In the early 1990s, the California Air Resources Board (CARB) started planning its “Phase 2” requirements for reformulated gasoline (RFG). RFG is gasoline blended to tight specifications designed to reduce pollution from motor vehicles. CARB consulted with refiners, environmentalists, and other interested parties to design these specifications. As the outline for the Phase 2 requirements emerged, refiners realized that substantial capital investments would be required to upgrade California refineries.
Assume a refiner is contemplating an investment of $490 million to upgrade its Californian plant. The investment lasts for 23 years and does not change raw-material and operating costs. The real (inflation-adjusted) cost of capital is 9%.
How much extra revenue would be needed each year to recover that cost?