Sandy exposes risks of light touch US oil regulation

NEW YORK: This year began with the US government fretting about the fragility of the East Coast fuel market. Amid the devastation wrought by Hurricane Sandy, 2012 will also end on this theme.
Yet in between these two different, but deeply interrelated episodes, little was done to tackle the underlying vulnerability of the fuel distribution network in the most densely populated part of the country.
Announcements in late 2011 that as many as three Philadelphia-area refineries would close due to persistent losses sparked genuine concern over the stability of the East Coast fuel market at the start of the year.
The shutdown of these refineries would increase the region’s dependence on imports and strain the existing distribution infrastructure which, in places, was feared inadequate to handle market demand.
These risks were clearly detailed in an extensive report published in February by the Energy Information Administration, an arm of the Department of Energy.
But once it became clear that at least some of the refinery closures might not go ahead, complacency returned. Policymakers resumed their default stance of hoping that market forces would ensure a resilient system.
The fact that the government, on some level, was aware of the acute vulnerabilities of the distribution system makes the stuttering response to Sandy all the more surprising.
It took days after the storm slammed into the coast before large scale measures to tackle a regional fuel crisis, such as a waiver of the Jones Act restricting coastal shipping to US-flagged vessels, were put in place.
In the meantime panicking consumers bought up ever drop of oil in sight, leading to huge lines and waste at the height of the crisis.
Yet this was far from the worst case scenario.
The US was fortunate that the bulk of the problem with oil infrastructure in the wake of Sandy was lost electricity at terminals and filling stations.
Major damage to a pipeline or dock facilities could have had far more disruptive and long-lasting complications.
The oil industry in the US has long enjoyed freedom from regulation imposed on other parts of the energy sector.
Oil, unlike electricity, is not a public utility, at least under current policy frameworks. And as such, oil companies have fewer duties toward their customers.
For the most part this market design has worked out very well for the US. Motorists can buy fuel just about anywhere at a competitive price, something anyone who has spent
time in a country with a state-dominated oil industry would say is a luxury not to be trifled with.
For the most part companies are free to pursue profit maximizing behavior in downstream markets, including full freedom to export refined products into international markets.
They are relatively free to shut down unproductive infrastructure and despite period probes into price fixing face limited market regulation.
Indeed, the current regulatory framework has allowed profit-maximizing companies to deliberately minimize their inventories of fuel in response to signals from the futures market even though this raises the risk of fuel price spikes.
But of course, oil is not just a widget. Oil companies may not be utilities, but they produce a vital commodity for modern, industrialized life. Like it or not, we depend upon oil.
Yet light-touch regulation meant that a fuel crisis erupted in on the east Coast even though there was oil on hand. For lack of generators, filling stations were shut. Without customers able to take fuel, pipelines could not operate.
Again the question must be raised. What would have happened if the storm had caused more damage? What if the storm had hit New York Harbor directly, rather than only swamping it with a surge of water?
This is not to say that downstream oil activities need to be regulated like utilities. But what is clear is that the muddle of US policy on upstream oil production has its equal in the disinterest and ignorance than dominates policy thinking about the downstream sector.
This seems the only adequate explanation of the slow response to the fuel crisis sparked by Sandy.
Within the government there is a limited understanding of the vulnerabilities of the fuel system to disruption coupled with a reflexive reluctance to interfere in a private market.
Gone are the days of the Seven Sisters, when the oil majors dominated the market from wellhead to filling station and acted like utilities even, at times, helping each other out.
Now the market is more fragmented, a development that makes it more economically efficient, perhaps, but leaves vulnerabilities not always covered by market pricing.
The market, after all, doesn’t pay for redundancy, it punishes those who invest in return-destroying facilities.
That suggests a role for policy. But there has been no serious debate. No reflection on the desirability of allowing critical fuel stocks to fall to a minimum if the market says so.
No reflection on the costs imposed by the Jones Act, which entrench small vested interests at a cost to consumers.
And no reflection on the costs of not investing in redundant infrastructure, or, put another way, hoping that someone else will provide that infrastructure for free.

— Robert Campbell is a Reuters market analyst. The views expressed are his own.