2004: Sign of the Future for Refiners?

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2004 Sign of the Future for Refiners?

• Joanne Shore
• John Hackworth
• Energy Information Administration
• NPRA Annual Meeting
• March 2005

www.eia.doe.gov
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Perspective

• In the business world, the rearview mirror is
  always clearer than the windshield.
• Warren Buffet (1930- )
• The trouble with our times, is that the future
  is not what it used to be.
• Paul Valery (1871-1945)

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2004 A Year of Highs

• High Prices
• High Price Differentials
• High Margins

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Shifts in Crude Oil Price Levels
Source Bloomberg West Texas Intermediate Crude
Cushing spot price
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Shifts in Light-Heavy Crude Oil Price
Differentials
Source Bloomberg spot prices
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Shifts in Margins
Note 3-2-1- spread assumes 3 barrels of crude
oil produce 2 barrels of gasoline and 1 barrel of
distillate. Source Bloomberg spot prices Gulf
Coast conventional gasoline, No. 2 heating oil,
WTI
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Questions

• What drove crude prices up in 2004?
• What caused the light-heavy crude price
  differences to change in the short run?
• What role did refinery capacity and heavy crude
  oil production play in 2004 light-heavy crude oil
  price differentials?
• Are higher refinery margins going to continue in
  the future and what lies ahead for refinery
  capacity?

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Drivers Behind Crude Price Increases

• Tight markets Demand outpacing supply
• Little spare crude oil production capacity

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Significant OPEC Production Growth Required in
2004-6 To Balance Demand
Annual World Oil Demand Growth
Annual Non-OPEC Capacity Growth
Source EIA Forecast Short-Term Energy Outlook,
February 2005
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World Market Balance was Tight, But Similar to
2003
Venezuela
Source International Energy Agency, Data Base
2/10/05
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Surplus Crude Oil Production Capacity Shrank in
2004
Source EIA Estimates
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Available Crude Capacity Affects Price
Source Bloomberg WTI Spot April 1999-Jan 2005
EIA Calculations
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Surplus Crude Oil Production Capacity
Inventories Explain Price
Source EIA
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Questions

• What drove crude prices up in 2004?
• What caused the light-heavy crude price
  differences to change in the short run?
• What role did refinery capacity and heavy crude
  oil production play in 2004 light-heavy crude oil
  price differentials?
• Are higher refinery margins going to continue in
  the future and what lies ahead for refinery
  capacity?

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General Market Factors Affecting Differentials
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Heavy vs. Light Price Differentials Rise As Crude
Price Rises
Light Product Prices Increase
Light Crude Oil Prices Increase Most
Crude Oil Price Increases
Residual Fuel Prices Flat
Heavy Crude Oil Prices Increase Least
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Light-Heavy Product Price Difference Increases
with Crude Oil Price
Source Bloomberg spot price
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Light-Heavy Product Price Differential Crude
Oil Price
Source Bloomberg spot prices GC - Gulf Coast,
NWE-Northwest Europe ARA Barge, WTI West Texas
Intermediate Cushing
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Light-Heavy Crude Price Differential Crude Oil
Price
Source Bloomberg spot price
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Light-Heavy Price Differentials
Source Bloomberg spot price
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Questions

• What drove crude prices up in 2004?
• What caused the light-heavy crude price
  differences to change in the short run?
• What role did refinery capacity and heavy crude
  oil production play in 2004 light-heavy crude oil
  price differentials?
• Are higher refinery margins going to continue in
  the future and what lies ahead for refinery
  capacity?

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Theories on How Capacity Constraints Drove
Light-Heavy Differentials

• Overall world refining capacity limit
• Constraints on conversion capacity

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Theory on Overall Capacity Limit Constraints

• Assumption
• Light product demand is increasing
• World refining capacity is running at maximum
  utilization
• Refiners desire to substitute light for heavy
  crude oil
• But additional light crude oil not available

• Results
• Light product stocks drop sharply
• Price for light products rise sharply
• Product price pulls crude prices up and pulls
  light crude up more than heavy
• Additional heavy crude oil wont be used

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Evidence to Support Hitting Capacity Limits?

• Did light product stocks drop price spike?
• Any signs that incremental heavy crude oil
  production was not used?
• Was world refining running at maximum utilization?

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Is World Refining Capacity Running at Maximum
Levels?

