2019 is shaping up to be a year of volatility for the downstream industry as crude prices, product demand, and export markets are all expected to make headlines as the industry marches towards IMO low sulfur regulations set for Jan 1, 2020. In our first issue of the blog this year, we highlight key issues and risks we see for refiners this year.

Crude Prices:

We are entering 2019 with crude prices in a bear market, WTI crude having dropped from its 2018 highs of $75.3/bbl on October 1st to end the year at $45.8/bbl. With prices steadily rising throughout the first half of 2018, global crude supply continued to remain strong particularly US Lower 48 which saw production levels at the Permian reach 3.4mb/d through the first six months of 2018, 1 mb/d higher than the prior year period. Eventually, we ended the year in a crude oversupply environment which then began taking its toll on prices, and led to supply cuts of 1.2mb/d announced by OPEC and non-OPEC producers at a meeting in early December in an attempt to rebalance the market.

In 2019, we expect to see more volatility in crude prices. The first half of 2019 will see WTI crude prices continue to average between $40-$50/bbl as the supply overhang lingers on coupled with continued worries about a global economic slowdown. As we enter the second half of the year, we expect crude prices to strengthen as the market rebalances from the supply cuts and refinery runs increase in response to demand for light sweet crudes to meet IMO low sulfur fuel specifications.  A key risk we see on crude prices is the role of OPEC in managing global supply. How will OPEC and other allies respond to falling or surging prices during 2019 in its desire to maintain stability in energy markets? Also, how resilient will L48 supply continue to be in the face of a prolonged decline in crude prices?

Refined Product Demand:

We do not expect much demand growth increase during the first half of 2019 despite relatively lower crude prices compared to prior year period. With historically low U.S. unemployment rates already, along with lower forecast for economic growth next year, we see lower overall product demand growth. Gasoline and distillate markets are expected to diverge from one another as gasoline markets globally are expected to be in surplus from lower demand and higher crude runs, while distillate markets will gain strength from higher demand resulting from the IMO fuel specification change. While expectations for transport fuel demand are flat to modest growth, we see continued increase in petrochemical demand from new ethane crackers being built in the US Gulf Coast and other regions around the world.

We see two main risks to product demand in 2019. First, how will demand respond to the crude price volatility we expect next year, especially if we remain in a lower crude price environment for a prolonged period of time? Another key risk we see is on the forecast for economic growth. With trade tensions between the U.S. and China still creating uncertainties in the financial markets, and the threat of higher tariffs still a real possibility, what will the global economy in 2019 look like and what impact will that have on demand for refined products?

Crude Differentials:

2018 saw favorable crude differentials for US refiners, with the Brent-WTI spread averaging $6/bbl, providing margin uplift for most refineries processing domestic light sweet crudes. This differential was higher than prior year, driven by pipeline constraints impacting the price of WTI at certain times during the year. In 2019, we expect the Brent-WTI spread to widen further as crude pipeline takeaway capacity out of the Permian continues to lag growing production.

Speaking of pipelines, Canadian producers have had a difficult 2018 as a lack of available pipelines continues to constraint options for them to deliver crude to refining markets. The WTI-WCS differential averaged $27.8/bbl in 2018, driven by sustained weakness of WCS pricing at Hardisty from refinery outages in PADD II and lack of pipeline optionality to evacuate heavy crudes. The pain felt from producers was enough for the Alberta Premier to announce on December 2 a production cut of 325kb/d of heavy crude supply in an effort to prop up prices.

One risk we see on crude differentials is heavy crude supply from Venezuela and Mexico. Declining output from these producing countries and a lack of sufficient takeaway capacity from Canada could further impact light-heavy spreads particularly as US Gulf Coast refiners look to maximize heavy crude processing in light of the upcoming IMO fuel specification change. Another development to watch for is timing of the Line 3 replacement which is scheduled for end of 2019. Delays to the startup of this line could prolong the impact on the WTI-WCS differential.

Crude & Product Exports:

2018 was a record year for US crude exports with weekly averages of 2.3mb/d achieved during the last 3 months of the year. US light sweet crude exports to Europe and Asia have been steadily growing since 2017 as higher gasoline yields have been favorable in cracking configurations in those regions. Exports have also replaced declining light crude production in those markets. In 2019, we expect crude exports to continue growing as production from the Permian continues its upward trend, supported by growing export logistics on the US Gulf Coast.

Product exports were also strong in 2018 with PADD III refineries running at an average crude utilization rate of 94% to satisfy strong demand from Mexico and South America, which saw refinery utilization rates average 42% and 61% respectively last year. We expect exports to remain strong in 2019 as refineries in Latin America continue to struggle with low utilization rates and a potential slowdown in their economies.

Key risks to export markets for crude remains the continued trade tension between the US and China. In August of 2018, China halted purchases of US crudes in retaliation to tariffs imposed by the US, which reduced overall exports to Asia. Should trade tensions escalate in 2019 and result in higher tariffs, there could be a severe disruption in US crude exports to China, limiting a major destination market for US crudes. A key risk for product exports is an economic slowdown in Latin America which could impact demand for refined product imports. Recent elections in Mexico and Brazil and the continued political turmoil in Venezuela present risks to growth of refined product demand.

IMO 2020:

With exactly a year to go before the sulfur spec change goes into effect on January 1, 2020, refiners are preparing for the upcoming changes. With decades of investment in coking and hydrocracking capacity, the industry stands ready to maximize distillate fuels production and upgrade lower quality residual fuels. With the exception of a handful of IMO related capital investments, refiners are mainly tweaking their unit configurations to position themselves for optimal use of their assets.

During 2019, we expect to continue seeing more activities around low capital spend optimization projects designed to increase upgrading capacity through creep. We also expect more scrubbers being installed as the shipping industry also prepares for IMO 2020. The rate of scrubber addition could have the single biggest impact on how wide the distillate to fuel oil spread could be and how long it stays wide. As we monitor events throughout the year, we are also keeping a close eye on resid balances as excess resid competes with other substitution fuels in the power markets. We also expect feedstock competition in 2019 as FCC and Hydrocracker economics dictate availability and pricing of VGO.

We see a number of risks in the lead up to and after the implementation on Jan 1, 2020. First, ensuring consistency in compliance measures and enforcement procedures with penalties for non-compliance. Another key risk is on commercial distortions arising from compliance not being equally enforced across all markets. For instance, could crude supply be at risk if waiting on a shipment and counterparty is not following rules? Also, what approach will be taken to the use of waivers if compliant fuels are not available at bunker hubs or segregation of marine fuels is not feasible in port bunkering?

Turner, Mason & Company, continues to monitor developments in the crude, refining and midstream markets. Our latest views are being incorporated in our Crude & Refined Products and World Refining Construction Outlooks, which will be issued to clients with our 2019 publications in February and August. If you would like more information on this, or for any specific consulting engagements with which we may be able to assist, please go to our website and send us an email or give us a call at 214-754-0898.

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