"Technology: The Engine to Do More for More"

Presentation by API President and CEO Red Cavaney
to the Middle East PETROTECH 2006 Conference

“Technology: The Engine To Do More For More”

INTRODUCTION
I am honored to join you at PETROTECH 2006 Conference, one of the most important energy-related conferences held worldwide. I deeply appreciate your invitation.

I believe the title of my presentation, “Technology: The Engine To Do More For More,” is in keeping with this year’s theme. The more advanced our technology becomes, the more efficient and effective our industry becomes – and the more energy we can provide to consumers. For the most part, I will be discussing the U.S. refining experience, but I believe this experience will be of interest to those outside our country who face similar challenges.

HYDROCARBONS: TECHNOLOGY AND EFFICIENCY
It may come as a surprise to some, but gasoline, diesel fuel, and other petroleum products have provided power to consumers for well over a century. Why have these hundred-year-old fuels endured for so long?

First, hydrocarbons have been the choice of consumers worldwide, because they contain more than twice the energy per gallon as many other energy sources. Thanks to advances in technology and market forces, our hydrocarbon-based economy is getting more and more energy efficient. In 1970, the United States used about 1.4 barrels of oil for each thousand dollars of real GDP. By 2000, that had fallen almost in half to about seven-tenths of a barrel. And, by 2025, our nation is projected to consume only about one-half a barrel of oil for each thousand dollars of GDP.

An additional reason why hydrocarbon fuels have endured so long is that technology has reduced dramatically the environmental impact of their use, enabling the production of cleaner, more efficient and environmentally responsible fuels. Seventy million more drivers – 70 percent more -- are on the road today in the U.S. than was the case 30 years ago. And, they are driving 143 percent more miles. However, despite this enormous increase in drivers and miles, vehicle emissions are down 41 percent. A major contributor was the phase-out of leaded gasoline, completed in the 1980s, which cut lead emissions by 98 percent. Further, the introduction of reformulated gasoline has led to significant reductions in ozone precursors and toxics emissions.

In addition, the average sulfur content in gasoline has been reduced by more than 90 percent to less than 30 parts per million. A new car today running on the new low-sulfur gasoline and equipped with the most advanced emissions reduction technology has 97 percent less emissions than had a new vehicle in 1970. It takes 33 vehicles running on low-sulfur gasoline today to equal the pollution emissions of just a single 1970 vehicle.

The removal of sulfur from gasoline and diesel fuels is a good example of the far-reaching benefits of advanced refining technology, which could extend the competitive life of gasoline and diesel by an additional 10 to 20 years. These very clean-burning fuels, used in advanced internal combustion engines, will likely be competitive, on a wheels-to-wheels basis, with other advanced fuel/vehicle systems, such as hydrogen fuel cells, hybrids and others.

Another example of technology benefits is the use of cogeneration to save energy in refineries. Cogeneration is the simultaneous generation of heat and electricity, can be more than twice as efficient as conventional generation, and is increasingly being implemented by refiners to help power their facilities. In some instances, excess electricity is generated at the refinery, which can be sold off-site for use by schools, hospitals and many other facilities.

Cogeneration is an important tool helping oil companies become more energy efficient. To demonstrate their commitment to continued improvement in aggregate energy efficiency, API member refiners have voluntarily agreed to a 10 percent improvement between 2002 and 2012 as part of API’s Climate Challenge Program. That program is contributing to a national goal of reducing greenhouse gas emissions by 18 percent by 2012. The most recent reporting cycle indicates that API members are on track to achieve their 10 percent improvement goal.

One of the major challenges facing the industry is to keep up with the demand from its ever-expanding base of customers. The U.S. Energy Information Administration projects that more than 5 million barrels per day of additional refinery capacity will be needed by 2025 to meet increasing consumer demand. In light of this, cogeneration can be an attractive investment for a refiner, which can reduce overall operating costs and increase the efficiency of refinery operations – efficiency improvements that help increase refinery production.

TECHNOLOGY AND REFINING CAPACITY
Technology has enabled refiners to continue to supply consumer choice. Advances in technology have helped refineries produce more from existing facilities than they did in the past. Refinery energy use is the single largest controllable cost for most refineries, often comprising more than 50 percent of non-crude operating costs. Advanced automation and monitoring equipment to enhance the operation of process units have increased the efficiency of energy use at many refineries. For example, applying advanced controls to distillation columns consistently reduces column energy use by 10 to 25 percent, while continuing to meet product specification targets. In addition, refineries have continued to produce cleaner and cleaner fuels, while process capacity has been maintained, and even expanded, through significant improvement in catalyst performance -- with less unit downtime.

American refineries are doing a better job of bringing product to market for less cost – and the consumer has benefited. Even though a new U.S. refinery has not been built from the ground up in 30 years, existing refineries are continually being upgraded and reworked to improve efficiency. Existing U.S. refining capacity continues to grow, having expanded from 14.7 million barrels per day in 1994 to 17.1 million barrels a day today. This expansion is the equivalent of about a dozen new 200,000 barrels-a-day capacity refineries. And, looking to the future, more than 1.3 million barrels a day of capacity expansion has already been publicly announced for the 2006 to 2011 timeframe. (Note that, when this presentation was originally submitted on November 15, 2005, the publicly announced refinery capacity expansion was “more than 1 million barrels a day.”)

