the supply side of the market
in terms of production trends, supply determinants, and export
levels. Section 2.5 presents demand-side characteristics,
including end-use markets, consumption trends, and import levels.
Lastly, Section 2.6 presents quantitative estimates of supply,
demand, and price projections.
A wide range of references were relied upon in the development
of this industry profile. Data from the U.S. Department of
Energy/Energy Information Administration (DOE/EIA) are relied
upon most extensively, since DOE/EIA provides the most
comprehensive production and consumption data by refined
petroleum product. In cases of conflicting or differing
information, preference is given to the most current and complete
data source.
2.2 PROFILE OF AFFECTED FACILITIES
This' section reviews the products and processes of the
refining sector of the industry, and identifies any differences
among product markets. The affected refineries are identified by
location, capacity, and complexity.
2.2.1 General Process Description
The refining process transforms crude oil into a wide range of
petroleum products which have a variety of applications. The
refining industry has developed a complex variety of production
processes used to transform crude oil into its various final
forms', many of which are already subject to some CAA controls.
EPA's source category list (57 FR 31576, July 16, 1992) required
by Section 112(c) of the CAA, identified two source categories
2-2
-------
within refineries for which NESHAPs are to be established. These
two categories are: (1) catalytic cracking (fluid and other)
units, catalytic reforming units and sulfur units, and (2) other
sources not distinctly listed. During development of the
proposed standard, EPA; determined that some of the emission
points from these two categories can be controlled by the same
control techniques, and as a result, the emission points within
these source categories will be regulated by a single NESHAP.
Upon revision of the source category list, all emission points
regulated by the subject NESHAP will be in a single source
category.
There are numerous refinery processes from which emissions
occur. Separation processes (such as atmospheric distillation
and vacuum distillation), breakdown processes (thermal cracking,
coking, visbreaking), change processes' (catalytic reforming,
isomerization), and buildup processes (alkylation and
polymerization) all have the potential to emit HAPs. HAP
emissions may occur through process vents, equipment leaks, or
from evaporation from storage tanks or wastewater streams. The
NESHAP will address emissions from all of these refinery
processes.
2.2.2 Product Description and Differentiation
Most petroleum refinery output consists of motor gasoline and
other types of fuel, but some non-fuel uses exist, such as
petrochemical feedstocks, waxes, and lubricants. The output of
each refinery is a function of its crude oil feedstock and its
preferred petroleum product slate. The five main petroleum
product markets which are analyzed in this EIA are motor
gasoline, residual fuel oil, distillate fuel oil, jet fuel, and
LPGs.
Motor gasoline is defined as a complex mixture of relatively
volatile hydrocarbons that have been blended to form a fuel
suitable for use in spark-ignition engines. Residual fuel oil is
a heavy oil which remains after the distillate fuel oils and
lighter hydrocarbons are distilled away in refinery operations.
Uses include fuel for steam-powered.ships, commercial and
2-3
-------
industrial heating, and electricity generation. Distillate fuel
oil is a general classification for one of the petroleum
fractions produced in conventional distillation operations. It
is used primarily for space heating, on- and off-highway diesel
engine fuel (including railroad engine fuel and fuel for
agricultural machinery), and electric power generation. Jet fuel
is a low freezing point distillate of the kerosene type used
primarily for turbojet and turboprop aircraft engines. LPGs are
defined as ethane, propane, butane, and isobutane.
Product differentiation is a form of non-price competition
used by firms to target or protect a specific market. The extent
to which product differentiation is effective depends on the
nature of the product. The more homogenous the overall industry
output, the less effective differentiation by individual firms
becomes. Each of the five petroleum products in this analysis
are by nature quite homogenous -- there is little difference
between Exxon premium gasoline and Shell premium gasoline -- and,
as a result, differentiation does not play a major role in the
competitiveness among petroleum refineries.
2.2.3 Distinct Market Characteristics
The markets for refined petroleum products vary by geographic
location. Regional markets may differ due to the quality of
crude supplied or the local product demand. Some smaller
refineries which produce only one product have single, local
markets, while larger, more complex refineries have extensive
distribution systems and sell their output in several different
regional markets. In addition, because refineries are the source
of non-hydrocarbon pollutants such as individual HAPs, volatile
organic compounds (VOCs), sulfur dioxide (SO2), and-nitrogen
oxide (NOV), many Federal, State, and local regulations are
J\.
already in place in some locations. Differences in the regional
"market structure may also result in different import/export
characteristics.
2-4
-------
The United States is segmented into five regions, called
Petroleum Administration for Defense Districts (PADDs), for which
statistics are maintained. PADDs were initiated in the 1940s for
the purpose of dividing the United States into five economically
and geographically distinct regions. Relatively independent
markets for petroleum products exist in each PADD, and much of
the data available from DOE and other sources is segmented by
PADD. Figure 2-1 illustrates the geographic breakdown for each
PADD.
Table 2-1 shows both State- and PADD-level capacity totals for
a variety of refinery processes. Several industry trends are
evident from the PADD-level totals in Table 2-1. First, PADD III
has more than twice the capacity of any other single PADD, mainly
because much of the domestic crude oil supply is located in this
'region. Conversely, PADDs I and IV have very little capacity.
Given the large population and correspondingly large petroleum
demand in PADD I and the small population and lower demand in
PADD IV, it is likely that the market for petroleum products is
in some way fundamentally different in each district. The
availability of petroleum products in each PADD plays a role in
the import/export characteristics of each region.
In addition to differences in regional markets, each of the
five product categories in this analysis possesses its own
individual market segment, satisfying demand among different end-
use sectors. The substitutability of one of the products — motor
gasoline, for example — is not possible with another refinery
output, such as jet fuel. Thus, each of the products in this
analysis is treated as a separate product with its own share of
the market. From a refinery standpoint, however, if the
production .of one refined product were to become less costly
after regulation, production of this product may increase at the
expense of a product with a more costly refining process.
2-5
-------
-------
TABLE 3-1. PRODUCTION CAPACITY OF OPERABLE PETHOLBUM REFINERIES 8
(AS OF JANUARY 1.1891)
PAD District
State
<«
Delaware
Georgia
New Jersey
New York
North Carolina
Pennsylvania
Virginia
West Virginia
PADBlTTotaJ* --
Illinois
Indiana
Kansas
Kentucky
Michigan
Minnesota
North Dakota
Ohio
Oklahoma
Tennessee
Wisconsin
PAi)D:lii.Tirtalfl j&f?
Alabama
Arkansas
Louisiana
Mississippi
New Mexico
Texas
•v
PADDlVTotala- -
Colorado
. Montana
Utah
Wyoming
.j-ADBYTotds
Alaska
Arizona
California
Hawaii
Nevada
Oregon
Washington
U.S.Totafe
Number of
Operable Rafineriet
Total
<• 22
1
2
6
1
1
8
2
1
40
7
5
8
2
3
2
1
4
6
1
1
3
S
22
6
4
34
18'
3
4
6
5
' 60 '
6
1
82
2
1
1
7
202 v
Operating'
/ • - ir :
i
i
4
1
1
8
2
1
, "i 30!
7
4
8
2
3
2
1
4
6
1
1
2
3
19
6
3
32
X . '. Jf '-,
2
4
6
6
" . "• 45~-
6
1
29
2
0
1
6
' " 184 -.'
Idle
'-•3'
0
1
2
0
0
0
0
0
/
' 1
0
1
0
0
0
0
0
0
0
0
0
1
0
3
1
1
2
,'tx'
1
0
0
0
5
0
0.
3
0
1
0
1
~18<
Atmospheric Crude Oil Distillation Capacity
Barrels per Calendar Day
Operating Idle
XS38V«£
140,000
6,640
334,600
41,860
3,000
744,316
66,700
12,600
f
'•. 2£7£,S02 *
937,600
429,900
2
218,900
118.600
267,100
68,000
467,100
395,600
60,000
33,200
113,500
63,900
2,286.707
362,400
74,800
3,876,600
639,875
76,000
139,660
164,500
169.726
2,980,090
239,640
10,000
2,094,160
146,300
0
0
496,100
14,607,079
' 'x 182,400
O
28,000
124,400
0
0
0
0
0
, '1,250
0
1,250
O
0
0
0
0
0
0
0
0
26,600
5,800
340,600
6,000
4,000
67,250
'"26,200
16,200
0
0
0
107,880
0
0
91,450
0
4,600
0
11,900
71$.,85Q
Barrel* per Stream Day
Operating Idle
1,463,000
152,000
6,000
352,000
46,000
3,000
772.600
60,000
12,500
t
8,436,303
994,000
443,100
374,483
226,300
129.000
279,220
60,000
477,000
416.200
62,000
36,000
116,300
67,000
2,388,900
383,000
79,107
4,097,000
,S66$60
86,000
145,600
160,000
175,750
/ ,
264,700
12,000
2,217,400
150,000
0
0
631,000
15,7)51,860 '
' 162,400
0
80,000
132,400
0
0
0
0
0
v »
2^500^
0
2,600
0
0
0
0
0
0
0
0
0
28,000
6,000
395^000
7,900
6,100
64,600
16,000.',
16,000
0
0
0
118,16*
0
0
98,700
0
4,700
0
12,754
804,664
-------
TABLE 2-1 (CONTINUED).
Delaware
Georgia
Now Jerwy
New York
North Carolina
Pennoylvania
Virginia
Wcat Virginia
Illinois
Indiana
Kansas
Kentucky
Michigan
Minnesota
North Dakota
Ohio
Oklahoma
Tennessee
Wisconsin
Alabama
Arkansas
Louisiana
Mississippi
New Mexico
Texas
Colorado
Montana
Utah
Wyoming
Alaska
Arizona
California
Hawaii
Nevada
Oregon
Washington
383,900
235.450
124,660
92,000
38,000
182,000
0
172,000
147,000
12,000
20.500
126.300
28,000
62,500
67,600
0
60,000
0
31,700
26,500
0
0
67,000
0
266,000
0
0
247,000
27,500
0
1,294,800
378,000
173,000
123,800
100,000
47.000
83,000
26.000
174,000
149,000
30,000
11,000
10,000
4,200
9,000
0
1,000
1,000
3,600
17,500
6,000
0
1,000
64,000
0
77,600
0
0
200,400
10,200
3,700
"< 928,600
302,300
99.8OO
93.800
46.000
33,000
69,600
12,100
162,«00
101.600
10,000
8,000
67,800
0
3,190
0
0
0
0
87,200
6,000
0
617,600
267,800
211,000
172,300
61.800
227,000
19,100
196,600
177,600
. 30,000
14,800
0
8,000
6,600
10,000
0
0
0
9,000
10,300
3
i
45,000
23,300
1,132,200
274,776
13,900
1,718,900,
12,000
0
680.700
83,500
0
373,800
0
19,100
896,600
80,000
33,800
1,642,800
0
775
11,500
7,000
4,600
125,600
26,000
11.200
630,300
96,000
21,050
1,147,600
tffj&MJJKti;f:
0
0
172,000
68,000
1,000
313,500
69,300
30,000
1,267,600
254,000
28,800
8,176,660
43,000
68,450
46,980
73,000
4,200
7,700
8,600
9,000
27,500
66,900,
64,800
62,000
6,000
7.000
1.347,600
74,250
0
16,000
255,500
0
0
630,900
13,000
O
0
72,000
o
0
666,700
20,000
0
0
118,600
1,000
6,260
10,600
12,500
31,000
0
0
14,000
0
0
0
7,000
SQ3V728
22,900
37,730
30,500
32,350
5,000
4,900
2,400
0
35,700
119,840
41,200
52,500
12,000
0
642,300
13,000
0
0
128,600
3,925,830
9,000
0
408,800
18,000
0
O
62,000
1,307,830
0
0
1,475,180
3,600
0
0
219,000
6.60<
35,OC
102.6C
i$
11.6C
6.C
60.C
-------
2.2.4 Affected Refineries, Employment, and Location
There are currently 192 operable petroleum refineries in the
United States.2 Though refineries differ in capacity and
complexity, almost all refineries have some atmospheric
distillation capacity and additional downstream charge capacity,
such as the processes described above in Section 2.2.1.
The most recent employment data source is the 1987 Census of
Manufactures for petroleum and coal products, which lists data on
employment and the number of establishments for SIC code 2911.
Table 2-2 provides an indication of the frequency distribution of
small facilities in the petroleum refining industry. An
adjustment to the U.S. Department of Commerce data was necessary
because of the estimation process used by DOC.4 Column 3 lists
the number of plants which can be attributed to-overestimation by
DOC. This conclusion was determined based on information from
DOE. Column 4 lists the actual number of refineries. Some
disparity still exists between column 4 and DOE data, but the
totals (219 and 213, respectively) are comparable. According to
the adjusted data set (column-6), slightly fewer than 4 percent
of refinery employees work in establishments of fewer than 100
people. The remaining 96 percent of the labor force in the ^
industry works at establishments of 100 employees or more.
On a firm level, 1990 employment data were available for
several of the larger petroleum refining companies. Table 2-3
lists employee and sales data for a sample of companies in SIC
2911. In addition to these large firms, there are numerous small
firms which typically operate one refinery. For the smallest
firms in this industry, employment data was not available.
2-9
-------
<*
ro
^-^
Cc!
CO
JD
P
M
§
13
M
fa
W
Pi
3
§
EH
H
CM
W
W
EH
a
M
3
ca
p£
JM
EMPLO
05
1
CXI
W
m
§
0)
OlrH
flS fd
4J 4J
U> S£
UJ t~*
O
„ S-i t|-j
0) O
r-t CD
cd
4J (U
0 >.
in EH O
rH
4J O)
0) £
S H
M CO
Q) CU
,Q -H
el t
n
"* & o a
4J (!)
C Cn
O
•rH (C
rH k
X)
-------
TABLE 2-3. 1990 EMPLOYMENT FOR SELECTED REFINING FIRMS
,5 6
Company
Number of
Employees
Amoco
ARCO
Ashland Oil
Chevron
Citgo
Diamond Shamrock
Exxon
Mobil
Occidental Petroleum
Phillips Petroleum
Sun Co.
Texaco
54,524
27,300
33,400
54,208
3,300
841
104,000
67,300
12,500
21,800
20,926
39,000
NOTES: 1 Diamond Shamrock had 1990 sales in excess of $1 billion, and therefore cannot be
considered a small entity.
2-11
-------
2.2.5 Capacity and Capacity Utilization
Refineries 'have many different specialties, targeted product
slates, and capabilities. Some refineries produce output only by
processing crude oil through basic atmospheric distillation.
These refineries have very little ability to alter their product
yields and are deemed to have low complexity. In contrast,
refineries that have assorted downstream processing units can
substantially improve their control over yields, and thus have a
higher level of complexity. Because of their differences in size
and complexity, refineries can be grouped by two main structural
features: (1) atmospheric distillation capacity (which denotes
their size) and (2) process complexity (which characterizes the
type of products a refinery is capable of producing).
Capacity is the characteristic'most often used to categorize
petroleum refineries in market analyses. Throughout this report,
capacity will be used as a measure of production and output.
National refining production capacity was summarized on a
regional and State basis in Table 2-1. Appendix A, at the end of
this report, lists the production capacity for all firms and
refineries in the petroleum refining industry.
Capacity utilization rates of petroleum refineries have been .
*~j
rising in recent years, reaching a high of 87.1 'percent in 1990.
This indicates that existing refineries are operating closer to
full capacity, and will have limited opportunity to enhance
production by increasing utilization.
During the past 23 years, the entire domestic refining
industry has been affected by crude oil quality changes, shifting
petroleum demand patterns, and evolving regulations, resulting in
a more complex,, more flexible refining industry. Ownership of
U.S. refiners changed through consolidation and foreign
investments. Throughout the 1970s, the number of U.S. refineries
rose rapidly in response to rising demand for petroleum products.
In the early 1980s, the petroleum refining industry entered a
period of restructuring, which continued through 1992. A record
number of U.'S. refineries were operating in 1981. A decline in
petroleum demand in the early 1980s caused many small refineries
and'older, inefficient plants to close. • The refinery shutdowns
2-12
-------
resulted in improved operating efficiency, which enabled the
refinery utilization rate to increase, despite Blower crude oil
inputs. As of January 1, 1992, there were .192 operating
refineries, compared with 324 in 1981. Trends in the nation's
operable'refining capacity and capacity utilization are presented
in Table 2-4. Note that operable capacity has remained
relatively constant since 1985, while capacity utilization has
risen steadily.
2.2.6 Refinery Complex!ty
Complexity is a measure of the different processes used in
refineries. It can be quantified by relating the complexity of a
downstream process with atmospheric distillation, where
atmospheric distillation is assigned the lowest value, 1.0. The
level of complexity of a refinery generally correlates to the
types of products the refinery is capable of producing. Higher
complexity denotes a greater ability to enhance or diversify
product output, to,improve yields of. preferred products, or to
process lower quality crude oil. By defining refinery
complexity, it is possible to differentiate among refineries
having similar capacities but different process capabilities. In
theory, more complex refineries are more adaptable to change, and
are therefore potentially less affected by regulation.
