By John Auers and Robert Auers
Much has been written (including in this blog) about the impacts of the U.S. Light Tight Oil boom. It has caused massive changes in all segments of the petroleum industry. In the upstream, U.S. producers have experienced a record setting renaissance, OPEC has been set back on their heels, and companies around the world are scrambling to learn from and react to the boom. The U.S. midstream has been presented with numerous opportunities and also challenges as the rapidly growing production seeks routes to refineries even as environmentalists and NIMBY activists set roadblocks to those projects. At the back end of the supply chain, refiners, particularly on the US Gulf Coast are having to adjust to crudes that are out of their “sweet” spot (pun intended). To make matters even more challenging, those same refiners are facing additional difficulties as the production of their preferred heavy grades in Venezuela and Mexico continues to decline and the delays caused by the anti-pipeline crowd limit the ability to access Canadian barrels. Talk of Venezuelan sanctions, the implications of the IMO low sulfur bunker rules and factors throw more uncertainty into the equation. In today’s blog, we will discuss this issue, as we imagine US Gulf Coast heavy crude refiners dejectedly humming the classic Stones tune (and controversial Trump campaign standard) “You Can’t Always Get What You Want.”
“No you can’t always get what you want”
Over the past thirty years, the U.S. has come to dominate the global refining industry. Prior to deregulation in the early 1980s, the U.S. had more the 300 refineries with an average capacity of less 60 MBPD, resulting in total U.S. refining capacity of just under 18 MMBPD. However, as a result of deregulation, total refining capacity in the U.S. declined to roughly 15.5 MMBPD in the mid 1990s as smaller, less efficient plants closed due to poor economics. Meanwhile, many larger U.S. refineries received new investment in both total crude capacity and, especially, upgrading capacity. Beginning in the mid-1990s, the rate of brownfield expansion began to outpace the rate of refinery closures in the U.S. and U.S. refining capacity began to grow once again. Total U.S. refining capacity is now 18.6 MMBPD with 141 operating refineries, giving an average refinery capacity of 132 MBPD. Furthermore, the average U.S. refinery now contains about 56% of its crude capacity in downstream upgrading (coking and cracking) capacity. This is significantly higher than the ratio of upgrading/crude capacity in any other major refining region of the world. The investments in upgrading units were incentivized by growing heavy crude production, especially from Canada and Latin America, during the 1990s and 2000s, providing strong economics for processing heavy crude into clean fuels. However, in the second half of the 2000s, Latin American (especially Mexican) heavy crude production began to fall. Meanwhile, the first signs of the U.S. light tight oil (LTO) boom began in the Bakken around 2007, but didn’t really pick up until after the great recession in 2010. Addtionally, pipeline constraints have made it difficult to move Canadian heavy crude to U.S. Gulf Coast refineries. This gave U.S. refiners access to growing volumes of discounted LTO and reversed the longstanding trend of the U.S. crude diet getting heavier and heavier. This data is presented in the graph below.
“But if you try sometime you find you get what you need” –
Despite a brief lull after the oil price crash, the U.S. LTO boom shows no signs of stopping and all of this crude will need to find a home. Thankfully, the U.S. now has the ability to export this crude instead of requiring it to be processed in a U.S. refining system designed for a much heavier slate. Still, most Gulf Coast refiners are at or near a limit in terms of the amount of LTO they can process due to economic incentives that favor processing large volumes of LTO. Therefore, virtually all additional LTO production will continue to go to exports, which have recently been consistently above 2 MMBPD already. At the same time, Enbridge’s Line 3 replacement (which will likely be coupled with a reversal of the Capline pipeline to St. James, LA) and TransCanada’s Keystone XL are looking increasing likely as compared to Kinder Morgan’s TransMountain loop, providing improved access to Canadian heavy crude for Gulf Coast refiners. Furthermore, the adoption of the 0.5% S IMO Bunker rules in 2020 look to be a major boon for most U.S. Gulf Refiners as most have significant coking capacity and already do not sell much product into the bunker fuel market. Additionally, these new regulations will widen the light/heavy and sweet/sour differentials, the latter of which has become all but irrelevant in an era of low sulfur transportation fuels in most of the world. This will increase the value of U.S. LTO in the global market and decrease the value of many medium sour crudes from the Gulf of Mexico and Middle East, which are ideal crudes for many Gulf Coast refiners. Currently, most of the medium-heavy sour Middle Eastern crudes go to Asia and Europe, and many of the refiners in these regions do not have resid upgrading capability and produce large volumes of high sulfur bunker fuel as a result. As many of these refiners switch to a sweeter crude diet in 2020, we expect increased volumes of medium-heavy Middle Eastern sour crudes to find their way to U.S. Gulf Coast coking refineries. The chart below details the relative values of some crudes from varying areas of the world in 2020 as compared to today in a cracking refinery with now resid upgrading capability. Note that a very small volume of unique heavy sweet crudes will see their value rise significantly due to the new IMO regulations.
Turner Mason & Company analyzes the impacts of changes in crude supply, refinery investment, logistics developments, regulations and other factors and events that impact crude availability and refiner’s crude slates. We recently released our Crude and Refined Products Outlook which looks closely at the midstream sector. In The Outlook, we take a look at crude pipeline projects as well as other midstream trends and likely impacts of the 2020 IMO regulations. We take that analysis and overlay that with our crude production forecasts to see the impact that potential over or underbuild scenarios may have on crude supply and production. For more information on this or our other publications, or if we can provide any other specific consulting services for you, please feel free to contact us.