Royal Dutch Shell will go ahead with a 325,000 barrel-per-day capacity expansion of its Motiva refinery in Port Arthur, Texas, that will make the plant one of the biggest in the world.

The Anglo-Dutch group said on Friday the project, the first big U.S. refinery expansion in decades, would cost $7 billion.

The 285,000 bpd Port Arthur refinery is owned by Motiva Enterprises LLC, Shell's U.S. unit Shell Oil Co.'s equal joint venture with Saudi Refining Co.

Shell, the world's second-largest non-government controlled oil group by market value, said the expansion would increase the refinery's crude oil capacity to 600,000 bpd, making it the largest refinery in the U.S.

The expansion is equivalent to building the first new refinery in more than 30 years in the United States, where there are no approvals for new refineries, leaving expansion as the main option to increase capacity.

Shell said it was confident it could finish the expansion, which is expected to include additions to the refinery's crude distillation capacity along with hydro cracking and coking capacity, within the budgeted $7 billion and on time.

We are now confident that we can deliver this project at the $7 billion level and in the time frame -- by 2010, Rob Routs, head of Shell's downstream operations, told reporters on a conference call.

Routs said the group had delayed a decision on the refinery's expansion so that it could have a firm grip on the capital estimate and timing of the project.

Motiva has awarded the main construction contract to a Bechtel/Jacobs (JEC.N: Quote, Profile, Research) joint venture.

Shell shares were 0.1 percent higher in London at 20.94 pounds by 7:27 a.m. EDT.

TIGHT BALANCE

U.S. refiners have grown flush on a tight balance between expanding demand for oil products and only a slow growth in supply in recent years that has made the U.S. market more dependent on imports.

Strains in U.S. refining capacity following hurricanes, maintenance and accidents have contributed to the spike in the oil price over $84 a barrel. U.S. WTI crude hit a record high of $84.10 on Thursday.

Shell's move to invest in expanding capacity in the U.S. comes at a time the group has sold some of its European refining operations.

Routs said the refined products markets in both countries were very different, with demand, especially for gasoline in Europe, in decline.

The European refineries put up for sale by Shell were high-cost operations which would have difficulty competing in a low margin environment.

Overall, Shell said it expected oil refining margins in the long term to narrow as new refining capacity came on stream in the Middle East and Asia.

In the long run there will be quite a lot of new capacity coming online East of Suez that will drive worldwide margins down, Routs said, adding that the expanded Port Arthur refinery would be profitable even if margins were low.

(Additional reporting by Alexandra Hudson in Amsterdam and Alex Lawler in London)

Energy