2-1.3
-------
TABLE 2-4. AVERAGE ANNUAL OPERABLE AND CAPACITY
UTILIZATION RATES8
(THOUSAND BARRELS PER DAY)
PADD
Year/Element
II
III
IV
V
Total
U.S.
1985
Operable Capacity
Utilization Rate
1986
Operable Capacity
Utilization Rate
1987
Operable Capacity
Utilization Rate
1988
Operable Capacity
Utilization Rate
1989
Operable Capacity
Utilization Rate
1990
Operable Capacity
Utilization Rate
1,538 3,367 7,199 558 3,010 15,671
75.4 81.5 77.2 77.6 75.6 77.6
1,456 3,296 7,106 534 3,065 15,459
84.3 85.9 83.5 81.0 78.2 82.9
1,450 3,282 7,174 - 535 3,202 15,642
86.6 86.9 82.5 81..7 '79.1 83.1
1,464 3,302 7,449 537 3,176 15,927-
88.5 88.7 81.8 84.7 84.2 84.4
1,452 3,267 7,377 552 3,054 15,701
87.2 89.2 84.2 83.4 88.4 86.3
1,505 3,307 7,165 555 3,091 15,624
83.5 92.0 85.6 83.4 87.9 87.1
2-14
-------
As Table 2-5 indicates, the complexity of a refinery usually
increases as its crude capacity increases. (Lube plants are the
'exception to this rule.) As, Table 2-5 indicates, well over 50
percent "of the operable capacity (50,000 to 100,000 bbl/d) can be
found at refineries with above-average complexity (above 7.0).
Likewise, the smaller refineries are apt to be less complex.
2.3 MARKET STRUCTURE
The purpose of this section is to characterize the market
structure of the refining industry. Market structure has
important implications for the resultant price increases as a
result of controls. For example, in a perfectly competitive
market, the imposition of control costs will shift the industry
supply curve by an amount equal to the per-unit control costs and
the price increase will equal the cost increase. A perfectly
competitive market is characterized by many sellers, no barriers
to entry or exit, homogeneous output, and complete information.
In other words, a perfectly competitive market is one in which
producers have small degrees of market power and pricing is
determined by market forces, rather than by the producers. ' An
indication of the .market structure of the petroleum refining
industry is provided by an assessment of the number of firms
operating refineries, market.concentration, vertical integration,
and diversification. Each of these factors is discussed
separately.
2-15
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2.3.1 Market Concentration
Market concentration is a measure of the output of the largest
firms in the industry, expressed as a percentage of total
national" output. Market concentration is usually measured-for
the 4, 8, or 20 largest firms in the industry. A firm's
concentration in a market provides some indication of the firm's
size distribution. For example, on one extreme, a concentration
of 100 percent would indicate monopoly control of the industry by
one firm. On the other extreme, concentration of less than 1
percent would indicate the industry was comprised of numerous
small firms.
The American Petroleum Institute (API) has compiled a time-
series set of market concentration data for the petroleum
refining industry.9 Concentration is measured based on refining
capacity, which, in turn, is based on information developed from.
DOE/EIA data on operable refining capacity per calendar day.
Table 2-6 summarizes refinery concentration for selected years in
the past decade. Until recently, the top four firms have
consistently comprised over 30 percent of the market share, but
most market concentration ratios have marginally decreased in
recent years.
API also gauges market concentration by using the Herfindahl-
Hirschman index, which is defined as the sum of the squared
market shares (expressed as a percentage) for all firms in the
industry. If a monopolist existed, .with market share equal to
100 percent, the upper limit of the index (10,000) would-be
attained. If an infinite number of small firms existed, the
index would equal zero. An industry is considered unconcentrated-
if the Herfindahl-Hirschman index is less than 1,000. Ratings
are also developed for moderately concentrated (between 1,000 and
1,800) and highly concentrated (greater than 1,800) industries.
As Table 2-6 shows, the petroleum refining industry has always^
Q
been considered unconcentrated.
2-17
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2.3.2 Industry Integration and Diversification
-.. Ver;t4:cal-.' integration exists when the same firm supplies input
for several "stages of the production and marketing process.
Firms that operate petroleum refineries are vertically integrated
because -they are responsible both for exploration and production
of crude oil (which supplies the input for refineries) and for
.marketing .the finished petroleum produbts after refining occurs.
"To'-a'sseSs" the'"'level of vertical integration in the industry,
firms are generically classified as major or independent.
Generally speaking, major energy producers are defined as firms
that .'are vertically 'integrated.
;• A;.definit,i:©.n;.p.f-.major- energy producers, majors, was originally
developed jby-^pQE'/EiA in '1976.10 Selection criteria for the list
of publicly owned major firms included those which had either at
least 1 percent of the production or the reserves of oil, gas,
coal, or uranium, or 1 percent of the refining capacity or
petroleum product sales. DOE's current list contains 20 major
energy companies. Table 2-7 lists the 20 firms (with refining
capacity) that are currently considered to be major energy
producers. The table also shows the percentage of refining
capacity operated by each of the firms. The crude capacity of
the major, vertically integrated firms represents almost 70
percent of nationwide production.
For the ma"jo"r oil companies, horizontal integration exists
because these firms operate several refineries which are often
distributed around the nation. Seventy-three of the 109 firms in
the industry operate only one refinery each. These are the
smaller independent firms. The major firms operate several
refineries, and the largest, Chevron, operates 13. Fourteen
firms operate four or more refineries each.
Diversification exists when firms produce a wide array of
unrelated products. In the short run, diversification may
indirectly benefit firms that engage in petroleum refining, since
the costs of control in petroleum refining may be dispersed over
other unaffected businesses operated by the firm. Over the long
term, however, firms will not subsidize petroleum product
2-19
-------
production.with.profit from other operations, but will shut down
unprofitable "operations'"Tristead.
TABLE 2-7. MAJOR ENERGY FIRMS WITH REFINING CAPACITY11 12
Company
•Amerada Hess
Amoco Oil . s, . ., .
Ashiand Oil , ,
Atlantic Richfield
BP Oil
Chevron U.S.A.
Coastal Corp.
E.I. Du Pont
Exxon
Fina Oil & Chemical
Kerr-McGee Corp.
Mobil Oil
Pacific •Resources. •
Phillips 66
Shell Oil
Sun
Texaco
Total Petroleum
U.S. Steel
Unocal
Total
.-..' '.Barrels per
Calendar
Day
(Operating)
30,000
. . ,. , . -974^000
•••'•' 346,500
415,740
733,500 '
1,495,100
248,700
406,500
1,147,000
165,000
156,8.00
838,000
93,500
305,000
1,082,900
515,000
320,000
197,600
604,500
226,000
10,301,340
Percentage
of
National
Total
0.2%
6.5%
2 . 3%
2.8%
4.9%
10.0%
1.7%
2.7%
7.7%
1.1%
1.0%
5.6%
0 . 6%
2.0%
7.2%
3.4%
2.1%
1.3%
4.0%
1.5%
68.9%
2-20
-------
gsaaa^wiMiffi^jj^^
2.3.3 Financial Profile
This subsection examines the financial performance of a sample
of the petroleum refining industry's major firms. In order to
evaluate the financial condition of the refinery operations of
firms,- annual reports to stockholders were used as a source of
data for a small sample of firms. While this sample is too small
and diverse to be considered representative of the aggregate
industry, the data presented are more recent and more refinery-
specific than API's data. The compilation of financial data for
this small sample is presented at the end of the chapter.
The sample of annual report data presents refinery-specific
data in order to provide a preliminary assessment of the
condition of the refinery segments of firms in the industry. The
firms included in this sample are listed in Table 2-8. This 12-
firm sample as a whole operated 59 refineries in 1991, and
represented 45.3 percent of the industry's total refining
capacity. Refining capacity in the sample ranges from 165,000
bbl/d to 2,139,000 bbl/d. Refinery-specific data obtained from
annual reports are presented in Table 2-9. Over the 5-year
period from 1987 to 1991, operating income per dollar of revenue
increased from 1 percent to 4 percent. Capital expenditures
increased steadily, while refined product -sales continued a
period of decline. The consolidation taking place in the
refining industry is reflected in the decreasing crude oil
capacity and refinery runs shown in the table.
According to DOE, refined product margins are a good indicator
of overall refinery financial performance..1^ The difference
between refined product costs and refined product revenues is the
refined product_margin. During the 1980s, refined product
margins were affected by a shift in product slates to gasoline
and jet fuels, the decrease in crude oil prices, fluctuations in
demand, and an increase in refinery. utilization rates.14 Refined
product margins for the years 1977 through 1988. are shown in
Table 2-10. In constant 1982 dollars, the refined product margin
fluctuated over this time frame, decreasing between 1985 and 1987
and then increasing significantly in 1988. The fluctuations in
the refined product margins reflect the volatility of the market
2-21
-------
:^
and the degree to which refineries' -revenues are often subject to
significant change over short time periods. In the early half of
1990, the margin between overall U.S. refined product prices and
crude oil import costs rose to record levels, given falling crude
oil prices and stable gasoline prices.15 After the invasion of
Kuwait, U.S. refined product prices did not keep pace with crude
oil prices for the remainder of the year. This negatively
impacted refinery revenues for 1991.
TABLE 2-8. FIRMS IN SAMPLE FOR REFINERY-SPECIFIC FINANCIAL DATA
Amoco Oil Inc.
Ashland Petroleum
Chevron U.S.A.
Coastal Corporation
Diamond Shamrock
Kerr-McGee Corporation
Mobil Oil Corp.
Murphy Oil
Phillips 66 Co.
Shell Oil Co.
Sun Co. Inc.
Texaco Refining and
Marketing
2-22
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TABLE 2-10
REFINED PRODUCT MARGINS
1977-1988
14
Refined Product Margin
Year
Current
Dollars
Constant
Dollars
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
0.64
0.75
0.85
1.00
0.83
0.85
0.71
0.01
1.09
0.67
0.15
1.78
0.95
1.
1.
,04
,08
1.17
0.88
0.85
0.68
0.01
0.98
0.59
0.13
1.46
2-24
-------
Firms have.three sources of funding fpr the capital available
for purchasing ettiission cotttrol equipment to comply with the
NESHAP. These sources include (1) internal funds, (2) borrowed
funds, and (3) stock issues. Typically, firms seek a balance
between the use of debt and stock issues for financing
invest merits.. Debt-to-equity ratios reflect a measure of the
exte.nt;:to ••which,.the,.f-i-rm has- balanced- the tax advantages of
borrowing with the;-.f'iriaricial safety of stockholder financing.
Based on information obtained in the annual reports of the 12
companies in the refinery sample, firms anticipate that
internally, generated- funds will fund most of . their capital
expenditures.. '.:• Other/, fiirms-re cognize the need to also draw on
available credit-l'iries:-and commercial paper borrowing. As
indicated in Table 2-9, the total amount of credit available to
these 12 firms as of December 31, 1991 was $13,462.9 million, or
an average of $1,121.9 million per firm. DOE has published
annual capital expenditures by domestic refiners.16 This trend
is presented in Table 2-11. Overall, capital expenditures have
doubled since 1977, although spending peaked in 1982 and has
since been in a period of decline.
Planned uses of investment funds by the 12 firms in the
financial sample over the next few years include construction of
diesel desulfurization .units, expansion of existing units, and
-''__'_'• v "*
construction of units to manufacture methyl tertiary butyl ether
(MTBE) and oxygenated fuels. In a 1991 study, Cambridge Energy
Research Associates (CERA) surveyed refiners and oxygenate
producers to evaluate the ability of the refining industry to
meet CAA provisions.17 Among the firms in the CERA survey, the
majors and some large independents plan ,to fund their investments-
primarily or entirely from internally generated cash flows, while
most of the small refineries surveyed are planning on resorting
to the debt market for funds.
2-25
-------
TABLE 2-11-./ g^P-ITAL^E^PE$JDITUI^6S BY DOMESTIC
1977-1988
Year
1977
.1978
1979'
1980
1981
1982
1983
1984
19-85
i « ~f\ >*'
•1.986
I'ffff?: .
1988
Current Dollars
1,029
1,430 .
;< .'•-'•'"'••••.' •'.:' ;:--.".'.2-7,l2'2^1 •;.••'.•..'.* •'•' .. "
' 2-,S47
4,041
4,973
3,695
• ',. . •'-. 3,6.8.1 .
," ". 2} 380 . ,
" ' * - -« ' «7c'o"'' ' '' '''" " ' ' "-'-":"
• , . • • :. '._L / '/ ^^ .• - • •
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3,675
1982 Constant
Dollars
1,529
1,981
>'• -.""2-", 82 6
2,972
4,299
4,973
3,556
3,418
,. ... , ;2,148 ''••
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,1,631
3,020
2-26
-------
2.4 MARKET SUPPLY CHARACTERISTICS
This section analyzes the supply side of the petroleum
refining industry. Historical production data are presented, and
the factors which affect production are identified. The role of
foreign competition in this industry is also assessed.
2.4.1 Past and Present Production
The domestic supply of refined petroleum products and its
components for the past decade are shown in Table 2-12. A
significant increase in domestic demand in 1984 stimulated
domestic refinery production. Refiners have increased production
almost every year since 1984. Historically, motor gasoline has
been the product that is supplied in the greatest quantities to
meet increased demand. Most of the other petroleum products show
a net increase in supply over the past few years. The lack of
change in the yield for most refined petroleum products indicates
a relatively stable supply slate, but significant regulatory
costs could force some reshuffling of product yield.
Refinery production of motor gasoline has increased each year,
with the exception of periods of economic recession. Production
remained relatively steady from 1988 to 1992. Distillate fuel
oil output peaked at 3.3 million barrels per day in 1977, then
fell through 1983. Output has increased slightly almost every .
year since, reaching 3 million barrels per day in 1992. Jet fuel
production grew during the 1970s and 1980s, and almost doubled by
1990 before declining to 1.4 million barrels per day in 1992.
Residual fuel oil production generally declined from 1980 through
1985, and was 1 million barrels per day in 1992, compared with
0.7 million barrels per day in 1970.
2.4.2 Supply Determinants
The most important short-run production decision for an oil
refinery is to decide how much crude_oil to allocate for the
production of each of the refinery's products. The production
decision depends on the profit each of the oil products can
generate for the firm. Profits, in turn, depend on the
productivity of the oil refinery -- its ability to obtain each
2-27
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oil product as effectively as possible from a barrel of crude
oil. The quantity of crude oil a refinery will refine depends on
the capacity of the refinery and the cost of production. The' •
marginal costs of production of each product will determine any
future changes in production. Crude oil is the primary material
input to the refining process; as a result, the production of
refined products is vulnerable to fluctuations in the world crude-
oil market.
In the long run, production decisions are based on the cost of
capacity expansion relative to existing and anticipated future
price levels. A refinery uses different processing units to turn
crude oil into finished products, so when a particular processing
unit reaches capacity, output can be increased only by
substituting a more expensive process. Firms will typically
utilize sufficient crude oil to fill the appropriate processing
unit until the price increases substantially. At this point, the
firm would calculate whether the increased price warrants using
-1 Q
an additional, more expensive processing unit. ^
2.4.3 Exports of Petroleum Products
Some measure of the extent of foreign competition can be
obtained by comparing exports with domestic production. Table 2-
13 presents export levels and domestic refinery output for the
past decade. Exports as a percentage of domestic refinery output
steadily increased from 1984 to 1991, and then fell slightly to
5.6 percent in 1992. Distillate oil, residual fuel oil, motor
gasoline, and petroleum coke are exported in the highest volumes.
The combined export volumes of these products represent 75
percent of domestic refinery output shipped overseas.
2-29
-------
2.5 MARKET DEMAND CHARACTERISTICS
The purpose of this section of the profile is to characterize
the demand side of the petroleum refining industry, to identify
the end-use markets of each petroleum product in this analysis,
evaluate the extent to which price determines demand levels, and
define the role that imports play in satisfying domestic demand.
TABLE 2-13.
EXPORTS AND DOMESTIC REFINERY OUTPUT
(MILLION BARRELS PER DAY)
20
Year
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
Exports
0
0.
0
0
0
0
0
0
•o
0
0
0
.37
58
.58
.54
.58
.63
.61
.66
.72
.75
.88
.86
Domestic
Refinery
Output
13
13
13
13
13
•14
14
15
15
15
15
15
.99
.39
.14
.68
.75
.52
.63
.02
.17
.26
.20
.30
Exports As a
Percentage
of Domestic
Output
2
4
4
4
4
4
4
4
4
4
5
5
.6%
13%
.4%
.0%
.2%
-.3%
.2%
.4%
.7%
.9%
.8%
.6%
-
2-31
-------
2.5.1 End-Use Markets for Refined Products
; ,,Iii,ith:±_s_-_a.nalysis/ the end-use sectors that contribute to
demand for refined petroleum products are classified in the
following four economic sectors: (1) residential and commercial,
(2) industrial, (3) transportation, and (4) electric utilities.
