Are Refiners Entering a Golden Age or a Short Cycle?

1
Are Refiners Entering a Golden Age or a Short
Cycle?

• Global Refining Strategies 2007
• Barcelona, Spain
• April 2007
• Joanne Shore
• John Hackworth
• Energy Information Administration

www.eia.doe.gov
2
Short-Term Cycle or Golden Age?

• What has driven prices, margins, and light heavy
  price differentials to current high levels?
• How are these three variables related?
• What are the main drivers?
• How long might prices, margins, differentials
  stay elevated?

Source Bloomberg spot prices
3
Outline

• High Prices Crude Oil
• Drivers and Uncertainties Behind Margins and
  Differentials
• Other Supply/Demand Factors Affecting Future
  Petroleum Markets
• Energy Efficiency
• Biofuels
• Surge in Capacity Expansion Plans

4
The Main Factor Behind High Product Prices Crude
Oil Prices

• Strong Demand Growth
• Less Supply Growth
• Different Prospects for Future than seen in 1980

5
Today Little World Crude Oil Surplus Production
Capacity
Forecast
Source EIA Short Term Energy Outlook March 2007

6
Today See Typical Economic Relationship Between
Little Surplus Capacity and Price
Source Bloomberg WTI EIA Calculations
7
Prospects for Demand Correction Different than
Early 1980s Correction

• Fuel oil decline will not ease market pressure
  today as in early 1980s
• Easy fuel efficiency gains made in early 1980s
• Large Asian economies account for more growth
  today

Notes World Excluding FSU, Gasoline includes
aviation gasoline light distillate
feedstocks Source BP World Statistical Review
2006
8
Todays OPEC Non-OPEC Production Requirements
Different Than 1979-80
Source EIA Annual Monthly Energy Reviews.
9
Limited Prospects for Non-OPEC Crude Supply
Increases in Short Run
1960s
Known Reserve Access

• Fewer non-OPEC exploration prospects, field size
  declining
• Most efficient companies have limited access to
  known reserves
• Tar sands growth costly and slow

2004
Source Data from Business Week Online Slide
Show Why the Oil Giants Look Weaker
http//www.businessweek.com/magazine/content/06_20
/b3984001.htm May 15, 2006
10
Prices Expected to Remain Relatively High in
Short Term

• Future uncertain but could stay relatively high
• OPEC position has strengthened
• Demand growth has moderated only slightly
• No large surge in non-OPEC crude or other supply
  -- and costly
• Only OPEC can build excess capacity

Source EIA Short Term Energy Outlook March 2007
11
Drivers Uncertainties Behind Refinery Margins
and Differentials

• Margins
• Growing, but volatile
• Shift in gasoline and distillate contributions
• Refining utilization over-emphasized factor?
• Light-Heavy Differentials and the Importance of
  Crude oil Price
• Future Considerations

12
3-2-1 Spread (Margin Indicator) Grew with Crude
Price But Not Smoothly
WTI Spot
3-2-1 Spread
Source Bloomberg Spot Data Gulf Coast Gasoline,
No. 2 and WTI.
13
Distillate Cracks Increased More than Gasoline
Source Bloomberg spot prices Gulf Coast
Conventional No. 2 minus WTI
14
World Utilization Up, But Atlantic Basin
Utilization Not Changed Much Recently
Source BP World Statistics 2006 (crude
runs/capacity) and EIA Annual Energy Review
(gross inputs/capacity).
15
Light-Heavy Differentials Rose Since 2000, But
Will They Remain High?

• Product markets drive light-heavy product prices
• Impact of total product barrel value on crude
  value
• Differential Incentives for heavy-crude
  high-conversion refining

16
Light-Heavy Product Price Difference Increases
with Crude Oil Price
Source Bloomberg spot price
17
Light-Heavy Crude Price Differential Crude Oil
Price Move Together
Source Bloomberg spot prices
18
If WTI Drops from 70 to 40, Will Differential
Drop by 40 (17-10)?
Source Bloomberg WTI Cushing and Maya.
19
If WTI Drops from 70 to 40, Margin Relationship
Less Certain
Note Three hurricane months excluded (Aug-Oct
2006) Source Bloomberg Gulf Coast
product spot prices and WTI Cushing.
20
Bottom Line Crude Price Important Indicator of
Future Returns

• Rising price Increasing margins, increasing
  differentials
• Declining price Decreasing margins, decreasing
  differentials
• Price settles within a high price band
• Margins lose their boost from rising market
  dynamics, but may stay higher than seen in the
  1990s
• Differentials remain high -- even with more
  conversion capacity

21
Other Supply/Demand Factors Affecting Future
Petroleum Markets

• Demand
• Distillate/Gasoline Shift
• Energy Efficiency
• Supply
• Biofuels Reducing Need for Some Capacity
• Capacity Expansions Oversupply?

