Before long, though, there may be an even more desirable alternative to the traditional gasoline-powered car: the hybrid, which is a cross between an all-gas and an all-electric car. Already on the market, hybrids have proven as reliable as other cars, and their resale value is comparable. But they sell at a premium, battery replacement costs are high, and it’s not yet clear how long their batteries will last. That said, when the hybrid Lexus Rx400h is introduced in early 2005, it will cost only around $4,000 more than the gasoline version and its fuel savings will amount to about $2,500 per year over the first five years; what’s more, U.S. buyers receive tax incentives for buying so-called clean fuel vehicles. Thus, despite the premium purchase price, the Rx400h is already almost at breakeven with the gasoline model.
If gas prices continue to rise, hybrids could become economically superior choices. Their effect on gasoline demand would depend on how fast consumers buy them. Assuming hybrids achieved high levels of adoption — a 10 percent share of new vehicles by 2010 and 20 percent five years later — gasoline supply would top demand by 2015.
In the short run, refiners have reason to smile. Prices and margins are projected to stay high at least through 2006 because regulatory shifts and changes in consumer and automaker behavior will take a while to make a difference. So it is prudent for refiners to maintain and operate plants to take advantage of the good times. But longer term, caution is advisable. Refiners should prepare for possible tougher times by strengthening balance sheets, trimming expenses, and factoring lower future prices into any expansion plans. Given the current market, portfolio choices are paramount. And while a U.S. gas glut is not certain, it is certainly not out of the question. Refiners should start looking for export markets in places like China, Brazil, and Mexico, where demand will continue to exceed domestic supply.
The refining industry is traditionally cyclical. Long-term returns on capital averaged 9.5 percent between 1990 and 2002. But although the industry has experienced occasional periods of high returns, it has not been enough to compensate for the bad times. Refiners may hope that recent high returns signal better days as far as the eye can see. But the smartest of them won’t bet on it.
Harry Quarls (firstname.lastname@example.org) is a senior vice president with Booz Allen Hamilton in Dallas who specializes in the energy industry.
Robert Lukefahr (email@example.com) is a vice president with Booz Allen Hamilton in Houston. He has extensive experience in helping clients in energy and other industries with corporate growth strategies and long-term strategic plans.