Figure 2-2 shows a more detailed breakdown of the 93.2 percent
.•_p:etroleum, prpduct-demand attributed to fuel users for the years
"1.970 through 1990. Petroleum products used as transportation
fuel include motor gasoline, distillate (diesel) fuel, and jet
fuel, and accounted for an estimated 64 percent of all U.S.
petroleum demand in 1990. Since mobile source emissions will be
' .•reg.ulated • by Title II regulations, this output from petroleum
ire'f iiieries will be most affected by the CAA. The industrial
sector constitutes the second highest percentage of demand for
petroleum products, followed by household and electric utility
demands. . .
Petroleum is used most widely in the transportation sector.
In the household and commercial sector, light heating oil and
propane are used for heating and energy uses, and compete with
-natural gas and electricity. Petroleum fuels in the industrial
sector compete with natural gas, coal, and electricity. In the
industrial sector, residual and distillate heating oils are used
for boiler, and power fuel. .In the electric utility sector,
petroleum products satisfy demands for heavy residual fuel oil
and in smaller amounts, bulk light distillate fuel oil.21
In terms'of refined products, the motor gasoline and jet fuel
markets are associated with the transportation sector. The
markets for distillate fuel oil are associated with the
transportation sector (diesel-powered trucks), household (space
heating), industrial (fuel for commercial burner installations),
and electric utilities (power generation). The sectors that are
sources of demand for residual fuel oil include the commercial
and industrial sectors (heating), utilities (electricity
generation), and the transportation sector (fuel for ships).
Nonutility use of residual fuel has been decreasing due to
interfuel substitution in the commercial and industrial sectors.
2-32
-------
Because..-LPG's cover a broad"range of gases, demand levels are
attributable to various end users.
2.5.2 Demand Determinants
The' demand for refined petroleum products is primarily
determined by price level,.the price of available substitutes,
'and ec6n"cjtriic"-growth ••trends". The degree to which price level
influences the quantity of petroleum products demanded is
referred to as the price elasticity of demand, which is explored
later in this report. Prices of refined petroleum products
affect the.willingness, of consumers to. choose petroleum over
other- fuels, and may ultimately cause a change in consumer
behavior. In the transportation sector, the effect of high
gasoline prices on fuel use could reduce discretionary driving in
the short term and, in the long term, result in the production of
more fuel-efficient vehicles.
In the market for jet fuel, demand is primarily determined by
a combination of price concerns and the overall health of the
airline industry. In the residential sector, demand for home
heating (distillate)' is determined in part by price level, and
also by temperature levels and'climate. Temperature in different
areas of the country may determine the degree to which buildings
and houses are "insulated. Temperature and insulation are
exogenous factors which will determine heating needs regardless
of the price level of fuel. High prices for home he.ating oil
provide incentive for individuals to conserve by adjusting
thermostats, improving insulation, and by using energy-efficient
appliances. In some cases, higher oil prices also provide
incentive for switching to natural gas or electric heating.
(Adjusting thermostats is short-run response, which changing to
more energy-efficient appliances or fuels are long-run
responses.)
2-33
-------
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In the industrial sector,- fuel oil competes with natural gas
and coal for the boiler-feed market. High prices relative to
other fuels tend to encourage fuel-switching, especially at
electric utilities and in industrial plants having dual-fired
boilers. Generally speaking, in choosing a boiler for a new
plant, management must choose between the higher capital/lower
operating costs of a coal unit or the lower capital/higher
operating costs of a gas-oil unit. In the utility sector, most
new boilers in the early 1980s were coal-fired due to the impact
of legislative action, favorable economic conditions, and long-
term assured supplies of coal.22 Today, because the CAA will
require utilities to scrub or use a low-sulfur fuel, oil will
eventually become more competitive with coal as a boiler fuel,
although a significant increase in oil-fired capacity is not
expected until 2010.23
Demand levels in each of the end-use sectors are also
affected, in part, by the economic environment. Periods of
economic growth and periods of increased demand for petroleum
products typically occur simultaneously. For example, in an
expanding economy, more fuel is', needed to transport new products,
to operate new production capacity, and to heat new homes.
Conversely, in periods of low economic growth, demand for
petroleum products decreases.
2.5.3 Past and Present Consumption
Total consumption of all types of petroleum products has
fluctuated over the past 20 years, reflecting the volatility of
this market. The consumption level has been sporadic and has
shown an overall decline in recent years. Demand for individual
.petroleum product types has also fluctuated over this period, as
shown in Table 2-14. Of all the petroleum products, demand is
the greatest for motor gasoline followed by distillate fuel oil.
Over the 23-year period from 1970 to 1992, the demand for
residual fuel oil has decreased by 50 percent, showing the
greatest percentage of change over time of any of the petroleum
products; it has also been the only fuel to show a decline in
use. This decrease in residual fuel demand reflects a move in
2-34
-------
the industry from heavier fuels toward lighter, more refined
versions. This trend is expected to continue into the future
with efforts to further control air emissions.
All other types of fuel show increases in use, with the most
growth occurring in the market for jet fuel. Substantial gains
in airplane fuel efficiency in the last two decades, which have
resulted from improved aerodynamic design and a shift toward
higher seating capacities, have been exceeded by even faster
growth in passenger miles traveled.
25
The other categories show
an average growth rate of approximately 23 percent over this time
period. All major petroleum products registered lower demand in
1991 than in 1990, except LPGs. This was the first time since
1980 that demand for all major petroleum products fell
simultaneously in the same year. In this case, decreased demand
was brought on by warmer winter temperatures, an economic
slowdown, and higher prices resulting from the Persian Gulf
War.26
Motor gasoline demand increased from a 1970 low to a high of
7.4 million barrels per day in 1978. The increase reflected a 31
percent growth in the number of automobiles in use and a 25
percent growth in vehicle miles traveled.
21
From 1985 to 1992,
motor gasoline use accounted for about 42 percent of all
petroleum products consumed. - •
Changes in demand for distillate fuel oil were similar to
motor gasoline in that consumption reached its lowest- and highest
levels in 1970 and 1978, respectively. Between 1985 and 1992,
consumption was relatively stable and accounted for about 18
percent of total U.S. petroleum consumption. Residual fuel oil
demand, in response to lower-priced natural gas and other
factors, fell 64 percent, from a high in 1977 of 3.1 million
barrels per day to 1.1 million barrels per day in 1992.
2-35
-------
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&2twee&-the::-peri-dd-~i970 to 1990, expanding air travel spurred
a 57 percent growth in jet fuel demand. • Demand increased from a
1970 low of 1.0 million barrels per day to 1.5 million barrels
per day in 1990.
The variation in U.S. petroleum product demand has-been linked
tb\---chahg-.fe§;;.ih/-'the-"prices': of'• petroleum products relative to one
another, and relative to other energy sources. Dramatic
petroleum price increases and eventual steep drops were in
response to wars, political upheaval in crude oil producing
areas, "and'supply disruptions during the past two decades.
'2.5.4 Imports 'of Refined Petroleum Products
Table 2-15 presents import levels and domestic consumption for
the past decade. Imports as a percentage of domestic consumption
have fluctuated over this time period, although in 1992 levels
were 10.6 percent, or roughly the same level as in 1981. Table
2-16 compares exports to imports over the past decade. The
import to export ratio has decreased since 1981, due primarily to
steady increases in exports.
2.5.5 Pricing
As Table j2_-17 indicates, prices for petroleum products have
shown volatility over the time period from 1978 through 1992.
This volatility is mainly attributable to the fluctuations in the
global market for crude oil and the inelastic demand for
petroleum products. Inelastic demand allows refiners to pass
crude oil price increases on to consumers. Because petroleum
products are essentially commodity products, produced to standard
specifications with little product differentiation and produced
by a large number of refiners, little ability for pricing
flexibility exists in this industry.
2-37
-------
TABLE.-.<2--15.','.IMPQRTS AND DOMESTIC CONSUMPTION
. "OF REFINED PETROLEUM PRODUCTS-"
(MILLION BARRELS PER DAY)
Year
Imports
• • • • _:
Domestic
; Petroleum
.•• . : •-..Product
Imports As a
Percentage of
Domestic
Consumption
.... • ' • • ' Consumption
1981
1982
1983 .
1-984- .'
'19851.
1986
1987
1988
1989
1990
1991
1992
1
1
.-...,.:..•' - -I
••• •-."•': ,-.v>
' ••• 1
2
2
2
2
2
1
1
.60
.63
.'72
.--Q'i'V.
'.•8-7
.05
.00
.30
.22
.12
.85
.81
16
15
15
•;,:-. ".^•••::'.- -15
15
16
16
17
17
17
16
' 17
.06
.30
.23
173 .
.73
.28
.67
.28
.33
.33
.70
.00
10.
10.
. .... 11.
- 12.
11.
12.
12.
13.
12.
12.
11.
10.
0%
6%
3%
8%
9%
6%
0%
3%
8%
8%
1%
6%
2-38
-------
p c:
TABLE 2-16. U.S. PETROLEUM PRODUCT IMPORTS AND EXPORTS^0
(THOUSAND, BARRELS "PER DAY)
Year
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
Imports
1,
1,
1,
2,
1,
2,
2,
2,
2,
2,
1,
1,
599
625
722
Oil
866
045
004
295
217
123
845
805
Exports
367
579
575
541
577
631
613
661
717
748
880
860
Net
Imports
1
1
1
1
1
1
1
1
1
1
,232
,046
,147
,470
,289
,414
,391
,634
,500
,375
965
945
Import/
Export
Ratio
4
2
3
3
3
3
3
3
3
2
2
2
.4
.8
.0
.7
.2
.2
.3
.5
.1
.8
.1
.1
2-39
-------
TABLE 2-17. PETROLEUM PRODUCT PRICE LEVELS, 1978-199227
Refiner
Year
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
Motor
Gasoline
48
71
103
114
106
95
90
91
62
66
67
75
88
79
78
.4
.3
.5
.7
.0
.4
.7
.2
.4
.9
.3
.6
.3
.7
.4
Prices
(Cents
of Petroleum Products to End Users
Per Gallon Excluding Taxes)
Jet
Fuel
38
54
86
102
96
87
84
79
52
54
51
59
76
65
61
.7
.7
.8
.4
.3
.8
.2
.6
.9
.3
.3
.2
.7
.2
.0
Distillat
e
Fuel Oil
37.
53.
77.
93.
89.
85.
85.
81.
53.
55.
51.
58.
72.
65.
62.
2
4
3
1
9
6
3
7
3
8
1
6
7
7
7
Residual
Fuel Oil LPGs
29
43
60
75
67
65
68
61
34
42
33
38
44
34
33
.8
.6
.7
.6
.6
.1
.7
.0
.3
.3
.4
.5
.4
.0
.8
33
35
48
56
59
70
73
71
74
70
71
61
74
73
66
.5
.7
.2
.5
.2
.9
.7
.7
•5
.1
.4
.5
.5
.0
.2
2-40
-------
2 . 6 MARKET OUTLOOK
This section presents quantitative production, demand, and
price projections available from the literature. Projections are
important to the EIA since future market conditions contribute to
the potential impacts of the NESHAP which are assessed for the
fifth year after regulation.
2.6.1 Supply Outlook (Production and Capacity)
The refining industry was operating near maximum capacity in
1991, with an average annual utilization rate of approximately 92
percent.28 This is an increase from levels of previous years,
which were shown earlier in Table 2-4. In the market for motor
gasoline, for example, production capacity is nearly at full
capacity. As a result, any increases in demand will have to be
met by imported products. This will result in an increase in
worldwide competition for gasoline. East Coast refiners,
accounting for more than 90 percent of all unleaded gas imports
to the United States, will be most affected by this increased
competition.29 DOC predicts that, although U.S. refinery output
will remain relatively unchanged, net imports of refined
28
DOE
petroleum products are expected to increase by 15 percent.
predicts net petroleum imports will rise to at least 10 million
bbl/d in 2010, and perhaps as high as 15 million bbl/d from the
1990 level of 7 million bbl/d as domestic oil production is
expected to decline. Imports are expected to supply between 53
and 69 percent of U.S. petroleum consumption by 2010, compared
with 42 percent in 1990. Refined products"will account for much
of this increase because most of the expansion in the. world's
refinery system is expected to take place outside the United
States
30
Over the next 5 years, the petroleum industry as a whole plans
to increase crude oil distillation capacity by an additional 2
percent, or 272,000 bbl/d, of which 44 percent would be produced
by new facilities.29 (The other 56 percent includes
reactivations and expansions.) The level of added demand will
2-41
-------
determine if this added capacity is sufficient to satisfy the
market without driving up prices.
Companies that operate more complex refineries (often the
largest refineries) will presumably be in a more favorable
position to make the necessary capital investments for the
transition to cleaner fuels. Such refineries will most likely be
those large enough to benefit from the economies of scale, and
with basic downstream configurations to facilitate compliance
with the new regulations. A financial analysis of major
petroleum refineries in the 1980s conducted by DOE concluded that
vertically integrated firms benefitted from integration in a
period characterized by increased regulatory activity and price
instability.31 The report found that the larger vertically
integrated companies could offset a loss in one subsidiary or
business operation with gains from another line of business. (It
is important to note, however, that in the long run, both large -
and small firms would close refineries which operate at a loss
over time.)
By contrast, smaller, independent, and less complex refineries
will face higher marginal compliance costs, and may not find it
economical to spend the required environmental capital.
Generally not as flexible as the larger, integrated companies,
these firms operate at greater risk from the effects of market
instability. As a result, an industry which has seen a high
level of consolidation in past years will be likely to see more
concentration.32
Supply Prediction. Given each of the considerations discussed
thus far, DOE has projected the future level of supply in the
refining industry. These projections, shown in Figure 2-3, are
based on a DOE prediction that the United States will become
increasingly more dependent on foreign refined products and crude
oil supplies, while domestic refiners will continue to invest in
downstream additions to meet environmental specifications.33 (It
should be noted here that DOE makes the assumption that products
imported from foreign refineries will meet U.S. specifications.)
2-42
-------
CO
-------
DOE's projections are based on the following four different
scenarios and assumptions:
•" - Assumptions
Scenario
High Economic Growth
Low Economic Growth
High Oil Price
Low Oil Price
2010 Oil Price
(1990 $)
$33.40
$33.40
$40.20
$23.00
Annual
Economic Growth
Rate
2.7%
1.8%
2.2%
2.2%
As shown in Figure 2-3, projections are the lowest in cases where
economic growth is low or when the price of oil is high.
Overall, the effect of the CAA on individual refineries is
dependent upon production capacity, economies of scale, degree of
self-sufficiency, capital cost, and ability of refiners to "pass~
through" higher costs to consumers. Predictions of the effect on
the aggregate industry are difficult at this time because of the
uncertainty of the ability of some refineries to develop plans
for compliance pending resolution of key issues affecting their
operations. A recent Harvard University study, however,
predicted that the promulgation,of environmental regulations was
likely to result in the early phase out of older, less
sophisticated facilities, combined with the upgrade and expansion
of more efficient, complex refineries at a faster rate.
2.6.2 Demand Outlook
DOC projects the demand for all petroleum products to rise
slowly and steadily over the. next 5 years, with domestic demand
for refined products increasing by 2.1 percent in 1992, assuming
an economic recovery and .a return to "normal" weather. DOC's
longer term demand prediction is for a steady growth rate of 1
percent through 1996.35' 36 By petroleum product, the 5-year
2-44
-------
projected growth rates are as follows-:
Motor gasoline: 0-1 percent
Jet fuel: 2.1 percent
Distillate fuel:
Residual fuel: 0-1 percent
Other products: 3.6 percent
6.1 percent
Given that two-thirds of petroleum product demand is
attributable to the transportation sector, projected demand
growth for motor gasoline will have the greatest effect on
refiners. Industrial demand for distillate fuel reflects the
strongest projected growth. According to DOE projections, the
consumption of diesel fuel in the transportation sector is
expected to grow by over 40 percent between 1990 and 2010. 7
Residential and commercial sectors are expected to show a
decrease in demand for petroleum products.
DOE has also projected future levels of demand as outlined in
Table 2-18. In comparison with DOE's supply projections in the .
previous section/ these demand projections fall between the high
and low economic growth supply projections, and between the high
and low oil price projections. Motor gasoline will remain the
leading end use of petroleum products throughout DOE's chosen
time frame, dropping off during 1990 and 1995, and rising again
to higher levels by 2010. DOE predicts the demand for residual
oil to rise, level off, and then begin to decline in 2010. Jet
fuel and distillate fuel .are both projected to rise steadily
through 2010.
