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Omar Mawji

Omar Mawji

Omar Mawji was previously an investment analyst at Katusa Research in Vancouver. He also served as the lead oil & gas analyst for institutional investors…

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Inside The World’s Most Sophisticated Refining Industry

Corpus Refinery

Over the past 5 years, focus on the U.S. oil & gas sector has centered around oil production from the U.S. shale revolution while neglecting, arguably, the most important part of the US oil & gas sector: U.S. refining. The shale revolution may have put the U.S. in the top 3 oil producers in the world, but the U.S. already has the top spot with the world’s largest and most sophisticated refining industry.

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In terms of size, China’s refining industry comes closest to the U.S. with over 15 million barrels per day (bbl/d) of refining capacity, but the industry operates at less than 75 percent utilization. The low utilization of Chinese refineries is because 3.5-4.5 million bbl/d of refining is done by independent “teapot” refineries that operate at 30 percent-60 percent capacity. These teapot refineries are inefficient and propped up by government regulations.

In terms of sophistication, South Korea’s industry is the closest competitor to the U.S., however, economics force refineries to operate at near full capacity. Operating at full capacity forced South Korea to export more than 1.3 million bbl/d of refined oil products in 2016 and it creates dramatic volatility in the profit margins of South Korean refiners when oil prices spike.

The combination of the U.S.’ size and sophistication puts its refining industry in a league of its own and that is not expected to change. U.S. history has helped build a diverse set of privately-owned refineries and infrastructure able to take on diverse types of crude oil and turn those into higher valued refined oil products.

The U.S. Shale Revolution: Lightening the Load

The U.S. shale revolution does have its place in this story. U.S. shale production brought a flood of light sweet oil to the domestic market and completely changed the landscape for U.S. refiners (the lighter from heavy the oil, the lower the viscosity and the sweeter from sour the oil, the lower the sulfur content).

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While the U.S. shale revolution increased total U.S. production by 65 percent from 2009, crude oil imports fell by only 11 percent. The shale revolution allowed the U.S. to replace light sweet crude oil imports from Nigeria, Angola, and Algeria with domestic shale production. Additionally, refiners re-configured some refineries to take on light sweet crude. However, just like not all crude oil is the same, not all refineries are the same.

Historically, much of the oil imported by the U.S. was from Venezuela and Mexico. Latin America was a primary supplier of heavy sour oil to regional U.S. markets, referred to as PADDs, where most refineries in the Gulf Coast, Midwest, and West Coast could refine their heavy oil. As the U.S. light oil revolution started in 2011, heavy oil imports have increase by 11 percent to 2016, but this time most of the heavy oil supplies are coming from Canada.

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Lucky Loonie

Call it luck or destiny, but the U.S. shale revolution came just in time. As an important heavy oil supplier to U.S. refiners, Canada’s Oil Sands producers were looking for ultra-light oil imports from Qatar and Australia to blend with its heavy oil so it could send more of its oil through pipelines into the U.S. market. During that time, the U.S. shale revolution began producing an abundance of ultra-light oil perfect to blend with heavy oil from the Oil Sands. This was the start of an intricate ballet of crude movement between the two countries.

The U.S. would send its ultra-light crude oil from shale formations up to Canada and Canadian producers would blend that ultra-light oil with heavy crude from Canada’s Oil Sands. The increase in ultra-light oil from shale formations helped Canadian producers boost Oil Sands production and supply more heavy oil through pipelines, trains, and barges to U.S. refiners. At the refinery, the U.S. would either refine the blend from Canada or strip the ultra-light crude from the blend and re-send the product to Canada to repeat the process.

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The mutual exchange of resources between the U.S. and Canada and the fact that Canada’s oil market was isolated from exporting across the Pacific and Atlantic Oceans helped U.S. refiners switch from Latin American to Canadian heavy oil. Canada’s isolation from international markets has made Canadian heavy crude oil the cheapest source of heavy oil delivered to U.S. refiners.

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U.S. Petroleum Power

Oil is a crucial product for energy security, but transport vehicles do not run on crude oil. A country without a refinery has no use for crude oil and, thus, must import petroleum products to ensure energy security. Countries with abundant oil production that lack domestic refinery throughput, like Canada and Mexico, are left to import petroleum products from the U.S.

