By John R. Auers
Over the last few weeks and months we’ve devoted a variety of blogs to various aspects of the rapidly changing petroleum supply and demand balance in the U.S. One of the most dramatic changes has been the evolution of the U.S. from the world’s largest importer of refined products to the largest exporter. This development has been facilitated by the increased competitiveness of the U.S. refining industry, a subject we discussed previously in “King of All the World” on 8/30,2016. The ability to place products in foreign markets has been critical to U.S. refiners, considering the sluggish domestic demand environment that has generally prevailed in recent years states side. While U.S. demand, particularly for gasoline, has perked up a bit with the drop in prices since 2014, that temporary boost might be coming to a close as we detailed in our recent blog “On the Road Again” from 2/28/2017. After all the U.S. is a mature market and there are a variety of factors (demographics, increasing efficiencies, alternative fuels, etc.) which work against domestic refined product demand growth. On the other hand, product demand growth in developing economies still has a ways to go. As a result the importance of export markets to the bottom lines of U.S. refiners will remain and likely become even more critical in the coming years. But with every opportunity there are challenges. In today’s blog we explore those challenges and provide some insight on the factors that will determine whether U.S. product exports can continue to “Sail Away” in growing volumes to distant shores.
“I’m Sailing Away” – Primarily to Destinations South
The U.S. refining industry has historically existed to serve domestic demand. This was a logical situation considering that the U.S. market has been both the largest market for refined products on a global basis and one which generally exhibited strong demand growth. In fact, with limited new domestic refining capacity being added, the U.S. had grown to be far and away the largest importer of refining products in the world, with net imports exceeding 3 million BPD by the end of 2005. However, that was to be the apex of import dependence. By the end of 2010, the U.S. had evolved into a net exporter and has since become the largest exporter of refined products in the world. Net product exports exceeded 3 million BPD by the end of 2016, and averaged 2.5 million BPD for the entire year, a ten year swing of about 6 million BPD.
This dramatic transition from importer to exp has come about both out of necessity (due to sluggish domestic demand) and opportunity (increased competitiveness, growing global demand, refining inefficiencies in other countries). We’ve detailed these aspects in several recent blogs and won’t repeat all of those discussions here. Instead we’ll note that some of the key developments were happening south of the border in Latin America. Demand , though irregular, has generally exhibited fairly strong growth in most Latin American countries while at the same time they have encountered difficulties in both operating existing refineries and building new capacity. As a result, the supply/demand balance in the region has headed in the opposite direction from that in the U.S. – moving from being generally self-sufficient to increased dependency on imported product.
Practically all of the products “sailing” into Latin America have come from U.S. refineries, providing the perfect replacement for declining domestic demand. In fact, Latin American destinations have been the most important home for U.S. products exports, growing to over 2 million BPD and equal to over one-quarter of total Latin American product consumption, as shown in Figure 2 below:
Diesel and gasoline have led the way, growing from less than 200 MBPD in 2004 to over 1.6 million BPD currently (last three months of 2016). At this level they comprise about 80% of total gasoline and diesel exports from the U.S., and are equal to over 30% of total Latin American consumption of these products. For some countries, the percentage is even higher. Most notably, over 60% of Mexican transportation fuels demand in the 4th quarter of 2016 was met by imports from U.S. refineries, a situation which was detailed in our blog from 2/21/2017 – “Down in Mexico”.
“We’re Search for Tomorrow on Every Shore”
While the export model has been very good to U.S. refiners, there is also cause for concern. For one, refiners, particularly on the USGC, have become more and more dependent on those export markets and with dependence comes risk. They have become particularly dependent on export markets for diesel, with over 37% of PADD 3 production (over 1 million BPD) now making it’s way offshore. PADD 3 refiners aren’t yet as dependent on exports for their gasoline production, but recently they have grown significantly, increasing by 50% from 2013 to 2016 and averaging 672 MBPD (15% of total production) last year. They especially spiked at the end of the year due to the problems in the Mexican refining industry, reaching almost 900 MBPD in December 2016 (19% of total regional production). It should be noted that since PADD 3 includes a number of non-export capable inland refineries, many plants located on the USGC are actually much more dependent on exports, in some cases exporting as much as 50% or more of their gasoline and diesel.