2.6.3 Price Outlook
Given that the demand for motor gasoline is price inelastic as
discussed in Section 2.5.5, the added capital investment that
refineries will be required to undertake in the production of
reformulated gasolines is likely to be passed on to consumers in
the form of a price increase. DOC has estimated this price
increase to be a 5 to, 10 cent-per-gallon rise in the price of
2-45
-------
motor gasoline.39 In a recent study undertaken by the .National
Petroleum Council, the impacts of air quality regulations on
petroleum refineries were assessed. One of the conclusions of
the study was that 'the costs of controlling air emissions are
likely to be passed along to consumers as increases in the final
price of refined products. (The study offered no quantitative
proj ections, however.)4 °
DOE has projected the domestic prices of petroleum products
for 2010, as outlined in Table 2-19. .. DOE projects the average
price for all petroleum prices to increase at a rate in the range
of 0.4 percent to 2.1 percent annually; These price increases
are due to projected increases in both domestic demand and crude
oil prices. DOE also accounted for higher refining and
distribution expenses in making these projections. The real price
of motor gasoline is projected to rise from $1.17 per gallon in
1990 to between $1.30 and $1.74 in 2010, depending on the level -..
of world crude oil prices. On-highway diesel fuel prices are
projected to increase to between $1.27 and $1.69 per gallon,
primarily because of the added refinery costs of desulfurization.
The average retail price of residual fuel oil, the least
expensive petroleum product, is projected to be within the range
of $25.52 to $40.79 per barrel in 2010.
If refineries are able to accommodate projected increases in
demand, the price level will remain fairly stable. However,
because the price level in this industry is contingent upon so
many factors independent of the industry, any price predictions
necessarily have their limitations. In the long run, therefore,
price forecasts will need to be modified with the occurrence of
any world events which will affect the supply of crude oil to the
refineries and therefore to the supply of refined petroleum
products. Refineries may also be faced with more environmental
legislation, escalating their pollution abatement costs. An
increase in regulatory costs would tend to increase the price of
refined petroleum products, all other factors held constant.
2-46
-------
TABLE 2-18. PROJECTED CONSUMPTION OF PETROLEUM PRODUCTS38
(MILLION BARRELS PER DAY)*
Product
Motor- Gasoline
Distillate Fuel
Residual Fuel
Jet Fuel
Liquefied Petroleum
Gases
Total Products
Supplied
1989
7.33
3.16
1.37
1.49
1.67
15.02
1990
7.21
3.02
1.23
1.49
1.55
14.50
1995
7.22
3.25
1.29
1.61
1.70
15.07
2000
.7.50
3.49
1.53
1.82
1.83
16.17
2005
7.83
3.70
1.53
2.01
1.96
17.03
2010
8.08
3.87
1.47
2.22
2.08
17.72
NOTES: *DOE approximates consumption by adding refinery production, natural gas liquids production, supply of
other liquids, imports, and stock withdrawals, and subtracting stock additions, refinery inputs, and-exports.
2-47
-------
TABLE 2-19- PROJECTED PRICES OF PETROLEUM PRICES41
(1990 DOLLARS PER GALLON)3
Alternative Projections for
- •
Product
Motor
Gasoline
Diesel Fuel
No. 2 Heating
Oil
Residual Fuel
Jet Fuel
1990
1.17
1.18
0.97
0.46
0.76
High
Economic
Growth
1.58
1.55
1.23
0.86
0.99
••
Low
Economic
Growth
1.57
1.52
• 1.15
0.82
0.95
'-—
2010b
High
Pric
e
1.74
1.69
1.32
0.97
1.13
=^=^=
Low
Pric
e
1.30
1.27
0.96
0.61
0.71
:===
NOTES: aProjected prices include estimated State and federal taxes.
bAssumptions used for each of the four scenarios are as follows:
Crude Oil
Price/Bbl
(1990 $)
Average
Annual Economic
Growth Rate
Annual
Energy Demand
Growth Rate
Annual
Electricity
Demand
Growth Rate
High Economic Growth Case:
Low Economic Growth Case:
High Oil Price Case:
Low Oil Price Case:
S33
$33
S40
S23
2.7%
1.8%
2.2%
2.2%
1.4%
0.9%
1.0%
1.3% .
2.2%
1.8%
1.9%
2.0%
2-48
-------
REFERENCES
1.
2.
3.
4 .
5.
6.
U.S. Department of Energy. Petroleum Supply Annual, 1992.
Volume 1. DOE/EIA-0340(90)/1. Energy Information
Administration. Washington, DC. May 1993.
Robert Beck and Joan Biggs. OGJ 300. Oil & Gas Journal.
Vol. 89. No. 39. Tulsa, OK. September 1991.
U.S. Department of Commerce. 1987 Census of Manufactures,
Petroleum, and Coal Products. Industry Series. MC87-I-
29A. Bureau of the Census. Washington, DC. April 1990.
Table 4.
Al Foreman. U.S. Department of Commerce. Bureau of the
Census. Washington, DC. Personal communication. April
21, 1992. .
Dun & Bradstreet. Million Dollar Directory.
Standard & Poor's.
and Executives.
Register of Corporations, Directors,
7.
9.
10.
11.
12.
13.
14.
Reference 2. Table 36.
Reference 2. Table FES.
American Petroleum Institute. Market Shares and
Individual Company Data for U.S. Energy Markets, 1950-
1989. Discussion Paper #014R. .Washington, DC. October
1990.
U.S. Department of Energy. Petroleum'Marketing Annual,
1990. DOE/EIA-0.487 (90) . Energy Information
Administration. Washington, DC. December 1991.
U.S. Department of Energy. Petroleum: An Energy Profile.
DOE/EIA-0545(91). Energy Information Administration. .
Washington, DC. August 1991.
U.S. Department of Energy. Performance Profiles of Major
Energy Producers, 1990. DOE/EIA-0206(90) . Energy
Information Administration. Washington, DC. December
1991.
U.S. Department of Energy. The U.S. Petroleum Refining
Industry in the 1980's. DOE/EIA-0536. Energy Information
Administration. October 1990.
U.S. Department of Energy. Annual Outlook for Oil and
Gas. DOE/EIA-0517(91). Energy Information
Administration. Washington, DC. June 1991.
15.
Reference 12.
2-50
-------
16. Reference 13 .
17. Cambridge Energy Research Associates. The U.S. Refining
Industry: .Facing the Challenges of the 1990s. Prepared
for U.S. Department of Energy. January 1992.
18. U.S. Department of Energy. Monthly Energy Review.
DOE/EIA-0035 (93/07). Energy Information Administration.
Washington, DC. July 1993. Tables 3.3 to 3.10.
19. Robert S. Pindyck and Daniel L. Rubinfeld.
Microeconomics. MacMillan Publishing Co. 1989.
20. U.S. Department of Energy. Petroleum Supply Monthly.
Energy Information Administration. Washington, DC. March
1991.
21, U.S. Department of Energy. The U.S. Petroleum Industry:
Past as Prologue 1970-1992. DOE/EIA-0572. Energy
Information Administration, Office of Oil and Gas.
Washington, DC. September 1993.
22. Bonner & Moore Management Science. Overview of Refining
and Fuel Oil Production. Houston, TX. April 29, 1982.
23. U.S. Department of Energy. Annual Report to Congress.
DOE/EIA-0173(91). Energy Information Administration.
Washington, DC. March 1992.
24 . Reference 18.
25. Dermot Gately. New York University. Taking Off: The
U.S. Demand for Air Travel and Jet .Fuel'. The Energy
Journal. Vol. 9. No. 4. 1988.
26. Reference 10.
27. Reference 10.
28. U.S. Department of Commerce. Petroleum Refining -- U.S.
Industrial Outlook 1992. Washington, DC. January 1992.
29. U.S. Department of Commerce. Petroleum Refining -- U.S.
Industrial Outlook 1991. Washington, DC. January 1991.
30. U.S. Department of Energy. Annual Energy Outlook, 1992.
DOE/EIA-0383 (92) . Energy Information Administration.
Washington, DC. January 1992.
31. Reference 13.
32. Reference 28.
33. Reference 30.
2-51
-------
34
35.
36.
37.
38.
39.
40.
41.
Henry Lee and Ranjit Lamech. The Impact of Clean Air Act
Amendments on U.S. Energy Security. Harvard University.
Energy 93-01. Cambridge, MA. 1993.
Reference 28.
•Reference 29.
Reference 30.
Reference 11.
Reference 29.
National Petroleum Council. Estimated Expenditures by
Petroleum Refineries to Meet New Regulatory Initiatives
for Air Quality. For presentation at the 86th Annual Air
& Waste Management Association Meeting. Denver, CO. 93-
WA-78A.03. June 13-18, 1993.
Reference 28. •
2-52
-------
'*i-.v;'''v?<^ii^rettv;.\M*^
3.0 ECONOMIC METHODOLOGY
3.1 INTRODUCTION
The economic methodology used in this study is outlined in
this chapter. Baseline values used in the partial equilibrium
analysis are presented, and the analytical methods used to
conduct each of the following analyses are described separately
in this chapter:
• Partial equilibrium analysis
• Impact of control costs on market price and quantity
• Trade impacts and plant closures
• Economic surplus changes
• Labor and energy impacts
• Capital availability analysis.
3.2
MARKET MODEL
3.2.1 Partial Equilibrium Analysis
A partial equilibrium analysis is an analytical tool often
used by economists to analyze the single market model. This
method assumes that some variables are exogenously fixed at
predetermined levels. The goal of the partial equilibrium model
is to specify market supply and demand, estimate the post-control
shift in market supply, estimate the change' in market equilibrium
(price and quantity), and predict plant closures.
3-1
-------
3.2.2 Market Demand and Supply
The baseline or pre-control petroleum refining market is
defined by a domestic market demand equation, a domestic market
supply equation, and a foreign market supply equation. It is
further assumed that the markets will clear or achieve . an
equilibrium. The following equations identify the market demand,
supply, and equilibrium conditions:
-------
3.2.3 MarJcet Supply Shift
The domestic supply equation shown above may be solved for the
price of the petroleum product, P, to derive an inverse supply
function that will serve as the baseline supply function for the
industry. The inverse domestic supply equation for the industry
is as follows: ^
^ P = (
A rational profit maximizing firm will seek to increase the
price of the product it sells by an amount that recovers the
capital and operating costs of the regulatory control
requirements over the useful life of the emission control
equipment. This relationship is identified in the ' following
equation:
[(C - Q) - (V * £>)] (1 - t) + D = k
S
where :
C = increase in the supply price
Q = output
V « measure of annual operating and maintenance control
costs
t = marginal corporate income tax rate
S = capital recovery factor
D = annual depreciation (assumes straight line
depreciation)
K = investment cost of emission controls
Thus, the model assumes that individual refineries will seek to
increase the product supply price by an amount (C) that equates
the investment costs in control equipment (k) to the present
3-3
-------
value of the net revenue stream (revenues less expenditures)
related to the equipment . So±ving the equation for the supply
price increase (C) yields the following equation:
C =
" D
D
Estimates of the annual operation and maintenance control
costs and of the investment cost of emission controls (V and k
respectively), were obtained from engineering studies conducted
by EPA's engineering contractor and are based on first quarter
1992 price levels. The variables depreciation and capital
recovery factor (D and S, respectively) are computed as follows:
S =
[(1
where "r" is the discount rate faced by producers and is assumed to
be a rate of 10 percent and T is the life of the emission control
equipment, which is 10 years for most of the emission control
equipment proposed.
Emission control costs will increase the supply price for •
each refinery by an amount equivalent to the per unit cost of the
annual recovery of investment costs and annual operating costs of
emission control equipment or C^ (i denotes domestic refinery 1
through 192). The baseline individual refinery cost curves are
unknown because production costs for the individual refineries
are unknown. Therefore, an assumption is made that the.
refineries with the highest after-tax per unit control costs are
marginal in the post-control market or that those firms with the
highest after tax per unit control costs also have the highest
per unit production costs. This is a worst case scenario model
assumption and may not be the case in reality. Based upon this
3-4
-------
assumption, the post-control supply function becomes the
following:
P = (£>
where:
C(C-,q-) = a function that shifts the post-control supply
function
C- - vertical shift that occurs in the supply curve for
the ith refinery to reflect post-control costs
q. = quantity produced by the ith refinery
This shift in the supply curve is illustrated in Figure 3-1.
3.2.4 Impact of Supply Shift on Market Price and Quantity
The impact of the proposed emission standards on market
equilibrium price and output is derived by solving for the post-
control market equilibrium and comparing the new equilibrium
price and quantity to the pre-control equilibrium. Since post-
control domestic supply is assumed to be segmented, or a step
function, a special algorithm was developed to solve for the
post-control market equilibrium. The algorithm first searches
. for the segment in the post-control supply function at which
equilibrium occurs and then solves for the post-control market
price that clear.s the market.
Since the market clearing price occurs where demand equals
post-control domestic supply plus foreign supply, the algorithm
simultaneously solves for the following post-control variables:
• Equilibrium market price
• Equilibrium market quantity
• Change in the value of domestic production or revenues.
to producers
»•• 'The quantity supplied by domestic producers
• The net quantity supplied by foreign producers.
The changes'in the market equilibrium are assessed by comparing
baseline equilibrium values with post-control equilibrium values
3-5
-------
3.2.5 Trade Impacts
Trade impacts are reported as the change in both the volume
and dollar value of net exports (exports minus imports). It is
assumed that exports comprise an equivalent percentage of
domestic" production in the pre- and post-control markets. The
supply elasticities in the domestic and foreign markets have also
been assumed to be equal. As the volume of imports rises and the
volume of exports falls, the volume of net exports will decline.
However, the dollar value of net exports may rise or fall when
demand is inelastic, as is the case for the petroleum products of
interest. The dollar value of imports will increase since both
the price and quantity of imports increase. Alternatively, the
quantity of exports will decline, while the price of the product
will increase. Price increases for products with inelastic
demand result in revenue increases for the producer.
Consequently, the dollar value of exports is anticipated to
increase. Since the dollar value of imports and exports rise,
the resulting change in the value of net exports will depend on
the magnitude of the changes for imports relative to exports.
The following algorithms are used to compute the trade
impacts:
AVZftf =
- (P0
AVX =
sd
- o
(or -
- P0Qod)
3-6
-------
where:
Sd
= the change in the volume of imports
the change in the dollar value of imports
= the change in the volume of exports
= the change in the dollar value of exports
= the quantity of exports by domestic producers in the
pre-control market
Subscripts 0 and 1 refer to the pre- and post-control
equilibrium values, respectively. All other terms have been
previously defined.
The change in the quantity of net exports (&.NX) is simply the
difference between the change in the volume of exports and the
change in the volume of imports, expressed as &QX ~ *QS • The
reported change in the dollar value of net exports (&.VNX) is the
difference between the equations for change in the value of
exports and the change in the value of imports, or &.VX - AVTM.
3.2.6 Plant Closures
It is assumed that a refinery will close if its post-control
supply price exceeds the post-control market equilibrium price.
Post-control supply prices for the individual refinery are
computed as described in Section 3.2.3, Market Supply Shift.
3.2.7 Changes in Economic Welfare
Regulatory control requirements will result in changes in the
market equilibrium price and quantity of petroleum products
produced and sold. These changes in the market equilibrium price
and quantity will affect the welfare of consumers of petroleum
products, producers of petroleum products, and society as a
whole. The methods used to measure these changes in welfare will
be described individually in the following sections.
3-7
-------
o
0
p
a>
T]
Q
33
m
CO
c.
CO
—I
O
O
TI
m
CO
o
o
m
-------
3.2.7.1 Changes in Consumer Surplus. Consumers will bear a
loss in consumer surplus, or a dead weight loss, associated with
the reduction in the amount of petroleum products produced and
sold, and the higher prices paid for the products purchased. .• . ...
This loss in consumer surplus represents the amount consumers
would have been willing to pay over the pre-control price for
eliminated production. In addition, consumers will be faced with
a higher price for post-control output. This consumer surplus
change, ACS is given by:
(Q/o.) e dQ
- P0Q0
The change in consumer surplus includes losses of surplus
incurred by both foreign consumers and domestic consumers.
Although the change in domestic consumer surplus is the object of
interest, no method is available to distinguish the marginal
consumer as domestic or foreign. Therefore, an assumption is
made that the consumer surplus change is allocable to' the foreign
and the domestic consumer in the same ratio as sales are divided
between foreign and domestic consumers in the pre-control market.
The change in domestic production (ACS) becomes the following:
ACS. = [1-
] ACS-
ACS J represents the change in domestic consumer surplus that
results from the change in market equilibrium price and quantity
resulting from the imposition of regulatory controls. While ACS
is the change in consumer surplus from the perspective of the
world economy, ACSj is the change in consumer surplus relevant to
the domestic economy.
3-9
-------
3.2.7.2 Change in Producer Surplus. The change in producer
surplus is composed of two elements. The first element relates
to output eliminated as a result of controls. The second element
is associated with the change in price and cost of production for
the new market equilibrium quantity. The total change in
consumer surplus is the sum of these two components. After-tax
measures of surplus changes are required to estimate the impacts
of control on producers' welfare. The after-tax surplus change
is computed by multiplying the pre-tax surplus change by a factor
of 1 minus the tax rate, (1-t) where t-is the marginal tax rate.
