Patrick Crow
Energy Policies Editor
Canadian refiners face large investments (27689 bytes) in the next few years to produce an array of cleaner fuels federal and provincial governments will require.
The Canadian Council of Ministers of the Environment (CCME) is examining how refiners should reformulate certain fuels to meet the nation's environmental goals. Its recommendations are expected in October.
Industry's representative, the Canadian Petroleum Products Institute (CPPI), has advised the ministers against a blanket approach to reformulation. It said mandates should be tailored to fit specific environmental problems in specific regions.
Because no one knows what CCME will decide, it is hard to figure refiners' costs, but most guesses are in the $1-3 billion (Canadian)/year range.
One analyst said, "Paying for new facilities will be difficult because returns are low and demand will stay flat, partly because refiners are under price pressure from U.S. competitors.
"Government and industry must agree to refinery improvements that can be financed from earnings in the marketplace."
The industry also is concerned about increasing competition from U.S. refiners.
Industry Canada has warned, "Environmental costs on their own do not put Canada at a competitive disadvantage with the U.S. The issue appears to be more one of (maintaining) Canadian petroleum industry viability resulting from large costs."
Canadian Refining Capacity, Utilization chart (28071 bytes)
THE NEED
Canadian refiners are quick to make key observations about air quality in their country: It has been improving during the past 20 years, and it is better than air quality in the U.S. So less will have to be done.
They say Canada does not have severe ozone problems like those that prompted the U.S. to require reformulated gasoline in some urban areas.
Industry Canada said the U.S. and Canada historically have approached environmental protection differently.
America has tended to set formal standards and regulations before full costs are known.
In Canada, "the federal government has focused on consultation and cooperation with the industry to achieve its environmental goals. This is in part due to the concurrent or shared federal-provincial division of environmental responsibility.
"Given Canada's largely voluntary approach, regional variations, and competitive considerations, exact requirements and timing of future Canadian environmental programs are difficult to forecast with any degree of certainty."
Canadian refineries, although sophisticated by world standards, generally are not as large or complex as those in the U.S.
Designed to run light, sweet crudes, Canadian refiners lack hydrofining capacity and the infrastructure that goes with it.
They did not invest in more complex technology during the 1980s to the same extent as American refiners because the Canadian government set the differential between light and heavy crude oil prices rather than allow market forces to set it. The differential was less than the open market spread and too low to justify major investments.
Also, Canada has greater demand for lower value-added products (distillates and heavy fuel oil) than the U.S. due to the mining and pulp paper industries and a higher proportion of heating oil consumption.
Industry Canada said, "Most refineries have considerable cracking capacity Few Canadian refineries operate cokers.
"It has been predicted for some time that relative prices would move in favor of refineries using heavier crude oils. But supplies of light oil have continued to be plentiful and, after rising for several years to a peak in 1991, heavy oil prices have since increased and light oil prices decreased."
Main Petroleum Products Average FOB Export Price chart (31999 bytes)
REFINERY ECONOMICS
Surplus refining capacity has been a problem in Canada for years. But the utilization rate-about 90% at present-has risen as plants have been mothballed.
Six refineries have closed in the past few years, but 24 are still in operation with combined capacity of 1,907,800 b/d. Of those, eight are very small, and two are mostly export plants.
In just 3 years - 1991 through 1993 - the downstream industry wrote off $1.1 billion in assets or almost 10% of the book value of its 1991 capital employed. The writeoffs mostly were closings of refineries.
National Energy Board data show demand for principal petroleum products in Canada averaged 1,427,600 b/d in 1994, up 2% from 1,394,800 b/d the previous year. Refinery production increased 3%.
Natural Resources Canada has predicted a 1.5%/year rate of demand growth to 2010. An industry group predicts growth will be 0.4%/year until 2000 and disappear after that.
Refiners' downstream revenues (net of federal excise taxes and provincial taxes) from the sale of oil products totaled $22.3 billion in 1991 before slipping to $20.7 billion in 1992 and $20.8 billion in 1993.
