Industry Committee on June 18th, 2007

[Tony Macerollo]

If you tried to set a price that was substantially different from that which you experience south of the border, it would manifest itself in another fashion. It could be a supply shortage, because product moves to the highest price, and in this case, whether it's gasoline or corn, it's a commodity, and the supply is going to go to the highest price. Therefore, it's the events south of the border that would have acted to shorten supply, that would have caused a supply increase, that would cause supply to move to that area.

[Gerry Byrne, Liberal, Humber—St. Barbe—Baie Verte, NL]

You raised the point that there's been no new capital...well, you didn't say there has been no capital investment; there have been no new refineries in North America for a significantly long period of time. This is almost a public utility that is operating on a pretty decent margin. It seems like an attractive investment opportunity for the oil and gas industry in particular—and I'm talking about primary producers—to actually take some of their own money and put it into refining capacity. In fact, as you know, the purchaser of Come By Chance in Newfoundland is a primary producer.

Why isn't that happening more and more? Why isn't there more vertical integration between the cash of the primary producer and the processing sector?

[Tony Macerollo]

Because the refining operation is—

There are a number of factors here. First of all, we are a very regulated industry. When governments, in both Canada and the United States, make pronouncements about conservation and energy efficiency—i.e., that we have to cut down on our consumption—they're sending messages into the marketplace that this is not a lucrative area to invest in. Government policy is trying to actually bring demand down.

Even though that hasn't worked, if I may be blunt—because it hasn't worked. Demand, very robust demand, continues in the Canadian marketplace. That coupled with environmental regulations, coupled with the whole series of planning involved to put together a refinery over a ten-year period, does not jibe with, as I mentioned in my brief, an inconclusive policy environment. We depend very much on government policy, and predictable government policy, to make those decisions.

[The Chair, Conservative, James Rajotte]

Last question.

[Gerry Byrne, Liberal, Humber—St. Barbe—Baie Verte, NL]

How is consumption affected by price? It doesn't seem to me to be a very elastic sort of relationship. It seems pretty inelastic. When the price was $1.48 at home, we were still finding a fair bit of gas—

[The Chair, Conservative, James Rajotte]

Mr. Baily.

[Dane Baily]

It's very elastic but it's not very responsive. When we had the price shocks in the seventies, it took until about 1981 for the demand to drop. It dropped about 20% to 30% in the early eighties, but the price shock started in 1973 and 1977.

So it will happen, but it takes time. That's basically because we don't all trade our cars in and buy something more efficient or reinsulate our houses or stuff like that.

In a very short period of time, in Katrina and Rita, the high prices actually did their job. They pushed demand down very significantly for a few months until the refineries could balance out and we could get additional imports from Europe.

[The Chair, Conservative, James Rajotte]

Thank you.

Thank you, Mr. Byrne.

We'll go to Mr. Shipley, please.

[Bev Shipley, Conservative, Lambton—Kent—Middlesex, ON]

Thank you very much for coming today.

I was just making a little analogy here, listening to my colleague from Oshawa, with his concern about blended fuels, that actually, under the Ontario mandate, should the Ontario premier go out, it would likely be good for his constituents. I think that's just a little understanding, I might add.

[Dan McTeague, Liberal, Pickering—Scarborough East, ON]

Are you looking at me?

[Bev Shipley, Conservative, Lambton—Kent—Middlesex, ON]

No, no.

You talk about profit here. I'm looking at the part above this chart in your presentation where you say, “Nevertheless, the fact remains, that over the last ten years, after tax profits have averaged about 1.5¢ per litre.” You also talk about going from zero in December up to 10.7¢ as of late. So there's great variation in what has happened.

When I look below the chart, I see the earnings per litre, which I'm taking to be the profit. It's almost on a vertical climb, whereas the ROCE price is staying around 17%, 17.5%, 16.9%, and then it was 14.3%.

Can you help explain that to me? How many litres are we talking about in terms of the profit?

[Dane Baily]

In Canada, about 100 billion litres of petroleum products are sold. So the 2.5¢ a litre says that the downstream industry, the refiners marketers, made about $2.5 billion last year. Just to put that in context, the capital spending over the last seven or eight years has been about 130% of earnings.

As you're seeing in the chart, the return on capital employed is dropping off. For the last few years there have been huge capital investments for these environmental projects and for expansion increases. The number of refineries is very misleading. We've closed three refineries since the year 2000, which cost about 100,000 barrels a day of capacity, but the total capacity in Canada is up 100,000. So there's a net change of 200,000 barrels a day of additional capacity, not with a new refinery but by expanding existing refineries.

The same thing happened in the States. Over the last ten years they've increased their capacity by 10%, which is almost the same value as the entire Canadian refining industry.

[Bev Shipley, Conservative, Lambton—Kent—Middlesex, ON]

One thing we heard the other day is that part of the problem at the refineries is around the pipelines to get it to them. There's limited capacity. I mean, there is all kinds of product, I think, but it's at the refining end where it's been limited.

You say that a number have closed down, but I'm wondering, have they just decided to close because of the profit margin or because the plants were inefficient?