Every dollar of after-tax surplus loss represents a complimentary
loss in tax revenues of t/(l-t) dollars.
Output eliminated as a result of control costs cause producers
to suffer a welfare loss in producer surplus. Refineries
remaining in operation after emission controls (M) realize a
welfare gain on each unit of production for the incremental
increase in the price and realize a decrease in welfare per unit
for the capital and operating cost of emission controls. The
total change in producer surplus is specified by the following
equation:
/ ^sd
M
.Since domestic surplus changes are the object of interest, the
welfare gain experienced . by foreign producers due to higher
prices is not considered. This procedure treats higher prices
paid for imports as a dead-weight loss in consumer surplus. From
a world, economy perspective, higher prices paid to foreign
producers represent simply a transfer of surplus from the United
States to other countries. The higher prices paid.for imports -
represent a welfare loss from the perspective of the domestic
economy. ' _
3.2.7.3 Residual Effect on Society. The changes in economic
surplus as measured by the changes in consumer and producer
surplus previously discussed must be adjusted to reflect the true
3-10
-------
.*^*:kfraj'^
change in social welfare as a result of regulation. The
adjustments are necessary due to tax effects differences and to
the difference between the private and the social discount rates.
Two adjustments to economic surplus are necessary to account
for tax effects. The first relates to the per unit control cost
(C^) that reflects after-tax control costs and is used to predict
the post-control market equilibrium. True cost of emission
controls must be measured on a pre-tax basis.
A second tax-related adjustment is required because changes
reflect the after-tax welfare impacts of emission control costs
on affected refineries. As noted previously, a one dollar loss
in pre-tax surplus imposes an after-tax burden on the affected
refinery of (1-t) dollars. Alternatively, a one dollar loss in
after-tax producer surplus causes a complimentary loss of t/ (1-t)
dollars in tax revenue.
Economic surplus must also be adjusted because the private and
social discount rates differ. The private discount rate is used
to shift the supply curve of firms in the industry since this
rate reflects the marginal cost of capital to affected firms.-
The economic costs of regulation must consider the social cost of
capital. This rate reflects the social opportunity cost of
resources displaced by investments in emission controls.
The adjustment for the two tax effects and the social cost of
capital are referred to as the residual change in economic
surplus, A£S. This adjustment is shown by the following
equation:
AT
ARS = J^ (Cd '-
a=l
APS • [t/(l-t) ]
where pc^ is the per unit cost of controls for each refinery,
vith the tax rate assumed to be zero, the discount rate assumed
to be the social discount rate of 7 percent, and all other
variables have been previously defined.
3.2.7.4 Total Economic Costs. The total economic costs of
the proposed regulations are the sum of the changes in consumer
3-11
-------
surplus, producer surplus, and the residual surplus. This
relationship is defined in the following equations:
EC = ACSd + APS + A2?S
where EC-is the economic cost of the proposed controls and all
other variables have been previously defined.
3.2.8 Labor Input and Energy Input Impacts
The estimates of the labor market and energy market impacts
associated with the alternative standards are based on input-
output ratios and estimated changes in domestic production. The
methodologies used to estimate each impact are presented
separately in the following sections.
3.2.8.1 Labor Input Impacts. The labor market impacts are
measured as the number of jobs lost due to domestic output
reductions. The estimated number of job losses are a function of
the change in level of production that is anticipated to occur as
a result of the proposed emission controls. The change in
employment is estimated as follows:
Al, = (Qod - Oid) LQ
where:
A!/ = the change in employment
I/0 = the number of production workers per million barrels of
annual production
Subscripts 0 and 1 represent pre- and post-control values,
respectively.
All other variables have been previously defined.
3.2.8.2 Energy Input. Impacts. The reduction in energy inputs
associated with the proposed standard results from the expected
reduction in expenditures for .energy inputs as a- result of
3-12
-------
production decreases-. The expected change in use of energy
inputs is calculated as follows:
where:
AE = the change in expenditures on energy inputs
EQ = the baseline expenditure on energy input per dollar of
refined petroleum output
All else is as previously defined.
3.2.9 Baseline Inputs
The partial equilibrium model requires baseline values for
variables and parameters that have been previously described to
characterize the petroleum refining market. Table 3-1 lists the
variable and parameter inputs to the model that vary for the five
petroleum products. Table 3-2 lists variables and parameters
that are assumed to be the same for all petroleum products.
The baseline conditions in the petroleum refining industry are
characterized by the baseline parameters and variables in the
tables. The baseline market prices, quantities, imports, and
exports for the five petroleum products were taken from the U.S.
Department of Energy, Petroleum Market Annual, 1992. Prices are
stated in cents per gallon excluding taxes and refinery output is
stated in millions of barrels produced per year. Sources for the
price elasticity of supply and demand are discussed in Section
3 3, Industry Supply and Demand Elasticities. The marginal tax
rate of- 25 percent, private discount rate of 10 percent, and
social discount rate of 7 percent are rates that have, been
assumed for the analysis as surrogates for the actual rates in
the economy. The equipment life of 10 years was obtained from
the study of' emission control costs conducted for EPA by the
engineering contractor. The' number of workers per unit of output
(L) and the energy expenditure per value of shipments (E) were
derived from the U.S. Department of Commerc4, Annual Survey of
Manufactures (ASM), 1991. Data from the ASM used to derive these
3-13
-------
estimates include the 1991 annual values for total number of
workers employed, total expenditures on energy, and the value of
shipments for SIC 2911.
3-14
-------
CO
^
g
a
H
I
w
a
M
.4
W
a
CO
o
M
b
M
U
W
o<
CO
I
I
CU
ro
CO
O
0)
4J rH
(0 -H
rH O
rH
•H rH
4J 4J 0)
o ra 3
rt -H H-l
•a Q
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04
3 rH rH
<1) (C-H
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rt -H rH
4J 10 0)
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r-
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in o
in o
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co oj
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r'j
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V£> O
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ord }H
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{?»]
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M
JH
En .•
«:.-.
w
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EH
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PJ
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ffi
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^
TABLE
.-:
•-P
.-.-T-H
'>
ameter
J^
(0
0)
rH
XI
fO
-H
rH
(0
to
CD , (C '4J rH E >l
rH j-i to nj & >H Cn
ft > -H -H O rH
ft X -H 0 3 XI
rH
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c
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o
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^Q
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13
CD
0
5 ^
Q. .g
3 Q.
T3 V
0 »
Q. *•-
1 =
TO 5
J3 >
c ra
o =
= o
£ ,_
o CL
°- 01
tfl 0>
ID 3
I!
= Q.
0 m
'•0 >,
3 O)
11
Q_ LIJ
»- OJ
to
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-------
Data inputs also include the number of domestic refineries
operating'- in i9j9_27i_ annual production per refinery, and control
costs per refinery. The number of operating refineries and
annual production per refinery were obtained from the Oil and Gas
Journal Refinery Survey, January 1992. Emission control costs
were obtained from engineering studies conducted by an
.engineering contractor .for- -EPA. .-'.. '
3.3 INDUSTRY SUPPLY AND DEMAND ELASTICITIES
Demand and supply elasticities are crucial components of the
partia,!' .equilibrium model that is used to quantify the economic
impact, of,-regulatory control cost measures on the petroleum .
refinery.-industry. This chapter discusses the price elasticities
of demand and supply used as inputs to the partial equilibrium
analysis. The price elasticities of demand for each product were
available from published sources. The price elasticity of supply
was estimated for this analysis. The techniques utilized to
estimate the price elasticity of supply are discussed in detail
in Section 3.3.2, Price Elasticity of Supply.
3.3.1 Price Elasticity of Demand
The price elasticity of demand, or own-price elasticity of
demand, is a measure of the sensitivity, of buyers of a product to
a change in price of the product. The price elasticity of demand
represents the percentage change in the quantity demanded
resulting from each 1 percent change in the price of the product.
Petroleum products represent a very important energy source
for the United States. Many studies have been conducted which
estimate the price elasticity of demand for some or all of. the
petroleum products of interest. Over one hundred studies of the
demand for motor gasoline alone have been conducted (see Dahl and
Stern1 for a survey of these model results). Numerous published
sources of the price elasticity of demand for petroleum products
exist and are discussed "in detail in the Industry Profile for the
Petroleum Refinery NESHAP (Pechan, 1993). The own-price
elasticities of demand used in this analysis are listed in Table
3-3.
3-17
-------
TABLE 3-3. ESTIMATES OF PRICE ELASTICITY OF DEMAND
Fuel Type
Long-Run Elasticity
Motor Gasoline
Jet fuel
Residual' Fuel Oil
Distillate Fuel Oil
Liquified Petroleum Gases
-0.55 to -0.82'
-G-. is3
-0.61 to -0.74;
-0.50 to -0.99'
-0.60 to -l.O2
The elasticity estimates reflect that each of these products
has inelastic demand. Regulatory control costs are more likely
to paid by consumers of products with inelastic demand compared
with products with elastic demand, all other factors held
constant. Price increases for products with inelastic demand
lead to revenue increases for the producers. Thus, one can
predict that price increases resulting from implementation of
regulatory control costs will lead to higher revenues for the
petroleum refining industry.
The market changes resulting from the regulations are based
upon the midpoint of the range of demand elasticities (with the
exception of jet fuel for which a range of elasticities was not
provided). A sensitivity analysis of this assumption is made
•using the upper and lower bounds of the range of elasticities and
is reported in Appendix B.
3.3.2 Price Elasticity of Supply
The price elasticity of supply, or own-price elasticity of
supply, is a measure of the responsiveness of producers to
changes in the price of a product. The price elasticity of
supply indicates the percentage change in the quantity supplied
of a product resulting from each 1 percent change in the price .of
the product.
3.3.2.1 Modeling Issues. Published sources of the price
elasticity of supply using current data were not readily
available. Two studies estimated the price elasticity of supply
for gasoline to be 1.964 and 1.475, respectively. Since the
3-18
-------
years of data used in these studies covered time periods during
the decade of 1970, it was determined that the price elasticity
of supply should be estimated econometrically using time series
data inclusive of more current information and of periods with
greater market stability.
The petroleum refinery industry has a history of long periods
of stable market conditions followed by periods of major market
disruptions, which must be considered in estimating the price
elasticity of supply using time series data. The Arab oil
embargo and the Iranian crisis in 1973 and 1978, respectively,
represent major crude oil supply disruptions that had significant
repercussions on the U.S. economy, and industrialized economies
of countries throughout the world. These market disruptions
drastically affected the market equilibrium for petroleum
products. The price per barrel of crude oil, the major input
into producing petroleum products, increased from an average
price of $4.15 per barrel in 1972 to an average price of $35.24 -
per barrel in 19816, an increase of 749 percent in nominal prices
and an increase.of 249 percent when these prices are deflated by
*7
the producer price index for all commodities. These events
suggest the possibility of a structural change or break during
the periods of the Arab oil embargo and the Iranian crisis as
noted by Tsurumi.4 A Chow test, or F-test, for structural change
was conducted for the period 1973 through 1979, or the period
relevant to these significant events. The statistical results of
this test are presented with the statistical results of the
model.
Another concern in estimating the price elasticity of supply
for petroleum refinery products is the joint product nature of
the five petroleum products. Joint products are products that
are produced jointly or in conjunction with other products.
Joint products may be categorized as either joint products of
fixed proportions, or as joint products of variable proportions.
Beef and leather are the classic example of a joint product with
fixed proportions. Alternatively, the petroleum products under
study represent joint products of variable proportions- Thus,
managers at petroleum refineries have some discretion over the
3-19
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level of production between refinery products. The jointness and
variability in the jointness of the products further complicates
the analysis.
Several model approaches were considered in the Analysis Plan
for the Economic Impact Analysis of Alternative NESHAP for the
Petroleum Refinery Industry (Pechan, 1993) . The most
theoretically sound methodology involved estimation of a
production function with a function of the five petroleum
products as the dependent or left-hand-side variable. It was
determined that software was not readily available to estimate
this type of model. Alternatively, a model estimating the
production function for each of the five products treating the
price of the alternative four products as dependent or right-
hand- side variables was recommended. This approach assumes- that
the prices of the alternative products, -are exogenous to the
model. In fact the prices of the five products are highly
correlated over time and are endogenous to the model.. Estimation
of this model was not successful.
Two alternative models were considered. The first involved
estimation of a supply-demand model, and the second was to
estimate a production function for the five products combined.
"The supply-demand approach estimates the price elasticity of
supply using simultaneous supply and demand equations and avoids
simultaneous system bias. This method allows for the treatment
of the price of alternative joint products as endogenous
variables. The results of the model estimated in this'manner
were less satisfactory than estimation of the production function
for the five joint products in terms of significance of the
model, significance and signs of the individual parameter
estimates, and goodness of fit measures. Consequently, it was
determined that the price elasticity of supply would be estimated
. using a production function for the five products combined.
3.3.2.2 Model Approach. The approach used to estimate the
price elasticity of supply is consistent with economic theory and
makes the best use of available data. The method of deriving a
supply elasticity from an estimated production function will be
3-20
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^^
briefly discussed. The industry production function is defined
as follows:
Qs = f (L.K.M, t)
where:
QS
£
K
M
t
the quantity of motor gasoline, jet fuel, residual fuel
oil, distillate fuel oil, and LPGs produced by domestic
refineries
the labor input or number of labor hours
real capital stock
the quantity of crude oil processed
a time variable to reflect technology changes
in a competitive market, market forces constrain firms to
produce at the cost minimizing output level. Cost minimization
allows for the duality mapping of a firm's technology (summarized
by the firm's production function) to the firm's economxc
behavior (summarized by the firm's cost function) . The total
cost function of the petroleum refinery industry follows:
,TC = h(C,K, t,Qs)
where TC is the total cost of production, C is the cost of
production (including cost of materials and labor) and the other,
variables have been previously defined. This methodology assumes
that capital stock is fixed, or a sunk cost of production. Thzs
model assumption is consistent with the goal of modeling post-
control market changes likely to occur. Firms facing prospective
regulatory emission controls will consider .embedded capital stock
as a fixed or sunk cost in economic decision making. Firms will
make economic decisions that consider those costs of production
that are discretionary or avoidable. In the short run, avoidable
costs are generally variable costs such as labor and materials.
investments in new capital, such as emission control equipment,
are also discretionary . Firms have the discretion to shut down
rather than make investments in required emission control
equipment. By contrast, costs associated with existing capital
are not avoidable or discretionary, but represent sunk costs.
3-21
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Differentiating the total cost function with respect to QS
rje-H v^a t-hfe "' margin_al r. cos t function:
MC = ti(C,K, t,Qs) '
where MC is the marginal cost of production and all other
variables have been previously defined.
••: ••.-- •'. -Fro-fit,. •maximizing .competitive firms will choose to produce the
quantity of /output that equates market price (P) to the marginal
cost of production (MC) . Setting the price equal to the
preceding marginal cost function and solving for 0s yields the
following implied supply function:
where P is the market price of the petroleum products, PL is the
price -of labor, PM is the price of crude oil, and all other
variables have been previously defined.
An explicit functional form of the production function may be
assumed to facilitate estimation of the model. For this
analysis, the Cobb-Douglas or multiplicative form of the
product ion -function is postulated. The Cobb-Douglas production
function has the convenient property of yielding constant
elasticity measures. The functional form of the production
T function, becomes : . . :;-
where:
sum of the industry output of the five product
categories in year t
real capital stock in year t
the quantity of labor hours used to produce the
petroleum products in year t
quantity of crude oil processed in year t
A,
Oii
"X" are "parameters to be estimated by the model.
This equation can be written in linear form by taking the
natural logarithms of both sides of the equation. Linear
3-22
-------
regression techniques may then be applied. Using the approach
described, the .impl-ied supply function may be derived as:
In = P0 + Y In P + P2 In K +P3 In PL + P4 In PM +• P5 In t
where:
p.. = factor price of the labor input
p., = . ..factor., price, .of ..the mat.erial.,. input -'
K. = real fixed-'capital.''
The coefficients, £_£ and 7, are functions of a±, the
coefficients of the production function.
The supply elasticity.,, y is equal to the following:
It is necessary to place some restrictions on the estimated
coefficients of the production function in order to have well-
defined supply function coefficients. The sum of the
coefficients for labor and materials should be less than one.
Coefficient values for aL and or^ that equal to one result in a
price elasticity of "supply that. is undefined, and values greater
than one result in negative supply elasticity measures. For
these reasons, the production function is estimated with the
restriction that -the- sum. of. the coefficients for-rthe inputs equal
one. This is analogous to assuming that the petroleum refining
industry exhibits constant returns to scale or is a long-run
constant cost industry. This assumption- seems reasonable on an a
priori basis and is consistent with the data.
3.3.2.3 Estimated Model. The estimated model reflects the
industry production function for the petroleum products using
annual time series data for the time period from 1963 through
1991. The following model was estimated econometrically:
In t + aL In L +
In M
In £>t'- ln A + aK ±n-K~
where each of the variables and 'coefficients has been previously
defined.
