Refinery outages -- red flag or red herring?

A spate of refinery outages in the U.S. -- including recent downtime at a

BP

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facility in Texas City, an

Exxon

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plant in Illinois and a

Sunoco

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plant in Philadelphia -- has repeatedly been cited on Wall Street and in the media as the villain in this month's surge in crude prices.

The assertion is debatable.

Fundamentally speaking, a shortage in refining capacity lifts gasoline prices, as supplies of the fuel dry up. But the same formula isn't as persuasive when it comes to crude. After all, if refiners can't process the crude they have, why would they need more?

"I can't see how refining issues affect crude oil in any way," says Mark Zandi, chief economist at Economy.com. "It would be the tail wagging the dog."

Bulls claim refinery outages push up crude for two reasons. One, when a refiner goes down, others jump into the crude market for a raw material they know they can process into a more valuable finished product. When gasoline is harder to come by, the spread between it and crude widens.

Two, in the current market, any supply disruption in an energy commodity will be felt across the complex as speculators flex their muscles. That so many crude traders focus on refineries ensures that refinery outages will drive crude.

Skeptics find both arguments specious. Refiners, they say, don't have enough spare capacity to meaningfully add to their current output. It's too risky to buy crude at these prices on spec, they say.

"Nobody wants $65 crude just lying around without the capacity to run it, especially ahead of the fall maintenance period," says Tim Evans, senior oil analyst at IFR Market.

As for the influence of speculators, nobody doubts that they're there. It's just that speculative demand breeds hype that in and of itself won't keep a commodity aloft over the long haul.

Here are some basics. The rate of growth in oil demand is falling at two of the world's biggest oil consumers, the U.S. and China. Crude inventories in the U.S. are at above-average levels, as are global inventories. Imports of crude oil to the U.S. were the second highest ever last week, at 11.1 million barrels a day.

In April, when oil spiked to its previous high around $59 a barrel, traders were supposedly fretting about the peak summer driving season and refineries' ability to meet gasoline demand. Meanwhile, demand is roughly 1.4% higher than a year ago, according to the Energy Department's latest report. The rate of growth is down from a year ago.

Bill O'Grady, director of market analysis at A.G. Edwards, says, "There is still enough refining capacity in the world." He maintains that OPEC has launched a campaign to blame the refineries for high oil prices, in an attempt to hide its own inability to bring down prices.

According to O'Grady, the real economics behind the oil price spike is years of underinvestment in exploration and production projects and rising depletion rates from OPEC countries.

Mike Conner at the Energy Department says the oil industry doesn't hold excess inventory of crude because of storage costs. "There is some inventory response to price expectations but not as much as people would think," he says.

Out of roughly 320 million barrels held by refiners in storage throughout the country, about 270 million must be in the refining system in order for it to work, according to Conner. Most of the inventory is actually in pipelines and different refinery units, while roughly 50 million barrels are kept in excess.

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needs about 11 million barrels of crude inventories, or 6.5 days of supply to maintain stable operations. "Due to the market contango and good margins, we are carrying an extra 5 million barrels in our system, or another three days," says Mary Rose Brown, Valero's spokesperson.

On the other hand,

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, an integrated oil company that owns seven refineries, said it doesn't maintain excess crude inventory. "We are running full out at this point; we can't buy more oil than we can process," says Kenneth Matheny, vice president of investor relations at Marathon.

Zandi believes there is no reason for oil prices to be at $65 a barrel. "It doesn't jibe with the fundamentals," he says. Nevertheless, Zandi believes current market psychology will prevail until there is an obvious slowdown in global demand, an event he predicts could occur at the beginning of next year at the earliest.

After Wednesday's inventory report showed crude inventories in the U.S. were ample, oil futures rallied to another record high. Nevermind crude -- as long as there was a drop in gasoline stocks to blame refiners for, the bulls were home free.