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U.S. oil refinery delays may spur supply crunch

NEW YORK (Reuters) - The stage is being set for a fuel supply crunch in the United States once the economy rebounds now that refiners have pushed back more than $10 billion worth of upgrades they had on the drawing board.

Pressured by the oil price collapse and the economic malaise, companies have also either slowed or scrapped expansions which could threaten 340,000 barrels per day of new capacity, spelling a return to lagging processing capability that helped push pump prices higher until last year.

“If the economy comes back faster than expected, we are going to be caught flat-footed and we’re going to see a big spike in prices,” said Phil Flynn, an analyst at Alaron Trading in Chicago.

Refining margins -- the difference between the cost of crude oil and wholesale price of petroleum products like gasoline -- have narrowed as fuel demand dwindled due to the economic meltdown, at times dropping into negative territory.

Valero Energy Corp VLO.N, the largest U.S. independent refiner, is chopping capital spending by $800 million in 2009, after posting a fourth-quarter loss in 2008 on a write-down of asset values.

The cuts will postpone the construction of a diesel hydrotreating unit at its Norco, Louisiana, refinery as well as an upgrade of gasoline-producing equipment at its Memphis, Tennessee, refinery, both envisioned in headier industry days.

“Looking at market conditions for the coming year, the sluggish economy is clearly a headwind against demand growth for refined products,” Valero Chief Executive Bill Klesse said. “To help stabilize margins, refiners must continue to use discipline in matching production with demand.”

Some work has also slowed on a 325,000-bpd expansion at Motiva Enterprises LLC’s Port Arthur, Texas, plant, the largest refinery project under way in the United States, according to a contractor working on it. The company said the project is under a cost review.

Other refiners delaying projects including Marathon Oil Corp MRO.N, ConocoPhillips COP.N, Sunoco Inc SUN.N, and Chevron Corp CVX.N.

At least some mirror a similar drop-off in spending on Canadian oil sands project expansions, which were aimed at providing crude supply for many U.S. refineries.

DEMAND DWINDLES

Fuel demand in the United States -- where no company has built a refinery since 1976 -- dropped initially in response to crude prices which soared to a peak of nearly $150 per barrel last July, pushing gasoline prices to about $4 a gallon.

When the U.S. economy slipped into recession, demand waned more with crude tumbling to around $35 a barrel and gasoline prices more than halved.

It’s unlikely that oil demand will outstrip refining capacity in the short term, even if refiners scrap expansion plans, analysts said.

U.S. gasoline demand fell for the first time since 1991 last year and total refined oil demand over the past four weeks was at 19.8 million bpd, down 1.3 percent from a year ago.

“The chances of refined product consumption increasing this year seem very slight,” said Joseph Arsenio, managing director at Arsenio Capital Management in Larkspur, California. “However, in the latter part of the year, it’s conceivable that we will see an across the board improvement (in demand).”

Indeed, weak demand has created a glut of gasoline in the recent months, squeezing refining margins. But a swifter than expected economic recovery could turn things around quickly.

“We may end up seeing the opposite of what we see now. We may see a situation where we run into shortages once liquidity increases and the economy starts to rebound,” said Mike Zarembski, senior commodities analyst for optionsXpress.

Putting the brakes on refinery expansions, which normally take years to complete, is risky in the long term. But the industry and consumers appear to have breathing room before higher fuel prices and fuel shortages reemerge, analysts said.

“I think it’s fair to say we’re probably going to end up with higher priced fuel because of these delays and postponements and deferrals, but that day of reckoning is at least two or three years away,” Arsenio said.

Reporting by Rebekah Kebede; Editing by Jeffrey Jones and Marguerita Choy

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