3-23
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3.3.2.4 , Data. The data used to estimated the model is
enumerated in Table 3-4. This table contains a list of the
variables included in the model, the units of measure, and a
brief description of the data. The data used in the analysis
represents data for the petroleum refining industry, SIC 2911,
with two exceptions. The data inputs for quantity produced (Ofc)
represents production at the five digit SIC level for.gasoline,
jet fuel, distillate fuel oil, residual fuel oil, and LPGs. The
capital stock variable represents real net capital stock for
petroleum and coke products SIC 29. Capital stock data were not
readily available for the Petroleum Refining Industry at the
four-digit SIC level from published sources for the relevant time
periods. However, limited data1 reviewed for specific years
during the study period indicates that the majority of gross
capital stock in SIC 29 relates to the petroleum refining
industry. Consequently, use of this capital stock data is
unlikely to create errors for the analysis.
The capital stock variable represents the most difficult
variable to quantify for the econometric model. Ideally this
variable should represent the economic value of the capital stock
actually used by the refinery industry to.produce petroleum
products for each year of the study. The most reasonable data
for this variable would be the number of machine hours actually
used to produce the refinery products each year. This
information is unavailable. In lieu of machine hours data, the
dollar value of net capital stock in constant 1987 prices, or
real net capital stock, is used as a proxy for this variable.
The capital stock data are flawed in two ways. The first flaw
occurs because the data represent accounting valuations of
capital stock rather than economic valuations. This aberration
is not easily remedied, and is generally considered unavoidable
in most studies of this kind.
The second flaw involves capital investment that is idle and
not actually used for production in a particular year. This
error may be corrected by adjusting the capital investment to
exclude the portion of capital investment that is idle and does
not contribute directly to production in a given year. In an
3-24
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effort to further refine the data, real capital stock was
adjusted for capacity utilization. This refinement would then
provide a data input that considers the.percentage of real
capital stock actually utilized in petroleum refining production
each year.
TABLE 3-4. PRODUCTION FUNCTION DATA INPUTS
Variab Unit of Measure
le
Description
Millions of barrels
Years
Millions of 1987
dollars
Thousand of labor man
hours
Millions of barrels
The output variable includes
the sum of annual production
for motor gasoline, jet -fuel,
residual fuel oil. distillate
fuel oil, and LPG7
Technology time trend
Real capital stock for
Petroleum and Coal Products
adjusted for capacity
utilization8'
Production worker hours
for Petroleum refineries^-
Gross input of crude oil to
petroleum product
distillation7
3-25
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3.3.2.5 Statistical Results. A restricted least squares
estimator was used to estimate the coefficients of the production
function model. A log-linear specification was estimated with
the sum of the ct± restricted to unity. This procedure is
consistent with the assumption of constant returns to scale. The
model was further adjusted to correct for first-order serial
correlation using the Prais-Winston algorithm. The results of
the estimated model are presented in Table 3-5.
TABLE 3-5. ESTIMATED PRODUCTION FUNCTION COEFFICIENTS
Variable
Estimated
Coefficients*
Adjusted R
t time
2
Capital Stock
Labor
Materials or crude
oil
0.9680
0.0481
(2.061)
0.4457
(4.916)
0.1447
(2.090)
0.4096
(4.507)
NOTES: *t-ratios are shown in parentheses.
The equation explains about 97 percent of the variation in the
output variable. The time variable and labor variable are
significant at the 95 percent confidence level, while the capital
and crude oil or material variables are significant at the 99
percent confidence level. The F test and the Chi-square test for
the estimated model show that the coefficients of the estimated
model are jointly significant at the 99 percent confidence level.
Using the estimated coefficients in Table 3-5 and the formula
for supply elasticity shown Section 3.3.3.2 Model Approach, the
price elasticity of supply for the five petroleum products is
derived to be 1.24. The calculation of statistical significance
for this elasticity measure is not a straightforward calculation
3-26
-------
since the estimated function in non-linear. No attempt has been
made to assess the statistical significance of the estimated
elasticity.
A Chow test for structural stability was conducted of the
coefficients to determine if a structural change occurred during
the period from 1973 through 1979. This period included two
significant supply disruptions of crude oil, the major input to
the petroleum refining process. The test of structural change
for the period using an F-test for linear restrictions leads to a
conclusion that a structural break did not occur during the
period for the estimated model. It is recognized that this
result differs from the conclusion of Tsurmi.4 However, the
model estimated by Tsurmi differed from the model estimated in
this analysis in many respects. The data used in the Tsurmi
study represented quarterly data rather than annual data used in
the present study. It should be noted that the supply elasticity
estimates reported in Yang and Hu also do not adjust for
structural change.5 As a further test of the model's results on
this issue, the model was re-estimated excluding data for the
period from 1973 through 1979. The results were quite similar to
those reported in this document in'terms of signs of the
coefficients and significance tests. The price elasticity of
supply estimated with such a model was 1.25. This price
elasticity of supply estimate is virtually the same as the
estimate used in the model reported.
3.3.2.6 Limitations of the Supply Elasticity Estimates. The
estimated price elasticity of supply for the five petroleum
products reflects that the petroleum refinery industry in the
United States will increase production of gasoline, jet fuel,
residual fuel oil, distillate fuel oil and LPG jointly by 1.24
percent for every 1.0 percent increase in the price of these
products. The preceding methodology does not estimate the supply
elasticities for the individual products or directly consider the
interrelationships between products. The assumption implicit in
use of this supply elasticity estimate is that the elasticities
of the individual petroleum products will not differ
3-27
-------
significantly from the elasticity of the products combined. This
does not seem a totally unreasonable assumption since the same
factor inputs are used to produce each of the petroleum products.
The methodology al'so does not explicitly consider the cross-price
elasticities for the petroleum products. Since these products
are joint products, changes in the price of one product will have
an effect on the quantity supplied of the other products.
The uncertainty of the supply estimate is acknowledged. It is
possible to conduct a sensitivity analysis of the price
elasticity supply. Such an analysis would quantify the impact of
this assumption on the reported market results.
3.4
CAPITAL AVAILABILITY ANALYSIS
It is necessary to estimate the impact of the proposed
emission controls on the affected petroleum refineries' financial
performance and their ability to finance the additional capital
investment in emission control equipment. Financial data were
not available for the majority of the refineries in the industry.
Financial data were only available for the largest publicly held
petroleum refining companies. For this reason, the capital
availability analysis has been conducted on an industrywide
basis.
One measure of financial performance frequently used to assess
the profitability of a firm is net income before interest expense
expressed as a percentage of firm assets, or rate of return on
investment. The pre-control rate of return on investment (r'oi)
is calculated as follows:
xoi =
1990
E —
t-^ \ a .
1986
/5 • 100
where n• is income before interest payments and a^ is total
assets. A five year average is used to avoid annual fluctuations
that may occur in income data. The proposed regulations
potentially could have an effect on income before taxes, n^, for
firms in the industry and on the level of assets for firms in the
3-28
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industry, a^. Since firm-specific data were unavailable for all
of the affected firms, sample financial data collected by the API
were used.-1--1- Data from the API study are available in the
Industry Profile for the Petroleum Refinery NESHAP (Pechan,
1993). The sample studied by API represents 71 percent of net
income in the industry and 70 percent of total industry assets.
These percentages will be considered to estimate changes in the
financial ratio, and are necessary to allocate changes in income
and assets resulting from emission controls to the study sample.
The average rate of return on investment for firms in the sample
was 6 percent. There is a great diversity among the refineries
in the industry; therefore, individual firm financial performance
may vary greatly from the sample estimate. The post-control
return on investment (pro!) is calculated as follows:
proi =
•100
where:
proi = post-control return on investment
Aii.£ = change in income before interest resulting from
implementation of emission controls for firms in
the sample
a^ = change in investment or assets for firms in the
sample
The ability of affected firms to finance the capital equipment
associated with emission control is also relevant to the
analysis. .Numerous financial ratios can be examined to analyze
the ability of a firm to finance capital expenditures. One such
measure is historical profitability measures such as rate of
return on investment. The analysis approach for this measure has
been previously described. The bond rating of a firm is another
indication of the credit worthiness of a firm or the ability of a
firm to finance capital expenditures with debt capital. Such
data are unavailable for many of the firms subject to the
3-29
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regulation, and consequently, bond ratings are not. analyzed.
Ability to pay interest payments is another criterion sometimes
used to assess the capability of a firm to finance capital
expenditures. Coverage ratios provide such information. The
interest "coverage ratio or the number of times income (before
taxes and interest) will pay interest expense is a ratio that
provides some information about the ability of a firm to cover or
pay annual interest obligations. The pre-control measure of
coverage ratio is as follows:
1990
tc =
ebiti
U = 1986 .interestit
/5
where:
tc
ebit
number of times earnings will cover annual interest
charges
earnings before interest payments and taxes
interest = annual interest expense.
The baseline five year average of the interest coverage ratio
was 7.14 times for the sample of firms in the API study. Post-
control coverage ratios may be estimated as follows:
ptc =
1990
ebit A / 5 + A ebit
i = 1986
1990
interest A / 5 + A interest
\ i =19 86
where Aei>it is the estimated change in earnings before interest
and taxes of the firm, Ainterest^ is the anticipated change in
interest expense, and all other variables have been previously
described. The A interest is calculated by multiplying the
capital expenditures for the proposed controls (&k) by the
assumed private cost of capital of 10 percent. Interest costs
are generally lower than the overall cost of capital for a. firm
and this method would tend to overstate the impact 'of controls on
industry interest coverage ratio.. Again the interest coverage
ratios of individual petroleum refineries may differ from the
average significantly.
3-30
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Finally, the degree of debt leverage or debt-equity ratio of a
firm is considered in assessing the ability of a firm to"finance
capital expenditures. The pre-control debt-equity ratio is the
following:
d/e =
•*1990
where d/e is the debt equity ratio, d is debt capital and e is
equity capital. Since capital information is less volatile than
earnings information, it is appropriate to use the latest
available information for this calculation. If one assumes that
the capital costs of control equipment are financed solely by
debt, the debt-equity ratio becomes:
pd/e =
d1990 +
1990
1990
where pd/e is the post-control debt-equity ratio assuming that
the control equipment costs are financed solely with debt.
Obviously, firms may choose to issue capital stock to finance the
capital expenditure or to finance the investment through
internally generated funds. Assuming that the capital costs are
financed solely by debt may be viewed as a worse case scenario.
The methods used to analyze the capital availability do have
some limitations. The approach matches 1990 debt and equity
values with estimated capital expenditures for control equipment.
Average 1986 through 1990 income and asset measures are matched
with changes in income and capital expenditures associated with
the control measures. The control cost changes and income
changes reflect 1992 price levels. The financial data used in
the analysis represents the most recent data available. It is
inappropriate to simply index the income, asset, debt, and equity
values to 1992 price levels for the following reasons. Assets,
debt, and equity represent embedded values that are not subject
to price level changes except for new additions such as capital
expenditures. Income is volatile and varies from period to
period. For this reason, average income measures are used in the
3-31
-------
study. The analysis reflects a conservative approach to
analyzing the changes likely in financial ratios for the
petroleum industry. Some decreases the cost of production
expected to result from implementation of emission controls have
not been..considered.' These include labor input and energy input
cost decreases. Annualized compliance costs are overstated from
a financial income perspective since these costs include a
component for earnings or return on investment. In general, the
approach followed is a worst case scenario approach that
overstates the negative impact of the proposed emission controls
on the financial operations of the petroleum refining industry.
3-32
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REFERENCES
1.
2.
3.
4.
5.
6.
7.
8.
9.
10
11.
Carol Dahl and Thomas Sterner. Analyzing Gasoline Demand
Elasticities: A Survey. Energy Economics. July 1991.
U.S. Department of Energy. Short-term Energy Outlook,
Vol. II. -DOE/EIA-0202/42. Energy Information
Administration. Washington, DC. August 1980.
Robert S. Pindyck and Daniel L. Rubinfeld.
Microeconomics. MacMillan Publishing Company.
1989.
Hiroki Tsurmi. A Bayesian Estimation of Structural Shifts
By Gradual Switching Regressions with an Application to
the U.S. Gasoline Market Bayesian Analysis in Econometrics
and Statistic Essays in honor of Harold. Jeffries. Edited
by Arnold Zellner. 1980.
Bong-Min Yang and Teh-wei Hu. Gasoline Demand and Supply
Under a Disequilibrium Market. Energy Economics. October
1984.
U.S. Department of Energy: Petroleum Marketing Annual,
1992. Volume 1 DOE/EIQ-0340(90)/I. Energy Information
Administration. Washington, DC. May 1993.
U.S. Department of Commerce. Business Statistics 1963-
1991. 27th Edition. June 1992.
U.S. Department of Commerce.
the United States 1925-1989.
Fixed Reproducible Wealth in
U.S. Department of Commerce. Survey of Current Business
Volume 73. Number 9. September 1993.
U. S. Department of Commerce.
Manufacturers. 1963-1991.
Annual Survey of
American Petroleum Institute. Financial Trends for
Leading U.S. Oil Companies 1968-1990. Discussion Paper
#017R. Washington, DC. October 1991.
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4.0 CONTROL COSTS, ENVIRONMENTAL IMPACTS,
COST-EFFECTIVENESS
4.1 INTRODUCTION
Inputs to the model outlined in the previous chapter include
the quantitative data summarized in Chapter 2.0 and control cost
estimates provided by EPA. This chapter summarizes the cost
inputs used in this EIA, and the methodology used for allocating
costs to each of the five petroleum product markets.
A Regulatory Impact Analysis (RIA) of alternative emission
standards includes a Benefit Cost Analysis (BCA). A BCA requires
estimates of economic costs associated with regulation, which do
not correspond to emission control costs. This chapter presents
the progression of steps which were taken.to arrive at estimates
of economic costs based on the emission -control cost estimates.
The environmental impacts associated with the chosen regulatory
option in this analysis are summarized and the cost-effectiveness
of the regulatory option is presented.
4.2 CONTROL COST ESTIMATES
Control cost estimates and emission reductions were provided
on a refinery level. The control costs estimated for each
refinery can be divided into fixed and variable components.
Fixed costs are constant over all levels of output of a process,
and usually entail plant and equipment. Variable costs will vary
as the rate of output changes. The costs were calculated for new
and existing petroleum refinery emission sources. New source
costs represent the control of new process units and equipment
built (or reconstructed or replaced) in the first 5 years after
4-1
-------
promulgation. It should be noted for regulatory purposes that
some of these units and equipment will be considered new sources
and others will be considered part of an existing source. It is
not possible to determine how many new units will fall into these
two categories; however, the emission points will require control
in either case.3
Table 4-1 presents the fifth year costs for the regulated
sources included in this analysis. Emission control costs are
the annualized capital and annual operating and maintenance costs
of controls based on the assumption that all affected refineries
install controls. The controls associated with each of the five
emission points are discussed separately below.
For equipment leaks, the MACT floor level of control is the
Petroleum Refinery New Source Performance Standard (NSPS) .-1 The
chosen control alternative is a level more stringent than the
floor, which is the HON negotiated regulation without connector
monitoring. The cost for this option was calculated assuming
monthly monitoring of gas valves and light liquid valves. The
annual costs for the floor are $69 million per year, while the
costs for applying the negotiated regulation to petroleum
refineries are estimated to be $65.8 million per year.2
The MACT floor level control for HAPs from miscellaneous
process vents is incineration or equivalent^control (i.e., 98
percent reduction or 20 parts per million by volume outlet
level). The cost and emission reduction represent the nationwide
cost of piping uncontrolled miscellaneous vents to existing flare
or fuel gas systems. The annual cost for controlling emissions
from miscellaneous vents was estimated to be $11.4 million per
year. The miscellaneous process vents include all process vents
at a refinery, excluding fluidized catalytic cracking unit
catalyst regeneration vents, catalytic reformer catalyst
regeneration vents, and sulfur plant vents:
A MACT floor analysis performed on wastewater collection and
treatment systems indicated that the MACT floor level of control
for this emission point is compliance with the benzene waste
operations NESHAP (BWON). No costs are therefore anticipated for
the industry to reach the MACT floor level of control.
4-2
-------
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The MACT floor level of control for floating roof storage
vessels requires control equivalent to the VOL Storage NSPS
requirements (which are listed in subpart Kb of CFR Part 60) ,
seals and conversion to floating roof or 95 percent control for
fixed roof vessels. This level of control applies to vessels
larger than 1,115 barrels storing liquids with true vapor
pressures greater than or equal to 3.4 psia.5 The annual cost
for MACT floor control is estimated to be $3.8 million.
Control cost'estimates were provided on an emission point and
on a refinery basis. A methodology was developed to allocate
these costs to the specific products in this analysis. The
allocation was based on each refinery's estimated production of
the five products of interest. The Oil & Gas Journal's U.S.
Refinery Survey publishes total daily output by refinery. Each
refinery's total production was multiplied by 0.90 since the five
products of interest accounted for 93 .percent of total refinery
output. Production of each specific product was estimated based
on the assumption that each refinery produces the national
average mix of the five products.