• Sometimes world capacity compared to wrong demand
• Must look at regional refinery utilizations
• Will show that world capacity not at maximum
  utilization, but demand growth is outpacing
  capacity growth for the moment

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Asia is Where Major Increases in Refinery
Utilization is Occurring

• Asian utilization increased, but Asia varies
  immensely
• China and India are big demand drivers and are
  adding capacity (soon enough?)
• Singapore export center utilization increased

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Singapore Utilization Pattern
Source EIA, IEA, BP
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World Capacity Utilization Up But Not at Maximum
(Percent Inputs/Distillation Capacity)
U.S. utilization calculation uses gross inputs,
other regions utilizations use crude oil
inputs. Source EIA, IEA BP
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Theory Conversion Capacity Constraints Drove
Differentials

• Assumption
• Light product demand increasing
• Refinery conversion capacity running at maximum
  utilization
• Increased crude oil supply is heavy sour

• Results
• Demand for light crude oil increases
• Added heavy crude oil run without benefit of
  conversion
• Residual fuel oil yield increases
• Over-supply of residual fuel oil

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Evidence to Support Being at Refinery Conversion
Limits?

• U.S. Clues
• Did U.S. complex refiners increase light crude to
  maximize light products
• Did they experience a residual fuel yield
  penalty?
• World Clues
• Did world residual yields increase?
• Signs of a flood of residual supply?

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U.S. Refineries Run Range of Crude Oil Imports
Source Form EIA-814 includes refineries in
Virgin Islands Puerto Rico
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Signs of U.S. Preferring More Heavy as
Light-Heavy Differential Increased
Source Form EIA-814
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Complex Refiners Used More Heavy Sour As They
Optimize Multiple Crude Types
Source Form EIA-814
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Crude Mix Changed with Little Yield Impact
Source Form EIA-810
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Aggregate OECD Residual Fuel Yields Did Not
Increase
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Residual Fuel Oil Stock Build Not Overwhelming
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Still, Light Heavy Crude Price Differences Relate
to Refineries without Bottoms Upgrading
Hurricane
Sources Yields IEA Users Guide 2004 Spot
prices Bloomberg
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Crude Oil Price was Primary Factor in 2004
Differential Increase

• Increase in crude oil price with associated
  product value impacts is primary driver behind
  light-heavy crude oil price differentials in 2004
• U.S. data support economic choice to use more
  heavy crude oil as product values shifted
• Refiners with upgrading used more heavy sour
  crude oil and moved to slightly heavier crude oil
  mix overall
• Yet yields not affected much
• World data do not support refinery constraints
  with associated desire for light crude oil theory
• Residual yields not noticeably affected
• Stocks implied no insurmountable supply of
  residual fuel oil

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Questions

• What drove crude prices up in 2004?
• What caused the light-heavy crude price
  differences to change in the short run?
• What role did refinery capacity and heavy crude
  oil production play in 2004 light-heavy crude oil
  price differentials?
• Are higher refinery margins going to continue in
  the future what lies ahead for refinery
  capacity?

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Margins What Lies Ahead

• 2004 margins up but for how long?
• Future implications for refinery capacity

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Margins Relationship to Crude Price
Source Annual Average Bloomberg spot prices
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Future Implications

• Near Term
• Crude prices remain relatively high
• Thus, differentials margins remain strong
• Longer Term
• Future S/D uncertainties
• Thus differential margin uncertainties
• Policy uncertainties product quality demand

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U.S. Refinery Expansion

• U.S. refining likely to continue to expand
• But U.S. may also need increases in product
  imports
• Still, short-term financial incentives for
  expansion look favorable
• Continued short-term market tightness
• Product specifications may increase product
  import prices

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World Capacity Expansion

• While world is not out of capacity, there is a
  need for increases to continue to meet growing
  demand
• Expansion plans are being announced
• Valid concern over timing of completed expansions
  versus demand growth both in U.S. and abroad

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Upgrading Capacity Expansion Potential

• US upgrading capacity expansion
• Expanded more than in other parts of the world
• Generally done in partnership with heavy crude
  producers
• Still room for some more
• Asia upgrading capacity expansion
• Perhaps next major expansion area
• Required to meet growing light product demand
• Partnerships with Middle East?
• Europe upgrading capacity expansion
• Demand not growing strongly
• Demand/refinery output mismatch
• Need to destroy residual fuel (demand declining)

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Conclusion 1 Crude Oil Price was Prime Mover in
2004
Crude
Differentials
Margins
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Conclusion 2

• Refinery capacitys role in 2004 price dynamics
  was sometimes overstated, but new capacity is
  needed.
• Beware of over-simplifications that indicate
  crude oil-refinery mismatches are creating
  serious market bottlenecks.
• Margins and differentials should favor expansion
  in the short run.
• Expansion needs to be sooner rather than later,
  with U.S. dialogue balancing competing concerns
  of security, environment, and supply availability.

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