[Dane Baily]

The major closure was Petro-Canada in Oakville. It's no secret that that refinery was not an attractive investment to put in the expenses required to desulphurize the gasoline. It was a smaller refinery and it just wasn't worthwhile.

There are three big refinery projects right now that are being talked about. Shell has one in southwestern Ontario; we're talking about 300,000 barrels a day. The total Canadian capacity is two million, so this is a huge chunk. Irving has another one, and Irving is primarily an export refinery. They supply all their local demands, but they export quality products to California—very specific gasoline blends required for California. It is a very sophisticated refiner, and that would double their capacity, another 300,000 barrels a day. Then there is another refining complex being discussed in Newfoundland. Those are huge investments.

You really have to put it into the context of the risks refiners are facing. One of the risks, certainly, is the demand, as Tony mentioned. If in the transportation segment Canada were to hit its Kyoto targets, the demand would have to drop by 30%. So it takes a fair bit of intestinal fortitude to spend $4 billion or $5 billion with the chance that your demand might go down by 30%. Those are the planning decisions that these major corporations have to look at before investing in that segment.

When you look at the upstream, over 80% of the profits of the integrated companies last year came from the upstream business. On average it's about 75%; last year it was 80%, and it's driven by the crude price.

[The Chair, Conservative, James Rajotte]

I'm sorry, we're over time, Mr. Shipley.

We'll go now to Monsieur Vincent.

[Robert Vincent, Bloc, Shefford, QC]

Thank you, Mr. Chairman.

You say that it costs $5 billion to build a new refinery and that even if the government invested money or provided subsidies, the industry would not want the refinery. Is there a particular reason for that?

[Tony Macerollo]

Mr. Vincent, it's very simple. The proponents to build a refinery have to go to their financing sources and say, “This is why it is worth your investment”. What you've seen up until at least recently is that the people who have the capital to give are looking at it and saying, “No, I can put that money elsewhere and make a better return”.

[Robert Vincent, Bloc, Shefford, QC]

In any case, until there is a new refinery, the margin stays as high as possible. The fact that there are no new players to increase the number of refineries and create a surplus is a lot more profitable for you. As long as there is a shortage of supply, the price can be kept high and blamed on demand. That is the best explanation that you can give us today. With new refineries, there would be a surplus, and gasoline would simply cost less.

[Tony Macerollo]

Conversely, you could do what many of our members have already done, and I'll remind you that even though some refineries have closed, existing refineries have expanded. The advantage of expanding an existing refinery rather than building a new one, among other things, is—You have to deal with the community around you. Not everybody wants a refinery in their backyard.

What I will tell you is that there has been expansion of refineries. We have increased our production of product. I'm not sure we need necessarily to determine the type of expansion that is required to get more supply, but what I can tell you is that the investment climate has to be good in order for that money to come.

[Robert Vincent, Bloc, Shefford, QC]

You have told us that a refinery would cost $5 billion, but from what I understand, it is not a question of money. ExxonMobil recorded an impressive net profit of $9.3 billion in the first quarter of this year. So that is not where a lack of money will be felt. But we understand that its sales went down by 2% because of the price of oil. Last year, oil was $73 a barrel, compared with $61 this year.

Even so, profit margins have been much higher. They made $39 billion last year and will make much more this year. But where is this profit coming from? According to the magazine Les Affaires, these people are making much more money because of the refining margins. Crude oil prices have declined, but the companies have increased the refining price.

The situation is even clearer in Canada. As my colleague mentioned, Petro-Canada recorded a net profit of $590 million in the first quarter, compared with $206 million last year in the same period. Not only did first-quarter profits double, but oil companies investing in the development of the oil sands can deduct 100% of their investment beginning in the first year.

Moreover, in a recent study that it prepared, the Canadian Association of Petroleum Producers provided estimates for the next three years on the impact that the tax breaks would have on oil companies. They amount to $5.1 billion in 2005; $4.5 billion in 2006; $3.2 billion in 2007 and $2.3 billion in 2008.

With that in mind, I do not think that building a refinery for $5 billion is a question of money. That is not a problem for the oil companies. Since the beginning, you have said that you own 16 refineries and refine 80% of the products on the Canadian market. If there are too few refineries, a new one should be built. In any case, the government will help you and give you tax breaks. Who will benefit?

[The Chair, Conservative, James Rajotte]

Please ask your question.

[Robert Vincent, Bloc, Shefford, QC]

Consumers will benefit.

[Tony Macerollo]

It's very simple.

Through you, Mr. Chair, to Mr. Vincent, I'll say two things.

First of all, the government's plans for criteria air contaminants—air pollution—in effect, prevent us from growing in Canada. If those numbers do not change, we cannot grow. However, we have been working with officials on this, and we're confident that something is going to break.

I'll make a deal with you. I will bring members of my industry to come and see you if you are interested in having a refinery built in your riding.

[The Chair, Conservative, James Rajotte]

Thank you.

I assume that goes for all the members of the committee.

[Tony Macerollo]

That's for all the members.