Emission control costs for the selected.control alternative
include those associated with storage vessels, process vents, and
equipment leaks (net of recovery credits). Costs are allocated
to the five products as follows:
• Motor gasoline - all costs associated with storage
vessel controls plus gasoline's "share" of process vent
and equipment leak costs.
• Jet fuel, residual fuel oil, distillate fuel oil, and
LPG _ each products' "share" of process vent and
equipment leak costs.
Product "shares" are computed, for each refinery, as the ratio of
the production of that product to total production of the five
products of interest.
4.3 MONITORING, RECORDKEEPING, AND REPORTING COSTS
In addition to provisions for the installation of control
equipment, the proposed regulation includes provisions for
monitoring, recordkeeping, and reporting (MRR). EPA estimates
' 4-4
-------
that the total annual cost for refineries to comply with the MRR
requirements is approximately $30 million. After incorporating
MRR costs, the total cost of compliance of the Chosen Alternative
is $111 million.
In order to calculate the costs of MRR associated with the
petroleum refinery NESHAP, estimates of hours per item (i.e., a
required MRR action), frequency of required action per year, and
number of respondents were estimated based on the requirements in
the proposed rule for all of the emission points. To compute the
costs associated with the burden estimates, a wage rate of $32
per hour (in 1992 dollars) was assumed. This assumption was
based on estimate that 85 percent of the labor will be
accomplished by technical personnel (typically by an engineer
with a wage rate of $33 per hour), 10 percent will be completed
by a manager (at $49 per hour), and 5 percent by clerical
personnel (at $15 per hour). All of the wage rates include an
additional 110 percent for overhead. Costs were annualized
assuming an expected remaining life for affected facilities of 15
years from the date of promulgation of the subject NESHAP, and
using an interest rate of 7 percent.
Compliance requirements vary in terms of frequency. This
variance is taken into account in the annualization of costs.
Performance tests to demonstrate compliance with the control
device requirements are required once. Compliance requirements
also include monitoring of operating paramenters of control •
devices and records of work practice and other inspections.
These activities must be reported semiannually. The compliance
requirements that must be met only once are annualized over the
time from the year in which they are to take place to the
expected end of facility life.
The MRR requirements are outlined separately for each emission
point. The proposed compliance determination provisions for
storage vessels include inspections of vessels and roof seals.
If a closed vent system and control device is used for venting
emissions from storage vessels, the owner must establish
appropriate monitoring procedures. For wastewater stream and
4-5
-------
treatment operations, the MRR requirements are outlined in the
rule for the BWON.
For miscellaneous process vents, the proposed standard
specifies the performance tests/ monitoring requirements, and
test methods necessary to determine whether a miscellaneous
process vent stream is required to apply control devices and to
demonstrate that the allowed emission levels are achieved when
controls are applied. The format of these requirements, as with
the format of the miscellaneous process vent provisions, depends
on the control device selected. The MRR requirements for
miscellaneous process vents are summarized by control device in
Table 4-2.
For equipment leaks, because the provisions of the proposed
rule are work practice and equipment standards, monitoring,
repairing leaks, and maintaining the required records constitutes
compliance with the rule. The HON equipment leak provisions are
appropriate to determine continuous compliance with the petroleum
refinery equipment leak standards. In summary, these provisions
require periodic monitoring with a portable hydrocarbon detector
to determine if equipment is leaking.
4.4 ESTIMATES OF ECONOMIC COSTS
Air quality regulations affect society's economic well-being
by causing a reallocation of productive resources within the
economy. Resources are allocated away from the production of
goods and services (refined petroleum products) to the production
of cleaner air. Estimates of the economic costs of cleaner air
require an assessment of costs to be incurred by society as a
result of emission control measures. By definition, the economic
costs of pollution control are the opportunity costs incurred by
society for productive resources reallocated in the economy to
pollution abatement. The economic costs of the regulation can be
measured as the value that society places on goods and services
not produced as a result of resources being diverted to the
production of improved air quality. The conceptually correct
valuation of these costs requires the identification of society's
willingness to be compensated for the foregone consumption
4-6
-------
opportunities resulting from.the regulation. In contrast to the
economic cost of regulation, emission compliance costs consider
only the direct cost of emission controls to the industry
affected by the regulation. Economic costs are a more accurate
measure o'f the costs of the regulation to society than an
engineering estimate of compliance costs. However, compliance
cost estimates provide an essential element in the economic
analysis.
Economic costs are incurred by consumers, producers, and
society at large as a result of pollution control regulations.
These costs are measured as changes in consumer surplus, producer
surplus, and residual surplus to society. Consumer surplus is a
measure of well-being or of the welfare of consumers of a good
and is defined as the difference between the total benefits of
consuming a good and the market price paid for the good.
Pollution control measures will result in a loss in consumer
surplus due to higher prices paid for refined petroleum products
and to the deadweight loss in surplus caused by reduced output of
petroleum products in the post-control market.
Producer surplus is a measure of producers welfare that
reflects the difference between the market price charged for a
product and the marginal cost of production. Pollution controls
will result in a change in producer surplus that consists of
three components. These changes include surplus gains relating
to increased revenues experienced by firms in the petroleum
industry experiencing higher post-control prices, surplus losses
associated with increased costs of production for annualized
emission control costs, and surplus losses due to reductions in
.post-control output. The net change in producer surplus is the
sum of these surplus gains and losses.
4-7
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Additional adjustments or changes in the residual surplus to
society are necessary to reflect the economic costs to society of
pollution controls, and these adjustments are referred to as the"
change in residual surplus to society. Specifically, adjustments
are necessary to consider tax gains or losses associated with the
regulation and to adjust for differences between the social
discount rate and the private discount rate. Since control
measures involve the purchase of long-lived assets, it is
necessary to annualize the cost of emission controls.
Annualization of costs require the use of a discount rate or the
cost of capital. The private cost of capital (assumed to be 10
percent) is the relevant discount rate to use in estimating
annualized compliance costs and market changes resulting from the
regulation. Firms in the petroleum refinery industry will make
supply decisions in the post-control market based upon increases
in the costs of production. The private cost of capital more
accurately reflects the capital cost to firms associated with the
pollution controls. Alternatively, the social costs of capital
(assumed to be 7 percent)6 is the relevant discount rate to
consider in estimating the economic costs of the regulation.
.The economic cost of the regulation represents the cost of the
regulation to society or the opportunity costs of resources
displaced by emission controls. A risk-free discount rate or the
social discount rate better reflects the capital cost of the
regulation to society.
The sum of the change in consumer surplus, producer surplus
and residual surplus to society constitutes the economic costs of
the regulation. Table 4-3 summarizes the economic costs
associated with the Chosen Regulatory Alternative. The economic
cost for"the Chosen Alternative for all petroleum products is
$132.35 million annually. The economic costs for individual
products range from $11.84 million annually to $66.71 million
annually for residual fuel oil and motor gasoline, respectively.
More details concerning the' methodology used to estimate these
welfare changes or the economic cost of the regulation are
discussed in Section 3.2.7 Changes in Economic Welfare.
4-12
-------
TABLE 4-3. ESTIMATES OF THE ANNUALIZED ECONOMIC COSTS ASSOCIATED
WITH ALTERNATIVE NESHAPS BY PETROLEUM PRODUCT MARKET1
(MILLIONS OF $1992- )
Petroleum
Product Market
Motor Gasoline
Jet Fuel
Residual Fuel
Change in
Consumer
Surplus
$250.26
$72.31
$16.30
Change in
Producer
Surplus
$ (129.27)
$ (43..02)
$(2.45)
Change in
Residual
Surplus
$ (54.28)
$ (16.26)
$(2.01)
Loss
in
Surplu
s
Total
$66.71
$13.03
$11.84
Oil ' .
Distillate Fuel $81.75. $(41.10) $(17.74) $22.91
Oil
LPGs $55.57 $(26.27) $(11.44) $17.86
TOTAL $476.19 $(242.11) $(101.73) $132.35
NOTES: 1 Brackets indicate negative costs or benefits.
4.5 ESTIMATED ENVIRONMENTAL IMPACTS
Table 4-4 reports estimates of annual emission reductions
associated with the chosen alternative. The estimate of total
HAP emission reductions is 54,000 Mg per year, and the total VOC
emission reduction associated with the regulatory alternative is
351,000 Mg per year. .
4.6 COST EFFECTIVENESS
Cost effectiveness is computed as annualized costs divided by
the emission reductions, and is presented 'in Table 4-4 for each
pollutant. Economic cost effectiveness is computed by dividing
the annualized economic costs by -the estimated emission
reductions.
.Generally, a dominant alternative results in the same or
higher emission reduction at a lower cost than all other
alternatives. Because this analysis evaluated'only one
alternative, however, there is no basis for comparison.
4-13
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TABLE 4-4. ESTIMATED ANNUAL REDUCTIONS USE-EMISSIONS
AND COST-EFFECTIVENESS ASSOCIATED WITH THE CHOSEN
REGULATORY ALTERNATIVE
Chosen Alternative
HAP Emission
Reduction,
(Mg/yr x 103)
53.7
VOC Emission
Reduction
(Mg/yr x 103)
351
Chosen Alternative
HAP Cost-
Effectiveness*
($/Mg)
$2,465
VOC Cost-
Effectiveness*
($/Mg)
$377
NOTES: "Cost-effectiveness is computed as estimated annualized economic costs divided by estimated emissions
reduced. Comparisons are made between the chosen alternative and the baseline conditions.
4-14
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REFERENCES
1. Oommen, Roy. Letter from Roy Oommen to James Durham, U.S.
Environmental Protection Agency. November 23, 1993.
2. Oommen, Roy. Letter from Roy Oommen, Radian, to Larry
Sorrels, U.S. Environmental Protection Agency. January
26, 1994.
3. Oommen, Roy. Letter from Roy Oommen, Radian, to James
Durham, U.S. Environmental Protection Agency. Chemical
and Petroleum Branch. November 10, 1993.
4. Zarate, Marco. Letter from Marco A. Zarate to James
Durham. U.S. Environmental Protection Agency. Chemical
and Petroleum Branch. November 30, 1993.
5. Murphy, Pat. Letter from Patrick Murphy, Radian, to James
Durham, U.S. Environmental Protection Agency. December 3,
1993.
6. U.S. Office of Management and Budget." Transmittal
Memorandum No. 64. Guidelines and,Discount Rates for
Benefit-Cost Analysis of Federal Programs. Circular
Number A-94. Washington, DC. October 29, 1992.
4-15
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5.0 PRIMARY ECONOMIC IMPACTS
AND CAPITAL AVAILABILITY ANALYSIS
5.1 INTRODUCTION
Estimates of the primary economic impacts resulting from
implementation of the NESHAP and the results of the capital
availability analysis are presented in this chapter. Primary
impacts include changes in the market equilibrium price and
output levels, changes in the value of shipments or revenues to
domestic producers, and plant closures. The capital availability
analysis assesses the ability of affected firms to raise capital
and the impacts of control costs on plant profitability.
5.2 ESTIMATES OF PRIMARY IMPACTS
The partial equilibrium model is used to analyze the market
outcome of the proposed regulation. The purchase of emission
control equipment will result in an upward vertical shift in the
domestic supply curve for refined petroleum products. The height
of the shift is determined by the after-tax cash flow required to
offset the per unit increase in production costs.. Since the
control costs vary for each of the domestic refineries, the post-
control supply curve is segmented, or. a step function.
Underlying production costs for each refinery are unknown;
therefore, a worst case scenario has been assumed. The plants
with the highest control costs per unit of production are assumed
to also have the highest pre-control per unit cost of production.
Thus, firms with the highest per unit cost of- emission control
are assumed to be marginal in the post-control market.
5-1
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Foreign supply is assumed to have the same price elasticity of
supply as domestic supply. The U.S. had a negative trade balance
for each of the refined products in 1992 with the exception of
distillate fuel oil that had a slightly positive trade balance of
$1.1 million. Therefore net exports are negative for all
products except distillate fuel oil in the baseline model.
Foreign and domestic post-control supply are added together to
form the total post-control market supply. The intersection of
this post-control supply with market demand will determine the
new market equilibrium price and quantity. Post-control domestic
output is derived by deducting post-control imports from the
post-control output.
Table 5-1 reveals the primary impacts predicted by the partial
equilibrium model. The range of anticipated price increases for
the five products vary from $0.03 to $0.14 per barrel produced
for residual fuel oil and jet fuel, respectively. The percentage
increases for each product are less than 1 percent and range from
0.24 percent to 0.53 percent.
Production is expected to decrease by 12.52 million barrels
per year for all products, an overall decrease in domestic
production of 0.24 percent. The estimated•annual reductions in
production of the individual products range from 0.65 million
barrels to 5.67 million barrels for jet fuel and motor gas,
respectively. The production percentage decreases range from
0.13 percent to 0.50 percent for jet fuel and residual fuel oil,
respectively.
Value of domestic shipments or revenues for domestic producers
are expected to increase for the five products approximately
$107.41 million annually. The predicted changes in revenues for
individual products range from an increase of $55.63 million in
motor gasoline revenues to a decrease in residual fuel revenues
of $11.92 million annually. The percent changes range from an
increase of 0.41 percent in jet fuel to a decrease of 0.26
percent in residual fuel oil revenues. Economic theory predicts
that revenue increases are expected to occur when prices are
increased for inelastic goods, all other factor held constant.
This revenue increase results given that the percentage increase
5-2
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in price exceeds the percentage decrease in quantity for goods
with inelastic demand. All of the refined petroleum products
follow the expected trend except residual fuel oil. Residual
fuel oil..has the highest trade deficit of the five products with
over 40 percent of domestic demand being satisfied by imports.
The magnitude of residual fuel oil imports causes domestic
residual fuel oil revenues to decrease in the post-control
market.
TABLE 5-1. SUMMARY OF PRIMARY IMPACTS
Estimated Impacts1
Price
Value of
Production. Domestic
4
Refined Product
Motor gasoline
Amount
Percentage
Jet fuel
Amount
Percentage
Residual fuel
Amount
Percentage
Distillate fuel
Amount
Percentage
LPG
Amount
Percentacre
Increases^2
$0.09
0.29%
$0.14
0.53%
$0..03
0.24%
$0.08
0.29%
$0.07
0.26%
Decreases
(5.67)
(0.22%)
(0.65)
(0.13%)
(1.62)
(0.50%)
(2.78)
(0.26%)
(1.80)
(0.25%)
Shipments ^
$55.63
0.07%
$53.22
0.41%
($11.92)
(0.26%)
$8.06
0.03%
$2.42
0.01%
NOTES- Brackets indicate decreases or negative values.
2Prices are shown in price per barrel ($1992). _
3Annual production quantities are shown in millions ot
barrels. ...... .p
4Values of domestic shipments are shown in millions o£
1992 dollars.
5-3
-------
. .. It is anticipated that approximately 7 refineries may close as
. .a-.-.-resuTt. of the decrease in production predicted by the model.
Those refineries with the highest per unit control costs are
assumed to be marginal in the post-control market. Refineries
that have post-control supply prices that exceed the market
equilibrium price are assumed'to close. This assumption is
. consis.tent with .the. perfect competition theory that presumes all
firms"'iri the industry are price takers. Firms with the highest
per unit control costs may not have the highest underlying cost
of production. This is a worst case assumption that is likely to
'.bias, the results and as a result, overstate the number of plant
.cl6vsures.'::and..pther: adverse effects of the proposed emission
•controls,^ ':'"
The estimated primary impacts reported depend on the set of
parameters used in the partial equilibrium model. One of the
parameters, the price elasticity of demand, consists of a range
for four of the five refined products. The midpoint of the range
of elasticities was used to estimate the reported primary and
secondary impacts. A sensitivity analysis of this assumption is
contained in Appendix B. Sensitivity analyses were performed for
the low and high end of the ranges of elasticities. In general,
.the sensitivity analysis shows that the estimated primary impacts
are relatively insensitive to reasonable changes of price
elasticity of demand estimates.
5.3 CAPITAL AVAILABILITY ANALYSIS
The capital availability analysis involves examining pre- and
post-control values of selected financial ratios. These ratios
include rate of return on investment, times interest earned
coverage ratio, and the debt-equity ratio. (Each of these ratios
are explained in detail in Section 3.4.) Data were not available
to estimate the ratios for many refineries in the industry.
Consequently, these ratios have been analyzed_pn an industrywide
basis. The industrywide ratios represent an average for the
industry. Individual firms within the industry may have
financial ratios that differ significantly from the average. Net
income was averaged for a five-year period (1986 thorough 1990)
5-4
-------
to avoid annual fluctuations -that -may occur in income due to
changes-"in =the-:;busi-ness--cycle. Debt and equity capital are not
subject to annual fluctuations; therefore, the most recent data
available (1990) was used in the analysis.
The" financial statistics provide insight regarding firms'
abilities to raise capital to finance the investment in emission
control''•£qu-i£pent.\ ,\.Tab.le 5-2-"shows the estimated impact on
financial ratios for the industry.