The most sophisticated refineries are mostly in Ontario, but because of geography and the North American Free Trade Agreement, more complex plants in the U.S. set regional products prices.
Industry Canada said, "The relative lack of complexity among Canadian refineries compared to U.S. refineries places considerable cost pressures on refineries in southern Ontario and Quebec whose margins are influenced by imported products from refineries with lower cost structure."
It noted gasoline prices are lower in the U.S. because of higher federal and provincial taxes in Canada, which represent about half the purchase price of gasoline.
COMPETITION EYED
An Industry Canada study of competition in the refining industry showed that products imports and flat demand have helped keep profts low.
Also, it noted, "Refiners can only recover in the marketplace the price allowed by the landed price of actual or potential imports in each region. Canadian refiners are 'price takers,' and there is no immediate short term link between refiners' expenses and their revenues."
Refiners will make large investments needed to upgrade plants "only if they believe there is a good prospect for a return to long term profitability."
In the past, Canadian refining profits have been held in check by a range of regulations and high excise taxes in relation to the U.S. Higher prices reduced domestic demand for products.
"Since 1985," Industry Canada said, "Canadian refined product prices reflect strong Canadian and potential import competition. Deregulation has fostered historically low petroleum product prices.
"Over as little time as a decade, the structure of the industry has been transformed, and only two major refinery centers survive, at Edmonton and in the Sarnia-Toronto region, and three minor centers in Montreal, the Atlantic region, and Vancouver.
"The industry remains subject to federal excise and provincial sales taxes on gasoline that far exceed U.S. taxes, but which are not out of line with taxes elsewhere. It also has been buffeted, possibly more than any other single industry, by a broad range of government policies.
"Since 1992 the refining petroleum industry has been coping with high costs and low profits generated by declining demand for refined products and low refinery utilization rates.",
The study said Canadian refiners face the threat of increasing imports, mostly in shipments from U.S. refiners who want to avoid making investments to meet U.S. product specifications and instead seek to supply the Canadian market.
Canadian plants are unlikely to ship much more refined product to the U.S., which receives almost 97% of Canadian product exports. The reason is that the more complex U.S. plants have greater flexibility in their choice of crude types and product slates.
RECOMMENDATIONS
Industry Canada recommended that the nation carefully consider its environmental agenda as it concerns refiners and view them as three industries: Atlantic, eastern, and western.
The report said Environment Canada, Transport Canada, and CPPI should develop a strategy for a consistent set of national fuel standards.
Dumping of off-spec product from other countries is a major concern of the Canadian industry and potentially represents a serious environmental problem.
Industry Canada said,"With standards in place, costs increase, but they do so for everyone and therefore tend to level the playing field internally and with respect to imports. National standards also provide greater potential for incremental cost recovery.
"In the absence of national standards, costs will be lower, but lower quality imports, especially from the U.S., may set product costs and harm Canadian competitiveness."
The report said governments should assess the effect of high taxes on demand for products and fuel tax fraud that results from high prices.
MINISTERS' STUDY
Environmental ministers are working in several areas to synchronize their efforts. They want to clarify federal and provincial roles eliminate duplication among programs, and make laws and rules more consistent across Canada.
One of the CCME task forces is trying to develop options for improved national standards for reduced auto emissions and for minimum reformulated fuels standards. The Cleaner Fuels and Vehicles Task Force is cochaired by the British Columbia and federal ministers.
Among the provinces, British Columbia has made some of the toughest proposals. It is unclear how the recent resignation of B.C. Environment Minister Moe Sihota will affect the process.
Refiners, auto manufacturers, and environmental groups are advising the task force, which has about 10 studies under way examining vehicle and fuel options.
The refining industry said CCME should focus on reducing gasoline vapor pressure in some regions, lowering benzene, and reducing sulfur in conventional gasoline.