Source BP World Statistics 2006.
22
Demand Factors Impacting Future Atlantic Basin
Needs

• Europes growing imbalance between distillate
  gasoline
• U.S. continued growth in gasoline distillate
  with distillate growing more strongly
• Potential increase in efficiency requirements
  (greenhouse gas, energy security, etc.)
• Europes potential mandates
• U.S potential policy change
• Slow impacts

Note U.S. imports includes blending components.
2006 is based on January-October data.
Source IEA, EIA Petroleum Supply
Monthly Annual
23
Biofuels Changing Capacity Needs

• Europes biofuel interest increasing
• Biodiesel compatible with diesel capacity
  shortfall
• Ethanol in gasoline exacerbates over-supply
  situation
• U.S. seeing diminishing need for new gasoline
  capacity
• Increase in ethanol
• Increase in import availability from Europe

24
Refinery Capacity Poised for Major Expansions

• Incentives resulted in capacity investment plans
• Plans cover all areas
• Increased throughputs
• Increased use of low-quality heavy feedstocks
• Increased light product yields
• Upgrade to top quartile

25
U.S. Capacity Expansions 2007 through 2011 (KB/D)
Note Dist Crude distillation unit FCC Fluid
catalytic cracking HC Hydrocracking. Sources
Oil Gas Journal, company presentations,
Hydrocarbon Processing Boxscore
26
Capacity and Complexity Increases Through Next 5
Years
Note Dist Crude distillation FCC Fluid
catalytic cracking HC Hydrocracking.
Source EIA, FACTS, company
presentations, Oil and Gas Journal, Hydrocarbon
Processing Boxscore.
27
Complexity is Increasing
Down-Stream Capacity as Percent of Distillation
Capacity Jan 1, 2007 and Jan 1, 2012
Note FCC Fluid catalytic cracking HC
Hydrocracking.
28
Capacity and Consumption 5-Year Changes2007
through 2011
Sources Capacity see previous slides Demand
EIA, BP World Statistical World Review 2006,
FACTS, IEA
29
Not Surprising that Outlooks/Plans Vary
Sources Trade press articles, company
presentations and press releases.
30
Potential for Over or Under Expansion And Does
it Matter?

• Barring calamities
• In the next 2-3 years, capacity will likely
  remain tight
• In next 5-10 years, not likely to see
  utilizations drop to levels seen in early 1980s
  from expansion
• Expansion that reduces utilization several
  percentage points not likely to have much impact
  on margins
• Regionally, the highest risk for oversupply that
  might impact Atlantic Basin margins is in Middle
  East Atlantic Basin is not likely to over-expand
• Decrease in residual fuel supply from bottoms
  upgrading not likely to be enough to push
  residual fuel prices much closer to crude oil
  price and significantly reduce differentials.
  (Demand for residual fuel is declining.)
• Rising facility construction costs and biofuels
  use may reduce rate of facility expansion

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Looking Ahead Crude Price Factor

• Forecast Fluctuate in band much higher than
  during the 1990s (perhaps in the 60-70 range?)
• Margin impact
• Lose the boost from being in a rising market
• But still may support higher margins than in the
  1990s
• Light-Heavy differential impact
• Remain elevated
• Demand for residual fuel is shrinking (e.g.,
  bunker fuel market)
• Even with more conversion capacity destroying
  residual fuel supply, residual price not likely
  to rise more towards crude oil
• Uncertainty If crude oil prices fall, margins
  and differentials fall

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Looking Ahead Other Supply/Demand Factors

• Policies affecting biofuels and energy efficiency
• Biofuels impact supply mix and volume
• Ethanol use in U.S. reducing need for increased
  gasoline capacity, but U.S. still needs
  distillate capacity
• Biodiesel in Europe may help slow growing diesel
  supply gap, but ethanol in Europe adds to already
  excess gasoline supply
• Ultimate margin impact may be small affecting
  gasoline cracks more than distillate
• Energy efficiency improvements have slow impacts
  can adjust
• Will refinery expansion plans result in capacity
  oversupply?
• Seeing U.S. capacity plans shrink
• Largest potential for oversupply margin impact is
  in the Middle East, where could dampen European
  margins and thus Atlantic Basin margins some

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Short Cycle or Golden Age?
Maybe a Bronze Age...