Outlook: Where will refineries turn down in the economic downturn?

by Matthew V. Veazey

US refineries in the East Coast and Gulf Coast regions are particularly vulnerable to utilization cuts and will have to cut throughputs even further as a result of the economic downturn. That is the conclusion of a new report by the consulting firm Wood Mackenzie, "Where will refineries turn down in the economic downturn?"
The report compares refinery utilization rates in Europe with those on the Gulf Coast and East Coast in the US. Refiners in the US have cut utilization rates year-on-year in 2008 by 2.5 % on the Gulf Coast and 5 % on the East Coast; in contrast, the decrease on the opposite side of the Atlantic was a more modest 0.5 % during the same period. Note that the 2.5 % figure for the Gulf Coast excludes the impact of the September 2008 hurricanes.

Historically many refineries in the US have been geared up to maximize gasoline production. However, a potential global surplus of gasoline and falling US gasoline demand leave them more susceptible to utilizationcuts than their European counterparts, Wood Mackenzie argues.
"The US East Coast looks the most vulnerable region to lower utilization as this region has a high proportion of FCC refineries, which are currently geared towards gasoline production," said Alan Gelder, Head of Downstream Oil Americas for Wood Mackenzie. "We believe that these East Coast refineries are likely to continue to supply their immediate area -- most are located around the Philadelphia/New Jersey/Maryland area -- but are uncompetitive in supplying gasoline to other areas (such as New England and the southern Atlantic Coast states)."

In contrast, Gelder pointed out, European refineries offer a competitive advantage to supply these markets: the European diesel deficit protects them via stronger middle distillate prices. He explained that European middle distillate prices continued to rise until they were high enough to attract US refiners to switch yields to increase middle distillate exports to Europe.
According to Wood Mackenzie, new trade flows are being established across the Atlantic Basin as US refineries ship increasing volumes of diesel and gasoil to Europe.
"The big change in 2008 was that gasoil (and diesel) moved from being at broadly similar prices in the two markets, to a marked premium in North West Europe versus the US Gulf Coast, with the US becoming the marginal source of European diesel/gasoil imports," Gelder explained.

Demand decline
Overall, Wood Mackenzie forecasts demand to decline by around 1.1 mm bpd in the US and Europe between 2008 and 2010.
"At the same time, we forecast non-refinery supply in the US and Europe to grow by a combined 0.4 mm bpd over the same time period, mainly because of increased biofuels use," Gelder said. "Refining capacity in these regions is also forecast to grow by 0.9 mm bpd due to expansions of refineries, which will result in additional pressure on throughputs at existing capacity."

Gelder noted that demand should stabilize by 2010 but utilization should continue to fall through 2015 because non-refinery supply such as natural gas liquids (NGLs) and biofuels will continue to rise.
"It has become increasingly clear that oil demand growth in the 2008-2010 period will be slower than in recent years," said Gelder. "The impact of this is being felt all over the world, but nowhere more so than in the US and in Europe. In both these regions, oil demand will once again fall in 2009, leading to downward pressure on refining margins and crude throughputs."

Back to the seventies
Wood Mackenzie anticipates a substantial reduction of throughputs in the US and Europe will be necessary. Taking into account the additional impact of refining capacity additions, this equates to an average reduction in utilization of around 5 % in addition to the reduction already seen in 2008. Put another way, refineries that in recent years boasted utilization rates above 80 and even 90 % likely will retrench into 70-% territory.
According to US Department of Energy figures, the last time utilization hovered in the 70 %-80 % range was in September/October 2008 after hurricanes Gustav and Ike crippled refining capacity along the Gulf Coast. These natural disasters notwithstanding, one would need to look back to 1985/1986 to find sustained utilization rates below 80 % in the US.

Less complex refineries will likely be on the leading edge of utilization cuts, Gelder added.
"As demand falls, the impact on crude throughputs is felt first by those refiners with relatively simple capacity," he explained. "This is because simple refineries produce a higher proportion of relatively low-value products such as fuel oil, and therefore typically achieve weaker margins. Therefore, while more simple refineries are faced with poor margins and face the possibility of run cuts, the more complex refineries are likely to be able to maintain higher rates of utilization."

From demand-pull to supply-push
Because US demand for refined products peaked in 2007, there will be reduced gasoline demand in the short term as a result of better fuel efficiency, Gelder said. In the longer term, he contends that refiners will increasingly rationalize capacity in order to cope with a refining system that is "imbalanced."
He pointed out that many projects in the Atlantic Basin are already under construction and most likely will be completed. They may balance out this additional capacity by delaying the projects that are not so far along.

The market environment has shifted, Gelder said. He explained that it has gone from a "demand-pull" situation driven by imports into the US to a "supply-push" environment biased toward exports to Europe.
"We think it is a structural situation that will continue for a long time," he concluded.

Matthew V. Veazey is Editor-in-Chief of DownstreamToday.