Don Smith, environment and safety manager for Imperial Oil Ltd.'s products and chemical division, said, "Those three do a lot toward addressing the needs. We don't see a reason to go very far beyond that."
He is concerned that ministers might try to limit fine particulate emissions.
Smith said, "The contribution from fuels to these fine particulates is not really understood. It's far too early to be taking action to address these. This is an area where policy may get too far ahead of science."
CPPI STUDY
After the environment ministers launched their program, CPPI prepared its own fuel reformulation proposals.
Its paper warned against the mandatory use of oxygenates in gasoline. "Carbon monoxide levels in Canadian cities are well within accepted limits and continue to decline with the modernization of the automobile fleet. Reducing carbon monoxide levels through the use of oxygenated gasoline is therefore not a priority for Canada."
CPPI said governments should act to reduce photochemical smog in the Windsor-Montreal industrial corridor in Ontario, and the Lower Fraser Valley (Vancouver) region of British Columbia.
"While smog in these problem areas, as measured by the concentration of ozone, has diminished somewhat over the past several years, it does occasionally exceed 'acceptable' levels. Further action is warranted."
It recommended a reduction in summertime gasoline vapor pressure beginning in 1997 to 9 psi from 10.5 in the Windsor-Montreal corridor and to 8.5 psi from 9 in the Lower Fraser Valley.
It said additional action, such as
reducing gasoline sulfur to very low levels to reduce nitrogen oxide emissions, would achieve limited environmental benefits at very high cost.
"The next generation of even lower emitting vehicles is likely to emerge in the U.S. in the early 2000s. These cars will be so clean burning that any future attempts to tighten the (fuel) standards further will represent a major example of diminishing returns. The vehicle technology is likely to migrate to Canada with lower sulfur in gasoline being the likely implication."
CPPI called for reducing the benzene content in gasoline to I vol % by 1999 because it is believed to be toxic "even though benzene levels in Canadian air are declining and there are no data to suggest that current levels pose any health risk to Canadians."
Benzene now ranges from 1.7% to 1.9%.
CPPI recommended refiners be required to use deposit control additives in gasoline. It said scientists should gather better data on fine particulates, polycyclic organic matter, and diesel emission toxicity before changing the composition of diesel fuel.
And it said the government should require all diesel fuel burned on the road to be low sulfur fuel by Oct. 1, 1997, if market demand justifies the remaining expensive investments refiners must make.
CPPI said CCME should set one national regulatory framework for fuel standards capable of recognizing local or regional differences.
"In addition, CPPI believes that nontax instruments, such as permit trading, to achieve industry-wide fuel formulation requirements would provide an efficient market based approach to achieve environmental goals where it makes sense."
CPPI said the combined costs of its recommendations would be $185 million/year, or 36% of total 1993 downstream earnings, "a significant commitment by any measure."
MMT BAN
Federal Environmental Minister Sheila Copps said in March Ottawa will ban methylcyclopentadienyl manganese tricarbonyl (MMT), an octane enhancer, from gasoline.
The federal government recently introduced legislation to block imports of MMT and shipments between provinces. The government wants a law passed by August, but that may be optimistic.
Canadian refiners have used MMT for 18 years. They are allowed to use 18 mg/I. and have been averaging 9-11 mg.
The manufacturer of MMT, Ethyl Corp., recently won a U.S. appeals court ruling which upheld its efforts to sell the gasoline additive in the states (OGJ, Apr. 24, p. 32).
A Canadian ban on MMT is estimated to cost refiners $50 million/ year. CPPI members have offered to limit the maximum concentration of MMT in gasoline to 9 mg/ 1.
CPPI REPORT
A CPPI task force reported on the MMT issue last February.
It said, "While there are a number of specific aspects to the MMT controversy, the potential impacts of the additive focus primarily on three components of the engine and exhaust system: spark plugs, exhaust gas oxygen sensors, and catalytic converters.
"Each of these components plays a key role in the effective functioning of the new emission control performance monitoring systems known as onboard diagnostics."
