MT:What is the mandate of the Canadian Petroleum Products Institute?

Macerollo: The Canadian Petroleum Products Institute does research and advocacy work for the refining sector. We start where the oil arrives at the refinery and cover all the way through to the regional station. CPPI runs the gamut from driver certification for fuel haulers straight through to advising government on issues ranging from competition, policy, climate change, air pollution, ground fuels and contamination. We also work on best practices.

MT:Fuel is an issue that touches everyone in the supply chain in one way or another and because of its importance, people are very sensitive to changes in pricing and tend to speculate on what’s causing these changes. One of the common beliefs is that the reason we have such high pricing right now is that oil companies are colluding to influence the price of fuel. What do you make of that belief?

Macerollo: Thank you for being so forthright with the question, because that is often the question that is raised. I’ve been on both sides of this issue. Since 2006, I’ve been with CPPI, but prior to that I worked in Ottawa for the Industry Minister, who was responsible for the Competition Act. There is a wide array of administrative penalties for violating the Competition Act and you can even go to jail. But about 60% of proven reserves in the world are now controlled by governments and not by companies. We’re talking about state-controlled corporations, whether they be in China, Kuwait or Venezuela and these are decision-makers who do not respond to market dynamics, but to other priorities. That has a big bearing on the supply of crude in the marketplace. But when it comes to the refining of crude and the retailing of the product, it is simply a case of available supply to meet demand. The added complication is that in the business planning environment, for at least the last 10 years, there have been fairly significant mixed signals sent by government about how business people in my industry should plan their investments. Since at least the Kyoto Protocol, there has been an attempt by governments, with a fair amount of rhetoric and conviction, to reduce demand for the products that we provide. When you have governments telling you the intent is to reduce demand, you are probably going to have a difficult time attracting the capital to expand.

MT:Another common belief is that Canada has its own ability to control prices because of its reserves. So if we produced more and refined more ourselves we could have a made-in-Canada price that would benefit Canadians. What do you think of that?

Macerollo: We actually have the second highest proven reserves in the world behind Saudi Arabia, but they’re difficult to get at. It’s energy-intensive and expensive to extract crude from Alberta’s oil sands. Back in the early 80s, we had a national energy plan which was an attempt to construct a madein-Canada energy framework. It was very controversial. But there is a more important point to discuss. Our ascension to the World Trade Organization and NAFTA means there is no unique Canadian market. In terms of refined petroleum products, there are three considerations that play into this. First is the global price of crude oil and that’s a price for everywhere in the world. In 1999, the price of crude oil was trading at about (US) $10 a barrel. In less than 13 months, it went up to $30 and then from 2000 to now it has gone from $30 to $125.And the largest chunk of that price increase, apart from the market manipulations of OPEC, is actually bringing people out of poverty in China and India. Because when you bring people out of poverty, they consume more. They make their first phone call, they drive their first car. They do the things we take for granted. The sheer magnitude of their populations is adding to the intensity of demand for energy.

Refined gasoline and diesel pricing, however, is determined on a continental scale. Since NAFTA, these products can move with a relative ease across borders and they do. At this point in time, with a few basic exceptions such as west of the Rockies, the wholesale price is set by the New York Mercantile Exchange on a daily basis. Every Wednesday, the US reports on available reserves and supplies of petroleum products in the US and the markets respond to inventory levels. When inventory levels are up, there tends to be downward pressure on pricing and when inventories are down, there is upward pressure on pricing. So we start with global, then continental and then go right down to the local level.

MT: When you look at a map of where most of crude is found, you immediately realize it tends to be found in areas of both political and environmental instability, such as storms and earthquakes. Can you comment on how those sources of instability are affecting the volatility in fuel pricing?

Macerollo: I come back to the issue of 60% of crude oil reserves in the world being owned by governments. That does create a lot of uncertainty because you frankly don’t know what a lot of the rationale is for their decisions to either increase or decrease production. If these reserves were in the control of companies that had shareholders and had to abide by international laws and be held accountable to governance legislation, there would be more of a discipline to the business decisions made. But clearly, when Iraq goes from being an oil producing nation to an actual oil importing country and you have people in Nigeria working for oil companies being kidnapped, these are shocks to the system and shocks to the system generally don’t get a calm reaction. We can call it volatility, but the reality of the matter is that a risk premium has been built into the marketplace as people try to protect themselves against future shocks.

MT: As you’ve mentioned, pricing at the refinery level is driven by different factors than is the case for crude. Can you elaborate further on the key issues affecting the price of refined diesel?

Macerollo: The first and biggest impact is the desulphurization of diesel. In Canada, the 16 refineries involved invested somewhere in the neighbourhood of $5.5 billion, and that’s just to put the machinery in place to take the sulphur out without producing an extra litre. The biggest cost right now is government regulation. In the US, they are going after each refinery with consent decrees regarding air pollution performance targets. In Canada, the same kind of dynamic is occurring. I’m not saying it’s for a bad reason, but I can’t tell you all of these refineries are going to be able to afford to comply. It takes about 10 years to build a new refinery and most of that time is spent getting environmental approvals. Most people don’t want a refinery in their backyard. On average in Canada, refineries are making about 1.5 cents a litre clear profit and that’s probably going to come down if the recession deepens in the US because the price of the product does not just reflect the sum of the costs involved, but also what the market will bear. The last time this happened was in 1999. There was a lot of excess capacity, a lot of environmental demands were being made and a lot of refineries closed. At that point, the profit margin was about 0.4 cents a litre.

MT: As you’ve mentioned, 10 years ago and also about 25 years ago, there were issues that led to the closing of many refineries and the decision to not invest in new capacity. But with the rise in demand we’ve seen the last 10-15 years and pricing at levels that probably makes it worthwhile to invest in new capacity, did refiners not miss the boat? It would seem their miscalculation is not only hurting Canadian businesses, but also refiners themselves who are missing out on today’s market opportunities.

Macerollo: While refineries have closed, capacity has actually increased. We’ve done a pretty good job of getting economies of scale. The number of refineries is not so much the issue as is capacity. There is no question that we are in precarious times. The National Energy Board has expressed concern about the lack of incentive to build new capacity in North America, despite the high prices. There are subsidies available south of the border and no one is taking them up. It really is a function of maximizing existing operations until the industry knows what the public policy is going to be around climate change.

MT: So what you’re saying is that refineries didn’t miss the boat on this increased demand. In their business model, building a refinery has to make sense not only now, but 25 years from now. And when they look at a carbon-constrained future, they are reticent to invest?

Macerollo: Yes. At the end of the day, business has to attract capital and the investment has to provide a return that is comparable to other options out there.

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What’s really behind today’s unprecedented fuel price spikes and is there any hope for a reprieve in the near future? Transportation Media editorial director Lou Smyrlis recently travelled to British Columbia to host a CITT seminar on fuel price volatility and its impact on all transportation stakeholders. The following is an excerpt from the opening interview with Tony Macerollo, vice-president, public and government affairs with the Canadian Petroleum Products Institute.