Global refining could take some surprising turns, Fesharaki says

The US will remain the world’s leading petroleum product exporter to Latin America, but refineries in India, South Korea, and parts of China could provide fresh competition in Southeast Asia, a leading market observer said at the Center for Strategic & International Studies on Oct. 27.

“The US has the world’s best refining system, but other countries are getting close,” said Fereidun Fesharaki, founder and chairman of the Facts Global Energy consulting group. “India’s Reliance refinery is the largest and best-managed in the world. Part of China’s refining system is close to US quality. No one ever expected the Koreans to have better refineries than Europe. Latin American refineries are far behind. New Middle East refineries are state-of-the-art.”

In a wide-ranging presentation centered on refining as an overlooked link in energy security issues, Fesharaki said otherwise sophisticated analysts can underestimate its significance by concentrating too heavily on crude oil supplies, which are more susceptible to politics.

“Oil prices are defined by many factors. Refined product prices are mainly driven by economic growth,” Fesharaki said. “Production flows for crude are largely decided by refining. Refined product flows are heavily driven by environmental considerations, as well as storage and infrastructure. Moving crude is much easier than moving products.”

He said, “Crude oil is very political. Refined products aren’t. There’s no [Organization of Petroleum Exporting Countries] or other cartel for them. Margins are huge, particularly for conventional oil. Today, US Gulf Coast refined products are economic at $30/bbl feedstock prices.”

How much a refiner invests depends on the type of crude that a plant processes, he said. “Refiners basically are manufacturers. Crudes have many varieties. Refined products don’t, but governments have set environmental standards that have gone much further in affecting product prices than overt supply maneuvers ever did,” he said.

Conditions vary across US

Venezuelan President Hugo Chavez tried to punish the US by reducing heavy crude oil supplies to Gulf Coast refiners, but the processors responded by increasing imports from Alberta’s oil sands, Fesharaki said. “US refining economics turned upside down dramatically. Cracking has gone far, and upgrading has made Gulf Coast refining among the world’s best. Refineries in California are in more of a cocoon because environmentalists have blocked entries by international competitors with severe restrictions,” he observed.

US product imports have dropped by 40% in the last 10 years, largely US crude was cheaper than comparable overseas grades, and the discounts grew after the shale revolution, Fesharaki said. Refineries built to process heavier grades can handle lighter crudes too, and product exports climbed to 4.5 million b/d, primarily diesel fuel to Europe and everything to Latin America, he noted.

“US refined product exports are critical to the rest of the world. This country will export more and more refined products,” said Fesharaki. “There is a gasoline shortfall that only US refiners can meet, not only in Latin America but also in Asia. There could be a 5 million-b/d change in US product flows in the next 10 years. US refiners have made money, but life is not simple. Basically, the $10-15/bbl difference between Brent and [West Texas Intermediate benchmark crudes] has disappeared.”

He added, “It’s going to grow more complicated. Today, the International Maritime Organization moved to change bunkering regulations worldwide. Fuel oil will begin to die as a bunkering fuel.”

Fesharaki referred to the IMO’s Marine Environment Protection Committee’s vote several hours earlier to move implementation of a 0.5% global sulfur cap on marine fuel to 2020 from 2025. The decision could affect global markets dramatically, he said.

Industry was not consulted

“The 175 IMO countries signed this bill, and not one of them talked to anyone in the oil industry. All the diesel surpluses in the world are going to be blended into low-sulfur fuel oil. A lot of people will make money. A lot of people will lose money,” he said.

Fesharaki said new refining investments are concentrated east of the Suez Canal now. “We see significant closures in Japan, where the population is falling and demand could drop 40% between now and 2040. In Korea, no refineries are closing and higher quality products are being made. In Australia, there are no taxes because everybody has to drive such long distances. But all of the refineries are closing. About half of them should be gone by 2020. In China, new refineries are being built—all by the government,” he said.

“The world needs US refining. Investments are lagging behind. Capacity has to grow,” he said. “Markets in Asia and Latin America will be the best destination for US product exports. As a world oil market player, the US is more significant when it comes to products than when it comes to crude oil.”

Latin American countries’ failure to build refineries has given US product exports their biggest boost, Fesharaki said. “Demand for crude oil is climbing, but when we look at refineries under construction in Asia, there won’t be enough gasoline. If diesel fuel has nowhere to grow thanks to IMO regulations, it will begin to be mixed with fuel oil,” he said.

“The pattern we have seen before of continuous investment in refining has stopped for now,” said Fesharaki. “The private sector is unwilling to invest in it because the competition is mainly governments. Decisions there don’t go through a proper due diligence process. But governments in the Middle East have less money from their crude sales because prices are down. Some want to increase military spending instead.

“At the end of the day, refining is cyclical and margins are limited. But it’s a natural hedge. Upstream assets are better investments in the long-term, but companies like BP, Shell, and ExxonMobil all are hanging onto their refining assets,” he said.

Contact Nick Snow at nicks@pennwell.com.

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