2004: Sign of the Future for Refiners? Joanne Shore John Hackworth Energy Information Administration NPRA Annual Meeting March 2005

2004: Sign of the Future for Refiners?2004: Sign of the Future for Refiners?

Joanne Shore

John Hackworth

Energy Information Administration

NPRA Annual Meeting

March 2005

www.eia.doe.govwww.eia.doe.gov

PerspectivePerspective

“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)

2004: A Year of Highs2004: A Year of Highs

• High Prices• High Price

Differentials• High Margins

Shifts in Crude Oil Price LevelsShifts in Crude Oil Price Levels

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$/B

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$20 Midpoint

$30

$40+?

Monthly Average WTI Spot Price

Source: Bloomberg West Texas Intermediate Crude Cushing spot price

Shifts in Light-Heavy Crude Oil Price Shifts in Light-Heavy Crude Oil Price DifferentialsDifferentials

$0$2$4$6$8

$10$12$14$16$18$20

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WTI-MayaWTI-MarsWTI-WTS

Light-Heavy Crude Price Differentials

Source: Bloomberg spot prices

Shifts in MarginsShifts in Margins

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Annual Average

Gulf Coast 3-2-1 Spread (Simplified Gross Margin)

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

QuestionsQuestions

• 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?

Drivers Behind Crude Price IncreasesDrivers Behind Crude Price Increases

• Tight markets: Demand outpacing supply

• Little spare crude oil production capacity

Significant OPEC Production Growth Significant OPEC Production Growth Required in 2004-6 To Balance DemandRequired in 2004-6 To Balance Demand

0.0

0.5

1.0

1.5

2.0

2.5

3.0

2000 2001 2002 2003 2004 2005 2006

Mill

ion

Bar

rels

Per

Day

ForecastAnnual World Oil Demand Growth

Annual Non-OPEC Capacity Growth

Source: EIA; Forecast Short-Term Energy Outlook, February 2005

2.3

2.4

2.5

2.6

2.7

2.8

2.9

Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05

Bil

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ls

NOTE: Colored Band is Typical Stock Range (1998-2002Average +/- 7 year Standard Deviation)

OECD Commercial Petroleum Inventories

World Market Balance was Tight, But World Market Balance was Tight, But Similar to 2003Similar to 2003

Source: International Energy Agency, Data Base 2/10/05

Venezuela

Surplus Crude Oil Production Capacity Surplus Crude Oil Production Capacity Shrank in 2004Shrank in 2004

012345678

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-90

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Mill

ion

Bar

rels

Per

Day

OPEC Surplus Crude Oil Production Capacity

Source: EIA Estimates

Available Crude Capacity Affects PriceAvailable Crude Capacity Affects Price

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60

0 1 2 3 4 5 6 7 8

Surplus OPEC Capacity (MMB/D)

WT

I Pri

ce (

$/B

arre

l)WTI Crude Price vs. OPEC Surplus Crude Production Capacity

Source: Bloomberg WTI Spot April 1999-Jan 2005; EIA Calculations

Surplus Crude Oil Production Capacity Surplus Crude Oil Production Capacity & Inventories Explain Price& Inventories Explain Price

$0$5

$10$15$20$25$30$35$40$45$50$55

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WTI Actual

DynamicForecast

Monthly Average WTI Crude Oil Price

Source: EIA

QuestionsQuestions





General Market Factors Affecting General Market Factors Affecting DifferentialsDifferentials

Market Dimension

Crude Market

Supply of light vs. heavy, price level

Refining Capacity

Availability of conversion

Product Market

Residual fuel vs. light product markets

Heavy vs. Light Price Differentials Rise Heavy vs. Light Price Differentials Rise As Crude Price RisesAs Crude Price Rises

Crude Oil Price

Increases

Light Product Prices

Increase

Residual Fuel Prices “Flat”

Light Crude Oil Prices Increase

Most

Heavy Crude Oil Prices

Increase Least

Light-Heavy Product Price Difference Light-Heavy Product Price Difference Increases with Crude Oil PriceIncreases with Crude Oil Price

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$/B

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No. 2 Heating Oil Gulf Coast

WTI Crude Price

3% Resid Gulf Coast

Crude Oil, Distillate, Residual Fuel Prices

Source: Bloomberg spot price

Light-Heavy Product Price Differential Light-Heavy Product Price Differential & Crude Oil Price& Crude Oil Price

$0$5

$10$15$20$25$30$35$40$45$50$55

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GC No.2 - 3% S Resid

NWE No.2 - 3% S Resid

WTI Crude Price

Crude Price & Price Differentials

Source: Bloomberg spot prices – GC - Gulf Coast, NWE-Northwest Europe ARA Barge, WTI – West Texas Intermediate Cushing

Light-Heavy Crude Price Differential & Light-Heavy Crude Price Differential & Crude Oil PriceCrude Oil Price

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WTI Crude Price

Crude Price & Price Differential ($/Barrel)


Light-Heavy Price DifferentialsLight-Heavy Price Differentials

$0$4$8

$12$16$20$24$28$32$36

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Cru

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Dif

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No.2 - 3%S Resid

WTI-Maya

Crude and Product Price Differentials ($/Barrel)


QuestionsQuestions





Theories on How Capacity Constraints Theories on How Capacity Constraints Drove Light-Heavy DifferentialsDrove Light-Heavy Differentials

• Overall world refining capacity limit

• Constraints on conversion capacity

Theory on Overall Capacity Limit Theory on Overall Capacity Limit ConstraintsConstraints

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 won’t be used

Evidence to Support Hitting Capacity Evidence to Support Hitting Capacity Limits?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?