The task force said about 80% of the MMT collects in the engine and exhaust system as manganese oxide. It said automakers' data shows these deposits are altering or interfering with functions of the emission control systems.
Ethyl presented conclusions from research and fleet testing that show no adverse effects and a significant environmental benefit in the form of lower nitrogen oxide emissions with MMT.
The CPPI task force concluded it could not reconcile the issue with the data available.
Canadian Petroleum Product Exports, 1994* chart (20141 bytes)
LOW SULFUR DISTILLATE
Canadian refiners have taken a significant step to reduce the use of distillate fuel containing sulfur.
In 1993, they signed a memorandum of understanding (MOU) with the minister of the environment to sell low sulfur (0.5%) diesel fuel at all service stations, truck stops, and on-road card locks and key locks beginning last Oct. 1. The agreement did not cover in-yard diesel fueling.
The action covers about one fourth of the Canadian diesel market. Only about half of the transportation sector is covered, and transportation accounts for only half of diesel consumption, with the other half used in off road by logging operations, mines, and the like.
CPPI said, "With the MOU, refiners have been and will be able to phase in investment in expensive sulfur treating equipment aligned with the growth in diesel engines requiring low sulfur diesel.
"Refiners do not want to invest for 100% on road low sulfur diesel significantly ahead of when the environmental benefits would be realized with new diesel engines. The CPPI believes the environmental benefits of supplying low sulfur diesel to old technology diesel engines is limited."
CPPI said it would advance the timing of I 00 % low sulfur diesel to Oct. 1, 1997, if by Oct. 1, 1995, "market demand for low sulfur diesel seems sufficiently robust to justify the remaining significant investments in sulfur treating equipment in refineries."
PIPELINE REVERSAL
Ontario refiners say reversal of Interprovincial Pipeline's segment between Sarnia and Montreal could improve the economics of operating their plants.
The line was built in 1976, with government support, to supply Montreal plants with western Canada crude.
Shipments on the 20-in., 300,000 b / d capacity line stopped for a while in 1991 and are only 15,000-20,000 b/d at present.
Crude from western Canada competes at Sarnia with crude moved by U.S. pipelines to the Chicago area.
Industry Canada said, "The Chicago market tends to be the major clearing center for Canadian crude production, where Canadian and U.S. crudes compete directly for market share. Changes in U.S. crude prices are immediately reflected in Canadian crude prices."
Ontario refiners think reversing the Interprovincial segment would give them more supply options, especially if production from Alberta drops or becomes heavier and if they cannot get crude because Gulf Coast-Chicago pipelines are full. Ontario refiners have been using imports via the U.S. for 5% of their crude supply.
One refiner said for 4-5 months last year, imported crudes via the U.S. were cheaper in Sarnia than domestic crude. "Within 2 or 3 or 4 years there will be an economic incentive to reverse the Sarnia to Montreal pipeline."
THE FUTURE
Apart from CCEM's effort to improve fuels, Environment Canada is assessing air and water pollution issues.
It is preparing a pollutants release inventory that will catalog emissions data for 178 substances. Government will use the report, due this summer, to bolster efforts to reduce potentially harmful emissions.
As a result of the Industry Canada report on competition, forecasters from government, industry, and outside firms recently met to discuss ways to develop petroleum demand forecasts that industry and government can support.
Although no one can predict what CCEM will decide on cleaner fuels, analysts believe it will require at least what CCPI has recommended.
That includes reducing the summertime vapor pressure of gasoline in the Windsor-Montreal and Lower Fraser Valley regions, cutting benzene in gasoline, further lowering sulfur in diesel, and requiring gasoline additives.
Analysts noted that this week marks the 10th anniversary of Canadian crude oil and products price decontrol, an event that began an era of surplus capacity, fluctuating crude prices, and slim profits. They said the next decade could be equally traumatic as the refining industry adjusts to costly environmental mandates.
Copyright 1995 Oil & Gas Journal. All Rights Reserved.