TABLE 5-2. ANALYSIS OF FINANCIAL RATIOS
Financial • Ratios:
Rate of" are turn oh
investment
Coverage Ratio (or
Times Interest
Earned)
Debt-Equity Ratio
/-Pre-Control Ratios Post-Control Ratios
5.91%
7.08
62.75%
5.91%
7.07
62.76%
As the table shows, the financial ratios remain virtually
unchanged as a result of the proposed emission controls.
5.4 LIMITATIONS. ,-
Several qualifications of the primary impact results are
required. A single national market for a homogenous product is
assumed in the partial equilibrium analysis. However, there are
some regional trade barriers that would protect individual
refineries. The analysis also assumes that the refineries with
the highest control costs are marginal in the post-control
market. Refineries that are marginal in the post-control market
have per unit control costs that significantly exceed the
average. This may be the result of the engineering method used
to assign costs tx>._individual refineries. Additionally, the cost
allocation methodology assigns all of the control costs to the
five petroleum products of interest. The result of the foregoing
list of qualifications is overstatement of the impacts of the
chosen alternative on the market equilibrium price and quantity,
5-5
-------
revenues, and plant closures. Finally, some refineries may find
it profitable to expand production in the post-control market.
This would occur when a firm found its post-control incremental
unit costs to be smaller than the post-control market price.
Expansion by these firms would result in a smaller decrease in
output and increase in price than would otherwise occur.
The results of the sensitivity analysis are reported in
Appendix B. These results show slightly more adverse impacts
when demand is more elastic. The analysis is relatively
insensitive to reasonable variations in the price elasticity of
demand.
The capital availability analysis also has limitations.
First, future baseline performance may not resemble past levels.
The tools used in the analysis are limited in scope and do not
fully describe the financial position of individual firms within
the industry but are more reflective of industry averages.
5.5 SUMMARY
The estimated impacts of the proposed emission controls are
relatively small. Predicted price increases and reductions in
domestic output are' less than 1 percent for each of the refined
products. The value of domestic shipments or revenues to
domestic producers for the 5 petroleum products combined are
anticipated to increase. Emission control costs are small
relative to the financial resources of affected producers, and on
average, refineries should not find it difficult to raise the
capital necessary to finance the purchase and installation of
emission controls.
5-6
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6.0 SECONDARY ECONOMIC IMPACTS
6 .1 INTRODUCTION
Implementation of emission controls may have an impact on
secondary markets including the labor market, the energy market,
foreign trade, and regional effects. The potential changes in
employment, use of energy inputs, balance of trade, and regional
refinery distribution are presented.
6.2 LABOR MARKET IMPACTS
The estimated labor impacts associated with the NESHAP are
based on the results of the partial equilibrium analyses of the
five refined petroleum products and are reported in Table 6-1. -.
The number of workers employed by firms in SIC 2911 is estimated
to decrease by approximately 114 workers as a result of the
proposed emission controls. The loss in number of workers
depends primarily on the reduction in production reported in ,
Chapter 5. -Gains in employment anticipated to result from
operation and maintenance of control equipment have not been
included in the analysis due to lack of reliable data. Estimates
of employment losses do not consider potential employment gains
in industries that produce substitute products. Similarly,
losses in employment in industries that use petroleum products as
an input or in industries that provide complement goods are not
considered. The changes in employment reflected in this analysis
are only direct employment losses due to reductions in domestic
production of refined petroleum products.
The loss in employment is relatively small. The magnitude of
predicted job losses directly results from the relatively small
decrease in production anticipated and the relatively low labor
intensity in the industry.
6-1
-------
TABLE 6-1. SUMMARY OF SECONDARY REGULATORY IMPACTS
Refined Product
Estimated Impacts1
Labor Input
2
Energy Input3
Motor, gasoline
Amount
Percentage
Jet fuel
Amount
Percentage
Residual fuel
Amount
Percentage
Distillate fuel
Amount
Percentage
LPGs
Amount
Percentage
Total five products
Amount
(52)
( 0.22%)
( 6)
(0.13%)
(15)
( 0.50%)
(25)
( 0.26%)
(16)
( 0.25%)
(114)
($5.79)
(0.22%)
($ .52)
( 0.13%)
($ .71)
( 0.50%)
($2.27).
( 0.26%)
($1-56)
(0.25%)
($10.85)
NOTES: Brackets indicate reduction or negative value.
Indicates estimated reduction in number of jobs.
3Reduction in energy use in millions of 1992 dollars.
6-2
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6.3 ENERGY INPUT MARKET
The method used to estimate reductions in energy input use
relates the energy expenditures to the level of' production. An
estimated decrease in energy use of $10.85 million annually is
expected for the industry. The individual product energy use
changes are reported in Table 6-1. As production decreases, the
amount of energy input utilized by the refining industry also
declines. The changes in energy use do not consider the
increased energy use associated with operating and maintaining
emission control equipment. Insufficient data were available to
consider such changes in energy costs.
6.4 FOREIGN TRADE
The implementation of the NESHAP will increase the cost of
production for domestic refineries relative to foreign
refineries, all other factors being equal. This change in the
relative price of imports will cause domestic imports of refined
petroleum products to increase and domestic exports to decrease.
The balance of trade overall for refined petroleum products is
currently negative (imports exceed exports). The NESHAP will
likely cause the balance of trade to become more negative. Net
exports are likely'to decline by 2.26 million barrels per year.
The range of net export decreases varies from 0.21 million
barrels to 0.91 million barrels for LPGs and residual fuel oil,
respectively. The related percent range from 0.54 percent to
40.92 percent for LPGs and distillate fuel oil, respectively.
The large percentage decrease in exports of distillate is the
result of the product having a very small positive trade balance
in the pre-control market. The dollar value of the total decline
in net exports is expected to amount to $68.22 million annually.
The predicted changes in the trade balance are reported in Table
6-2.
6.5 REGIONAL IMPACTS
No significant regional impacts are expected from
implementation of the NESHAP. The plant closures estimated are
6-3
-------
approximately 7 nationwide. Due to the manner used to estimate
control, costs for. the, individual refinery and the method of
allocating the costs to products, the facilities predicted to
close do not necessarily represent the facilities most likely to
close."' However, the facilities postulated in the model are
dispersed through the United States and not specific to a
.geographical region. Employment impacts are directly related to
plant cldsuxe''"arid production decreases: Employment impacts are
also dispersed throughout the country.
• \ .'TABLE. 6-2. FOREIGN TRADE (NET EXPORTS) IMPACTS
Refined Product
Motor Gasoline
Jet fuel
Residual fuel
Distillate " fuel
LPG ... .
':• Total
. ' V" ... ';• -;..' - •'
Amount
(0.43)
(0.23)
(0.91)
(0,48)
(0.21)
(2.26)
: Estimated Impacts1
Percentage
(0.54%)
(1.41%)
(0.81%)
(40.92%)
• (0.54%)
Dollar Value
of Net Export
Change
($21.92)
($ 8.14)
($16.81)
($12.67)
($. 8.68)
($68.22)
NOTES: Brackets indicate reductions or negative values.
2Millions of barrels.
3Millions of dollars ($1992).
6.6 LIMITATIONS
The estimates of the secondary impacts associated with the
emission controls are based on changes predicted by the partial
equilibrium model. The limitations•described in the Primary
Economic Impacts chapter is equally applicable to Secondary
Economic Impacts. As previously noted, the employment losses do
not consider potential employment gains for operating the -
emission control equipment. Likewise, the gains or losses in
markets indirectly affected by the regulations, such as
substitute product markets, complement products markets, or .in
6-4
-------
markets that use'petroleum products as-an input, have not been
considered. rtHis"'rimportant-to-:Lnote that the potential job
losses predicted by the model are only those directly linked to
predicted production losses in the petroleum refining industry.
6.7 SUMMARY -••-••
The estlmated.:'secQnd^r.y-.eGQnbmic impacts are:relatively small.
Approximately 114 job;"'losses may occur nationwide. Energy input
reductions are estimated to be $10.85 million annually. A
decrease is net exports of 2.26 million barrels annually in
refined products'-Is anticipated to occur. No significant
... ' ••• ..'=,..•' .".f •••:'.'.::-.j.-:.-.V'..-.' •-''•'•
regional impacts 'are."expected. „•,-;•
6-5
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7.0 POTENTIAL SMALL BUSINESS IMPACTS
7.1 INTRODUCTION
The Regulatory Flexibility Act requires that special
consideration be given to the effects of all proposed regulations
on small business entities. The Act requires that a
determination be made as to whether the subject regulation will
have a significant impact on a substantial number of small
entities. A substantial number is considered to be greater than
20 percent of the small entities identified. The following
criteria are provided for assessing whether the impacts are
significant. Whenever any of the following criteria are met, the
impact on small business entities is determined to be
significant:
1. Annual compliance costs (annualized capital, operating,
reporting, etc.) increase as a percentage of cost of
production for small entities for the relevant process or
product by more than 5 percent;
2. Compliance costs as a percent of sales for small entities
are at least 10 percent higher than compliance costs as a
percent of sales for large entities;
3. Capital costs of compliance represent a significant
portion of capital available to small entities,
considering internal cash flow plus external financing
capabilities; and
4. The requirements of the regulation are likely to result in
closure of small entities.
7-1
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7.2 METHODOLOGY -
Data are not readily available to estimate the small business
impacts for two of the criteria (Numbers One and Three)
established in the introduction. The information necessary to
make such comparisons are generally considered proprietary by
small business firms. Consequently, the analysis will focus on
the remaining two criteria of the potential closure of small
businesses and a comparison of the compliance costs as a
percentage of sales for small and large business entities.
The closure method of analysis will focus on the number of
petroleum refineries expected to close as a result of the
proposed emission controls and the relative size of the firms at
risk. Alternatively, a measure of annual compliance costs
including MRR costs relating to motor gasoline as a percentage of
motor gasoline sales will also be considered. The ratio of costs
to sales will be compared for small refineries to the same ratio-.
for all other refineries. The applicable ratios for the other
refined petroleum products may differ in magnitude from those
reported, but the differential between the ratios for small
businesses and larger business should remain relatively the same.
7.3 SMALL BUSINESS CATEGORIZATION
Consistent with Title IV, Section 410H of the CAA, a petroleum
refinery is classified as a small business if it has less than
1,500 employees or if its production is less than or equal to
50,000 barrels of oil per day. A refinery must also be
unaffiliated with a larger business entity to be considered a
small business entity. Information necessary to distinguish
refinery size by number of employees was not readily available.
However, daily production data were available from the Oil and
Gas Journal Refinery Survey (1-1-92). Based upon this size
*
'criterion, there were 63 refineries that were small business
entities in January 1992.
7.4 SMALL BUSINESS IMPACTS
The results of the partial equilibrium analysis lead to the
conclusion that approximately seven refineries are at risk of
7-2
-------
closure. This estimate represents approximately three percent of
the domestic refineries in operation arid eleven percent of those
designated to be small businesses. The estimated number of
closures is therefore less than 20 percent of the small
refineries. However, it is important to note that the firms
designated in the model as at greatest risk for closure were
small refineries.
Compliance costs as a percentage of sales were computed both
for 63 small refineries and for those refineries that are not
considered small. The cost to sales ratio for the small
businesses were 0.191 percent of sales while the cost to sales
ratio for all other refineries was 0.082 percent. The
differential between these two rates exceeds ten percent, and
consequently, a conclusion is drawn that a significant number of
small businesses are adversely affected by the proposed
regulations.
7-3
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APPENDIX A
PRODUCTION CAPACITY OF OPERABLE PETROLEUM
REFINERIES BY FIRM. AND REFINERY
(AS OF JANUARY 1, 1991)
-------
APPENDIX B
SENSITIVITY ANALYSES
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APPENDIX B
SENSITIVITY ANALYSES
INTRODUCTION
The sensitivity analysis contained in this Appendix explores
the degree to which the results presented earlier in this report
are sensitive to the estimates of the price elasticity of demand.
The -results presented in this report are based upon the price
elasticities of demand shown in Table B-l for the individual
petroleum products. The range of demand elasticity measures is
also shown. Jet fuel is the only product that has a single
measure of demand elasticity and a sensitivity analysis will not
be conducted for this product. This elasticity measure for jet
fuel is sufficiently small that reasonable deviations in the
measure are unlikely to have an impact on the model results.
TABLE B-l. PRICE ELASTICITY OF DEMAND
Refined Product
Elasticity Midpoint Range of Elasticity
Motor gas
Jet fuel
Refined fuel oil
Distilled fuel oil
LPG
-0.69
-0.15
-0.675
-0.745
-0.8
-0.55 to -0.82
-0.15
-0.61 to -0.74
-0.50 to -0.99
-0.60 to -1.0
The sensitivity analysis results are presented in Tables B-2
and B-3. Table B-2 reports estimates for the low measure of
elasticity and Table B-3 for the high measure.
The results using the low measure of elasticity differ very
little from the reported results. The signs of the changes in
price, quantity, and value of shipments are
B-2
-------
TABLE B-2. SENSITIVITY ANALYSIS FOR.ESTIMATED PRIMARY IMPACTS
' _
THE LOW MEASURE OF THE PRICE ELASTICITY OF DEMAND1
Refined
Product
Motor Gasoline
Residual Fuel
Distillate
Fuel
Market
Price Change
(%)
0.31%
0.25%
0.35%
0.30%
NOTES: 1 Brackets indicate
Market
Output Change
(%)
(0.19%)
(0.49%)
(0.22%)
(0.22%)
Change in the
Value of
Shipments (%)
0.12%
(0.24%)
0.13%
0.08%
decreases or negative values.
TABLE B-3. SENSITIVITY ANALYSIS FOR ESTIMATED
WITH
THE HIGH MEASURE OF THE PRICE ELASTICITY
Refined
Product
Motor Gasoline
Residual Fuel
Distillate
Fuel
Market Price
Change (%)
0.25%
0.23%
0.23%
0.22%
Market
Quantity
Change ( % )
(0.22%)
(0.51%)
(0.26%)
(0.26%)
PRIMARY IMPACTS
OF DEMAND1
Change in the
Value of
Shipments (%)
0.02%
(0.28%)
(0.04%)
(0.04%)
NOTES:
1 Brackets indicate decreases or negative values.
B-3
-------
unchanged and the relative size of the changes are not
significantly altered. The results of this analysis tend to
present relatively more favorable results for the industry.
The analysis conducted with the high end of the elasticity
range also does not differ significantly from previously reported
results for price increases and quantity decreases. The change
in value of shipments becomes virtually zero for Distillate and
LPG as a result of the proximity of the elasticity measures to
unitary elastic.
In summary, the sensitivity analysis does not indicate that
the model results are sensitive to reasonable changes in the
price elasticity of demand. This conclusion provides support for
greater confidence in the reported model results.
B-4
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TECHNICAL REPORT DATA
1. REPORT NO. 2.
EPA-453/D-94-052
4. TITLE AND SUBTITLE
Economic Impact Analysis for the' Petroleum
Refineries NESHAP
7. AUTHOR(S)
9. PERFORMING ORGANIZATION NAME AND ADDRESS
U.S. Environmental Protection Agency
Office of Air Quality Planning and
Standards
Emission Standards Division
Research Triangle Park, NC 27711
12. SPONSORING AGENCY NAME AND ADDRESS
Director
Office of Air Quality Planning and
Standards
Office of Air and Radiation
U.S. Environmental Protection Agency
Research Triangle Park, NC 27711
3. RECIPIENT'S ACCESSION NO.
5. REPORT DATE
July 1994
6. PERFORMING ORGANIZATION CODE
8. PERFORMING ORGANIZATION REPORT NO.
10. PROGRAM ELEMENT NO.
11. CONTRACT/GRANT NO.
68-D1-0144
13. TYPE OF REPORT AND PERIOD COVERED
14. SPONSORING AGENCY CODE
EPA/200/04
15. SUPPLEMENTARY NOTES
16. ABSTRACT-
AC! _ economic analysis of the industries affected by the Petroleum
Refineries National Emissions Standard for Hazardous Air Pollutants
(NESHAP) was completed in support of this proposed standard. The
industry for which economic impacts was computed was the petroleum
refinery industry.
Affected refineries must control HAP emissions by the level of
control required in the standard. Several types of economic impacts,
among them product price changes, output changes, job impacts, and
effects on foreign trade, were computed for the selected regulatory-
alternatives .
17.
KEY WORDS AND DOCUMENT ANALYSIS
a. DESCRIPTORS
Control Costs
Industry Profile
Economic Impacts
18. DISTRIBUTION STATEMENT
Release Unlimited
b. IDENTIFIERS/OPEN ENDED TERMS
Air Pollution control
19. SECURITY CLASS (Ripon)
Unclassified
20. SECURITY CLASS (Page)
Unclassified
c. COSATI Field/Group
21. NO. OF PAGES
147
22. PRICE
PA Form 2220-1 (Rev. 4-77) PREVIOUS EDITION IS OBSOLETE
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