There are certainly many challenges to maintaining and growing product exports. For one, as we saw in Figure 2, U.S. products are making up a growing and substantial part of total Latin American demand and at some point the market could reach a saturation point. Latin American demand has also been very irregular, and is dependent on economic performance, which in itself has been negatively impacted by misguided government policy at times. Economic nationalism will also have a role to play, as most of the largest importers, including Mexico, Brazil, Colombia and others have plans to reduce dependence on imports by building and expanding refinery capacity. Finally, there is always the worry about competition from other export oriented refining systems. This is particularly true of those in the Mideast, Russia and other oil producing nations which have feedstock advantages of their own and have expressed a desire to move to more “value added” export models.
Ultimately, to be able to continue to take advantage of export markets, U.S. refiners will have to diversify product destinations beyond Latin America. After Latin America, Europe has been the most important market for U.S. diesel exports, which reached more than 400 MBPD in 2013. While that market will continue to be important, sluggish demand on the Continent has led to those exports declining to just above 300 MBPD in 2016. We also move product to our neighbor to the north, Canada, but although gasoline and diesel exports have grown a bit recently to almost 100 MBPD, the potential for much growth beyond that level is limited.
The two product markets which hold the most hope for expanding exports beyond the traditional Latin American base are Africa (particularly West Africa) and Asia. Demand growth is expected to be strong in those regions, which in both cases are short refining capacity. As shown in Figure 4 below, U.S. gasoline and diesel exports to those regions have remained relatively low. Although there has been a bit of pick up in recent months, exports are still just at 100 MBPD, making up only 5% of total exports of transportation fuels.
Hope for expansion into West Africa is based on the poor outlook for European refining, the traditional source of incremental product supply for the region. Growing demand, albeit from a low base, problems building and operating refineries within the region, and relatively favorable transportation logistics are also factors that could serve to help grow product exports to West Africa.
Asia, given the size of the market and a strong product demand outlook, has a lot of potential for expanding U.S. product exports. However significant obstacles are also present. These include competition from Mideast and Indian export refineries, increasing refining capacity within Asia itself, and disadvantaged transportation costs (especially vs. the aforementioned export competition). While some “green shoots” of export growth have been seen in the last couple of years, this will be a difficult market for U.S. exports, but certainly one which will have to be pursued aggressively by U.S. refiners in the future.
“They sang to me this song of hope and this is what they said”
In the end, we here at Turner, Mason & Company, believe that U.S. refiners will continue to maintain a systematic and sustainable advantage over international counterparts. This will be necessary to support their ability to maintain product exports, which in turn will be critical to maintain refinery throughputs and margins. While a variety of challenges exist, there are some potential tailwinds on the horizon as well. One development, which we have discussed in several recent blogs, is the impending move to LS Bunker, mandated by the International Maritime Organization (IMO). The decision by the IMO last October to go ahead with a 2020 timeline for these specifications will both significantly increase diesel demand and negatively impact the economics of fuel oil producing refineries in Europe, Asia and Latin America, all very positive for U.S. product export hopes.
A variety of other factors, including environmental regulations, trade policies, other government policies, supply/demand developments, refinery construction activity, and overall economic growth will all impact the future for U.S. refined product exports. All of these factors are discussed in greater detail in our Crude and Refined Products Outlook which we publish biannually. Our most recent edition was published last month, and provides an analysis of the key market developments and issues that impact U.S. refiners. The Outlook also contains a forecast of both crude and refined product prices and demand, taking into account the factors that are discussed. If you are interested in learning more about our Outlook, or if there are other products or services with which we may be able to assist, please visit our website, send us an email or give us a call.