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Much of the U.S.’ gasoline exports head to markets in Latin America and the U.S.’ liquified petroleum gas (LPG) exports, also known as propane and butane, are sent to the Asia Pacific. The U.S.’ advantage of diversification of refining capacity allows refiners to produce differing yields of petroleum products based on the crude oil processed. Light oil refiners produce much heavier residual fuels over heavy refiners which have additional infrastructure like cokers used to reformulate residual fuels from heavy oil into higher value light fuels like gasoline and diesel.

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There is approximately 13.5 million bbls/d of refining capacity in the U.S. with coker units which is a good indication as to the heavy/medium sour refining capacity in the U.S. Most of this capacity is in the Gulf Coast, followed by the Midwest and West Coast.

As the shale revolution took flight, the US had a stable source of light sweet oil. Additionally, Canada provides a stable source of heavy and medium crude – providing the US with 47 percent of its heavy crude and 29 percent of its medium crude imports in 2016. With cheap crude oil inputs, a large sophisticated refining industry, and shipping access to markets in the Asia-Pacific, Europe, and Latin America, the U.S. has transformed into a net exporter of petroleum products.

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Related: Big Oil Is Making Enormous Efficiency Gains

A Couple Keys to US Refining Dominance

1. IOCs vs. NOCs

There are several changes in the global refining industry that have made and ensured the U.S. as the top refiner to the world. Historically, the U.S. refining industry was built by several international oil companies (IOCs) to balance the effect of price volatility from oil production. As oil prices fell sharply, oil producers would make less from selling crude oil but make more money from refining oil into less price sensitive petroleum products.

However, over the past decade, the world has seen IOCs spin off or sell off their refining units as the industry has become saturated with refiners. Currently, the refineries being added to the global market are being constructed by national oil companies (NOCs) which do not always prioritize refinery economics over energy security. Even as NOCs bring online a couple oil refineries in 2017/2018, the number of new refineries built in the future will not be able to keep up with global demand for refined oil products. Someone is going to have to balance the market and that will fall on net exporters of petroleum products like the U.S.

2. The Al-Naimi Effect

Back in 2005, the former Saudi Arabian Minister of Petroleum and Mineral Resources, Ali Al-Naimi, warned the world that light oil benchmarks like Brent are going to remain high until oil consuming countries can build refineries that can absorb more heavy/medium crude grades. While the US was a step ahead of the calls by Al-Naimi, countries in the Asia Pacific began building refineries to take on more heavy/medium crude oil grades.

In concert with the Asia Pacific’s oil consuming countries, Saudi Arabia had built refineries that process around 1.2 million bbl/d of their own medium/heavy crude. Al-Naimi’s comments and Saudi’s actions served to tighten the supply for heavy/medium crude globally and allow Saudi heavy/medium crude to access customers through refined oil product exports to countries without heavy/medium crude refining capacity. This trend has served its purpose in tightening heavy/medium crude price differentials to the European Brent light oil benchmark.

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The tightening spreads are lowering profit margins (referred to in refining as a crack spread) a refiner can make from refining a barrel of oil into various petroleum products. Most heavy/medium crude oil refiners are likely to continue to feel the squeeze in margins unless they have exclusive sources of heavy/medium crude oil that is shut out from the rest of the world.

Guess what? The U.S. happens to be sheltered from these issues, because much of the country’s heavy/medium crude comes from Canada. While Canada continues to struggle accessing markets outside of the U.S., the U.S. will continue to refine the world’s cheapest heavy/medium crude grades from Canada even as global heavy/medium crude grades could start trading at par to light oil benchmarks like Brent. Canada’s biggest weakness is one of the U.S. refining industry’s strongest asset.

(Click to enlarge) Related: How A $200,000 Well Could Drastically Change The Oil Industry

U.S. Refiners: Balancing the World

As the largest oil refinery industry in the world and domestic demand for refined oil products leveling off, the U.S. will be a key player in the future of balancing global refined product supplies. Since 2005, the U.S. has transitioned from a net importer of petroleum products to a net exporter of petroleum products. With rising oil supplies and limited additions to refining capacity, the importance of the U.S. and its ability to refine oil into lighter products will help feed the future global supply in key markets like Latin America and Asia.

Meanwhile, major regional oil exporting countries to the U.S. like Mexico and Canada will continue to require U.S. ultra-light oil and refined oil products supplies to keep exporting their own crude oil to the U.S. and feed their own demand for refined oil products. Through a combination of U.S. history, geography, technology, and timing, the world will increasingly depend on the strongest U.S. oil & gas sector – its refining industry.

By Omar Mawji for Oilprice.com

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