Despite slowing demand for petroleum products, refiners have been running at very high rates and setting new records.

Once again, American consumers are facing sharply higher prices for the fuels they so heavily rely on. Since the beginning of 2005, the price of crude oil has increased by more than 50 percent. The wholesale and retail prices of gasoline and diesel fuel followed this increase and have risen to record levels. Tight markets with increasing demand and limited supply and capacity have led to steadily higher prices, while producers have had limited ability to increase production. These tight markets became even tighter with the back-to-back arrival of Tropical Storm Cindy and Hurricane Dennis. Although these storms did far less damage than Hurricane Ivan, they did cause an interruption of oil production as platforms were evacuated, a decline in imports as ports were closed or restricted in operation, and a decline in some refining activity as some power losses and precautionary activities restricted operations. The net effect was yet another surge in futures prices, followed by wholesale and retail prices.

The petroleum industry has responded to these tight markets by running the refinery system harder than ever before. Our refineries are operating at 97.6 percent of capacity, producing record amounts of fuel. To add further supplies, record amounts of crude oil and gasoline were also imported. This has enabled a rise in inventories of gasoline and diesel fuel even in the face of increased demand. Tight markets also drove up natural gas prices, which, year-to-date, have averaged more than 15 percent higher than the comparable period in 2004. To round out this hydrocarbon summary, we see that propane prices are also up. The futures price of propane has averaged more than 25 percent higher this year than for the comparable period in 2004.

While the industry has been doing all it can to meet the needs of consumers, the remainder of the hurricane season could be challenging. We will need to keep the system running at high levels to meet the increase in demand that many analysts are projecting.

Switchover in Progress
We are also looking ahead to prepare for the coming winter. The industry has begun the smooth switchover to producing larger shares of heating oil to begin building inventories for the winter. Since the low point this year, refineries have increased their yields of high-sulfur distillate by about 25 percent.

This change, combined with the increase in refinery output, has led to an increase in refinery output of high-sulfur distillate of more than 25 percent. Inventories of both high- and low-sulfur distillate are now above average.

Unfortunately, the price of heating oil is very high and it appears from anecdotal reports that consumers and secondary inventory holders are not filling their tanks as fast as in past periods. As a result, the primary inventory of high-sulfur distillate in New England is now 46 percent above the five-year average. We will be monitoring this supply chain carefully to see how the summer fill action proceeds into the fall.

Looking further ahead, we are making the massive investments necessary to meet the dramatically lower sulfur requirement in diesel fuel next year. Refiners have made billions of dollars in investments in the refining and distribution system to produce the diesel fuel at well below the required sulfur level.

However, it appears that there are potential problems in the pipeline distribution system that need to be confronted. Specifically, tests indicate that diesel fuel could gain a sufficient amount of sulfur content to be non-compliant with the 15 ppm standard. We are working hard to address these potential problems and closely consulting with the EPA on possible solutions.

Petroleum Supply and Demand
Our estimates of U.S. petroleum supply and demand for the first half of 2005 show that U.S. petroleum demand (as measured by deliveries) slowed across all major products. At the same time, highway diesel continued to show the strongest growth of any major product.

Increases for all major products were slower than last year. Growth in gasoline consumption slackened to less than half a percent, dulled by sharply higher gasoline prices. Also contributing to weaker petroleum demand was a drop for heavy fuel oil, as higher prices for residual fuel reduced its economic advantage over natural gas for industrial and electric utility users.

Air travel has set records so far in 2005, and jet fuel deliveries have continued to rise, but at a slower rate than in 2004. Demand for distillate fuel oil, which includes both highway diesel fuel and home heating oil, also rose at a slower rate in 2005 compared with 2004.

Yet, low-sulfur diesel, the type used for on-highway transportation, still saw an increase of more than 3 percent - the strongest rise for any major product. Low-sulfur diesel demand now amounts to more than 3 million barrels per day, putting it at fully one-third the size of the domestic gasoline market. For some time, highway diesel demand has been growing strongly compared to gasoline.

Refiners responded to these developments in the first half of 2005 by running at very high rates and setting many new records. Production of diesel, as well as distillate fuel oil overall, reached new highs, as did production of jet fuel. Refiners' production of gasoline nearly matched the all-time high reached in the first half of 2004. Because of weakening demand and strong gasoline imports, gasoline inventories still ended the period at above-average levels.

Speaking of gasoline imports - including finished gasoline and gasoline-blending components - they surpassed 1 million barrels per day for the first six-month period ever. They now account for about 11 percent of all the gasoline we use in the United States.

But for distillate, despite a tight domestic market for diesel fuel and heating oil, foreign sources were apparently hard to come by, and imports fell. Imports of crude oil and petroleum products overall rose modestly and accounted for about 64 percent of all supplies used domestically.

We ended the first half with crude oil inventories at their highest level in six years, the result of a larger-than-seasonal build over the past six months. Inventories of both gasoline and distillate were at roughly average levels. Domestic crude oil production continued to decline in the lower 48 states and Alaska. Current crude oil production for the United States, compared with 20 years ago, is about 40 percent lower.  E+P

This column is based on the statements of John Felmy, American Petroleum Institute (API) chief economist, and Ronald J. Planting, manager of information and analysis for the API Statistics Department, at a July 20 briefing. For more information, see www.api.org