In spite of all these efforts, the U.S. refining industry has not kept up with growing demand. Over the same period of time, U.S. demand for refined products has increased from 17.7 million barrels a day to about 20.5 million barrels a day. I suspect refinery capacity expansion would have been larger had government policies not created significant regulatory uncertainty in the late 1990s. Less onerous regulations, set forth with great clarity, begets a climate more conducive to investments.

Refining capacity is a subject directly related to technology. Those who seek to build new refineries in the United States or, more likely, to expand existing refining capacity; require more, not less, technology. And, they need an investment climate and regulatory framework that encourages them to find and utilize these technologies.

EXPENDITURES AND RETURNS
During the 1980s and 90s, the U.S. oil industry earned relatively poor rates of return on its investments, especially for the refining sector that was hard hit with the need to meet various environmental requirements, including cleaner-burning fuels. Over the 10-year 1994 to 2003 period, the return on investment for the refining and marketing sector was 6.2 percent, or less than half as much as the 13.4 percent for S&P Industrials.

From 1995 to 2004, the industry spent $47.7 billion to bring refineries into compliance with environmental regulations, which included $16.2 billion in capital costs and $31.5 billion in operations and maintenance costs. Moreover, by 2010, the U.S. refining industry will have invested upwards of $20 billion to comply with new clean fuel regulations, alone.

Despite historically low rates of return and billions of dollars in nondiscretionary spending, U.S. refiners have steadily worked to improve efficiency to bring products to consumers for less cost. Back in 1980, the cost to refine, market and distribute gasoline averaged about 95 cents per gallon (in inflation-adjusted terms). By 1990, it averaged approximately 61 cents per gallon, and, by 2000, it was 52 cents per gallon, which is about where it has remained over the last five years. Multiplying these reductions by the 330 billion gallons of petroleum products consumed translates into billions of dollars of savings for American consumers.

REFINERS OPERATE IN A GLOBAL MARKET
It is also important to remember that the oil industry operates in a global market. Companies in a global market will make the best economic investment decisions in order to bring affordable petroleum products to consumers. Imports may be a more economical option than new or expanded U.S. refineries, but that is a decision best left to individual companies operating in the global market. Government policies should encourage, not discourage, that market.

The key to the future of U.S. product supply is interdependence – competing in and relying upon global markets, rather than seeking some unattainable “independence.”

If history has taught us anything, it is that markets work, and free markets – including the free flow of oil, products and technology with legal protections -- work best. When governments have allowed markets to function unhindered, the laws of supply and demand have ensured that supply meets demand at affordable prices over time. Moreover, free markets spur competition – and competition advances technology to the benefit of consumers and society as a whole.

However, when government has interfered with markets, the result has been price volatility, supply shortages, and other disruptions. One only need look at the U.S. in the early 1970s: Government-mandated price controls, allocation schemes, limitations on natural gas, massive subsidies to synthetic fuels, and other measures were tried, and all ultimately failed at great cost to the consumer and the economy.

FUTURE OIL SUPPLIES
We need to understand the energy realities our world faces. We need all sources of energy. We do not have the luxury of limiting ourselves to a few sources to the exclusion of others. Nor can we afford to write off our leading source of energy before we have found cost-competitive and readily available alternatives.

There is a misperception by some about the time and costs involved in any transition to the next generation of fuels. Consider what would be involved in replacing the dominant role of oil with a substitute like hydrogen or solar power. Most experts agree that such a transition will require dramatic advances in technology and massive capital investments – and take several decades to accomplish, if at all.

The repeated forecasts over the past century that we are “running out of oil” have consistently missed the mark, because they failed to recognize the impact of technology on oil and natural gas development. New technologies opened up new frontiers and lowered the cost of production, so much so that oil and natural gas remained competitive fuels throughout the entire 20th century. The U.S. Energy Information Administration projects conventional oil supplies, alone, will be sufficient to provide increasing quantities to U.S. consumers each year through 2044. And, this refers to recoverable oil using today’s technology and does not include vast unconventional supplies like shale. Moreover, energy analyst Daniel Yergin and his Cambridge Energy Research Associates recently completed a field-by-field global analysis that forecasts a 20 percent oil production capacity increase between 2004 and 2010, based on projects already planned.

The United States – and the world - cannot afford to leave the Age of Oil before realistic alternatives are fully in place. It is important to remember that man left the Stone Age not because he ran out of stones. And, we will someday leave the Age of Oil, but not because we will have run out of oil.

Yes, someday oil will be replaced, but clearly not until practical alternatives are found -- alternatives that are proven more reliable, more versatile, and more cost-competitive. We must rely on the energy marketplace to determine what the most efficient alternatives will be, and technology will be a key determinant in that regard.

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