Is World Refining Capacity Running at Is World Refining Capacity Running at Maximum Levels?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

Asia is Where Major Increases in Asia is Where Major Increases in Refinery Utilization is OccurringRefinery 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

Singapore Utilization PatternSingapore Utilization Pattern

50556065707580859095

100Ja

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cen

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Capacity Utilization (Crude Inputs/Distillation)

Source: EIA, IEA, BP

World Capacity Utilization Up World Capacity Utilization Up But Not at Maximum But Not at Maximum

(Percent Inputs*/Distillation Capacity)(Percent Inputs*/Distillation Capacity)

1998 2003 2004

U.S. 95.5 92.5 92.8

EU-15 94.5 88.9 91.3

Latin America 81.4 74.4

Middle East 93.0 87.1

* U.S. utilization calculation uses gross inputs, other regions’ utilizations use crude oil inputs.

Source: EIA, IEA & BP

Theory: Conversion Capacity Theory: Conversion Capacity Constraints Drove DifferentialsConstraints 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

Evidence to Support Being at Refinery Evidence to Support Being at Refinery Conversion Limits? 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?

U.S. Refineries Run Range of Crude Oil U.S. Refineries Run Range of Crude Oil ImportsImports

0

500

1000

1500

2000

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3000

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4000

<10% 10-30%

30-50%

50-70%

70-90%

>90%

Refineries by Percent Sweet Imports

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ou

san

d B

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ls P

er D

ay

Hvy Sour

Med Sour

Lt Sour

Med+Hvy Swt

Lt Sweet

Individual Refinery Crude Import Mixes 2003

Source: Form EIA-814; includes refineries in Virgin Islands & Puerto Rico

Signs of U.S. Preferring More Heavy as Signs of U.S. Preferring More Heavy as Light-Heavy Differential IncreasedLight-Heavy Differential Increased

0%

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100%

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Mar

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Ap

r-04

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Sep

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Med Sour

Lt Sour

Med+Hvy Swt

Lt Sweet

Crude Imports for a Mixed-Crude Company

Source: Form EIA-814

Complex Refiners Used More Heavy Sour As Complex Refiners Used More Heavy Sour As They Optimize Multiple Crude TypesThey Optimize Multiple Crude Types

21.1 21.1

11.1 9.0

18.4 20.0

14.5 10.0

34.9 39.9

0%

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100%

2003 2004 Jan-Oct

Heavy Sour

Medium Sour

Light Sour

Medium & HeavySweet

Light Sweet

9 Gulf Coast Refineries Using Mixed Crudes


Crude Mix Changed with Little Yield Crude Mix Changed with Little Yield ImpactImpact

Product Yields for 9 Gulf Coast Refiners Using Mixed Crude Oils

Yields 2003 Jan-Nov 2004 Jan-Nov

Gasoline 49.8 50.2

Light Products 80.5 80.9

Residual Fuel Oil 3.3 3.8


Aggregate OECD Residual Fuel Yields Aggregate OECD Residual Fuel Yields Did Not IncreaseDid Not Increase

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Yie

ld (

Per

cen

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Residual Fuel Oil Yield (Productinon/Crude Input)

OECD Asia

OECD Europe

North America

Residual Fuel Oil Stock Build Not Residual Fuel Oil Stock Build Not OverwhelmingOverwhelming

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Residual Fuel Inventories (Month End)

OECD Asia

OECD Europe

North America

Still, Light Heavy Crude Price Differences Relate Still, Light Heavy Crude Price Differences Relate to Refineries without Bottoms Upgrading to Refineries without Bottoms Upgrading

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LLS-Mars

Cracking Refinery ProductWorth: LLS- Mars

Price & Value Differences

Hurricane

Sources: Yields – IEA Users Guide 2004; Spot prices Bloomberg

Crude Oil Price was Primary Factor in Crude Oil Price was Primary Factor in 2004 Differential Increase2004 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

QuestionsQuestions




• Are higher refinery margins going to continue in the future & what lies ahead for refinery capacity?

Margins & What Lies AheadMargins & What Lies Ahead

• 2004 margins up – but for how long?

• Future implications for refinery capacity

Margin’s Relationship to Crude PriceMargin’s Relationship to Crude Price

0

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30

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4519

91

1993

1995

1997

1999

2001

2003

$/B

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WTI

GC 3-2-1 Spread

Annual Average WTI and Gulf Coast 3-2-1 Spread

Source: Annual Average Bloomberg spot prices

Future ImplicationsFuture 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

U.S. Refinery ExpansionU.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

World Capacity ExpansionWorld 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

Upgrading Capacity Expansion Upgrading Capacity Expansion PotentialPotential

• 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)

Conclusion 1 Conclusion 1 Crude Oil Price was Prime Crude Oil Price was Prime

Mover in 2004Mover in 2004

Crude

Margins

Differentials

Conclusion 2Conclusion 2

• Refinery capacity’s 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.

Documents

2004: Sign of the Future for Refiners? Joanne Shore John Hackworth Energy Information Administration NPRA Annual Meeting March 2005