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US refining: new again – part one

Hydrocarbon Engineering,

The US refining industry has enjoyed a golden time in recent years, operating in synergy with the boom in US oil production, which has been made possible by advances in shale oil development. The majority of the new crude output has been squeezed into local refineries, because US policy severely restricts the export of domestic crude. The sudden influx of domestic crudes has caused their price to fall in relation to international crudes. In addition, Canada has increased its production of synthetic crudes and diluted bitumens from its oilsands resources. Canadian output is largely landlocked, and the US is its natural market. These factors have caused a strong rise in US refinery utilisation. Initially, this benefitted refineries directly in the path of the new crude supplies. More recently, however, additional transport options have allowed crude supplies to flow to the coasts as well, evening out the country’s refinery utilisation. In addition, export options have expanded, including allowances for export of lightly processed condensate, trade with Canada, and potential exports to or crude swaps with Mexico.

The inexpensive feedstock has been a boon to US refineries. But is the boon over? One of the key questions today is how the market will respond to the drop in global oil prices, since oil prices affect so many facets of the business. There are now so many questions. Will prices remain low, and for how long? Will low prices shut in some of the US production from prospective shale plays? Will it shut in production in other parts of the world? With a more consistent low price regime worldwide, will other refineries increase throughput? Will there be a demand response? Will US refining lose its competitive edge in export markets? And ultimately, will the low prices succeed in shutting in non-OPEC production, derailing investments in alternative energy, and setting up the global market for another oil price shock? In many ways, a sharp downward correction in oil prices can be just as detrimental as an upward price spike. This article will discuss developments in US refining, how the industry has coped with recent changes, and which key changes may be on the horizon.

US oil product demand

Demand and demand pattern

Although the US refining industry is active in international trade, the industry’s prime directive has always been the satisfaction of domestic demand. For the most part, this has kept the industry quite busy. The US is by far the largest oil market in the world, and it has had the most exacting and wide ranging product quality specifications, complicated further by regional and seasonal segmentation. The demand barrel is a high value one, overwhelmingly dominated by gasoline and middle distillates. The immediate future direction of the industry will hinge largely upon how the market responds to lower prices. To some extent, the lower prices will stimulate demand. But US refiners have become huge players in international export markets, and the likely level of demand growth is tiny in relation to the volume that the US now exports. The future profitability of US refining may rely much more on export markets than it has in the past.

One of the most profound changes in the US market is the change from growth in oil product demand to an era of shrinkage. At the beginning of the decade (starting in 2000), demand was expected to grow slowly but steadily. Demand for oil products plus LPG/NGLS reached 20.8 million bpd in 2005, but it hit a plateau. In 2008, a serious price shock hit the international market, and crude spot prices skyrocketed above US$100/bbl. Recall that only a few years earlier, prices had been in the range of US$25 - 30/bbl. The US and several other major countries fell into serious recession. US demand fell by 1.9 million bpd between 2007 and 2009, and although demand has crept back up during the period from 2010 to today, it has not recovered to its 2007 level.

Between 2007 and 2008, demand dropped by 1.182 million bpd and between 2008 and 2009, demand dropped by another 727 000 bpd. Demand rebounded by 409 000 bpd in 2010. It then fell again by 298 000 bpd in 2011 and 392 000 bpd in 2012. In 2013, demand rose by 397 000 bpd. Data for the first ten months of 2014 show a small increase of 82 000 bpd. However, early release numbers for the full year of 2014 suggest that there will be a greater increase, and it is noteworthy that the large drop in prices did not occur until the early part of 2015. This suggests that US demand will grow more strongly in 2015 than has been forecast, barring geopolitical events that could force prices back up. Most forecasts of US oil demand foresee a long term downward slope, and this most likely will be the case. In the near term, however, low prices and an improvement in economic circumstances is expected to cause a slight rebound in demand.

For most US refiners, the most welcome rebound in demand would be in gasoline and diesel. Gasoline currently accounts for 53.6% of US finished product demand, and diesel accounts for 24.1%. Together, these two key fuels represent 77.7% of finished product demand. In 1985, the demand barrel included 48.1% gasoline, 20.2% diesel, and 8.5% fuel oil. US consumption of fuel oil has nearly vanished, since it has been phased out of all major end uses. Preliminary data for 2014 indicate that fuel oil’s share has fallen to 1.5% of the barrel. Gasoline and diesel are the only two key fuels that maintained positive rates of growth between 2000 and 2014. The growth rates were small, 0.36%/y and 0.53%/y respectively, but in contrast, demand for fuel oil continued to decline at -8.86%/y, demand for naphtha and petrochemical feedstocks fell at -4.69%/y, and demand for kerosene and aviation fuels fell by -1.44%/y. In total, US demand fell at an average rate of -0.34%/y from 2000 - 2014 (January - October).

Long term forecast of demand

In the long term, the EIA’s Annual Energy Outlook (AEO) forecasts that demand for liquid fuels and other petroleum will decline gently at an average rate of -0.052%/y between 2011 - 2040. The mix, however, will shift in favour of distillate fuel oil at the expense of gasoline.

In 2011, gasoline demand was 8.75 million bpd and distillate fuel oil demand was 3.9 million bpd. By 2040, the AEO forecasts that gasoline demand will fall to 6.84 million bpd (a drop of 1.91 million bpd) whereas distillate fuel oil demand is forecast to rise to 4.62 million bpd (an increase of 0.72 million bpd.) However, the past three years brought a greater resurgence in demand than expected, most noticeably in the case of gasoline. Significantly, the recovery in demand pre dates the current sharp drop in oil prices. While it would not be sensible to merely extrapolate future demand upward from the recent deviation in the trend lines, it is logical to expect that the next official forecast will recalculate the long term outlook based on a higher starting point, as well as perhaps a lower price forecast. This assumes that prices remain low during the coming year.

In an overall economic sense, a downward price movement is a mixed bag. Lower oil prices can stimulate demand and, in the case of a net importing country, reduce imports. Yet persistent low prices could shut in higher cost shale oil production and stymie investment in alternative and renewable energy resources. Although many US refineries are independent companies and/or have been spun off in one way or another from large, integrated oil companies, many retain interests stretching from upstream to downstream, and many have interests in alternative and renewable energy sources as well. In the near term, petroleum product demand (for all products except fuel oil) is expected to rise in 2015 over its 2014 level. Moreover, the shale plays now producing will remain economical, and output from them will continue to rise. Most producers believe that US output will continue to grow for the next few years even at US$50/bbl prices. Similarly, advances in unconventional production from Canadian oilsands reserves have brought down production costs, and Canadian output is expected to continue to grow. If global crude prices continue to sag, production from other non-OPEC sources might be the first to be cut. In such a case, crude acquisition costs to US refiners would remain relatively advantageous, just not as advantageous as they have been in recent years.

Written by Nancy Yamaguchi. This is an abridged article from Hydrocarbon Engineering’s March 2015 issue.

Read part two of this article here.

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