Refined product demand outrunning U.S. capacity

Terrence S. Higgins
National Petrochemical & Refiners Association
Washington, D.C.

Meeting U.S. gasoline demand at the beginning of the next millennium will be a challenge. With current refining operations at maximum levels and traditional import levels somewhat flat, growth in demand must be met by nontraditional sources, for example, capacity expansions and imported reformulated products.

Future fuel-quality regulations will play a key role. Overly stringent regulations in the near term may preclude full development of new supply sources, create tight markets, and increase our vulnerability to market disruptions.

Low margins, high demand

Since the passage of the Clean Air Act Amendments of 1990, refiners have been faced with large capital requirements to meet environmental programs for both their products and manufacturing facilities.

The National Petroleum Council estimated that refiners were expected to invest about $37 billion over the period 1991-2000. Unfortunately, this period has been characterized by relatively low oil prices and low refining margins. Not surprisingly, the refining industry responded with major restructuring and limited capacity expansions.

Over the same period, low oil prices and a strong economy have led to continued growth in petroleum-product demand. U.S. demand increased over 1.4%/year from 1990 to 1997, with more highly refined products (gasoline, jet fuel, and distillates) increasing by slightly more.

The U.S. is gravitating towards a situation in which demand for refined products is overtaking the capability of traditional supply sources. Refined products demand is projected to continue at a marginally lower but still somewhat substantial rate over the next 3-10 years.

The increase in gasoline demand over the next 7 years, i.e., about 900,000 b/d, is likely to exceed the growth seen over the 1990-97 timeframe. With existing refining capacity essentially full, the U.S. will have to find additional sources to cover the incremental demand.

Supply history

Table 1 [77,910 bytes] summarizes the changes in U.S. refined product supply over the period of 1990-97. Domestic production increased by over 12%, but net imports declined by nearly 25%. The net 10% increase in product supply came almost exclusively from U.S. refineries.

Table 2 [44,196 bytes] provides a snapshot of changes in refinery capacity and utilization during this period. Capacity remained relatively stable, and refiners boosted products by increasing utilization of existing facilities.

Crude oil capacity remained relatively unchanged, while crude distillation input increased 1.2 million b/d to over 95% utilization. Capacities of major downstream conversion facilities, catalytic cracking and hydrocracking, increased slightly, by approximately 200,000 b/d, but combined input increased by over 600,000 b/d.

By 1997, both crude and catalytic cracking utilization were near maximum levels, that is, both over 90% for the year. In a recent review of 1997 summer gasoline production, the Energy Information Administration (EIA) concluded its "...analysis provided clear indications that summer 1997, gasoline production from U.S. refineries was approaching the upper limit." Utilization of crude, catalytic cracking, and hydrocracking were 97.7%, 94.7%, and 92.7%, respectively, from May through August.

Table 3 [39,194 bytes] takes a look at gasoline supplies over the 1990-97 period. It shows contribution of refinery processes to gasoline production and changes in oxygenated and imported gasoline component blending.

Gasoline production increased by 903,000 b/d over the 1990-97 period. Roughly 640,000 b/d, or 71%, of the incremental gasoline was made available via increased refinery utilization. Oxygenates, driven primarily by the reformulated gasoline (RFG) program, contributed 185,000 b/d, or another 20%.

The remainder of the incremental gasoline production came from imported gasoline components. In terms of total U.S. gasoline supply, however, the imported components were offset by an almost identical reduction in net finished gasoline imports (Table 1).

Future sources

According to the EIA, refined product demand is expected to increase at a rate of about 1.4%/year through 2004 ( Table 4 [36,290 bytes]). During this period, refined product demand (about 1.9 million b/d) will actually exceed that of the prior 7-year period by 150,000 b/d.

For gasoline, the projected annual growth rate for 1997-2004 is slightly higher than that for 1990-97. Total volumetric growth is estimated to be over 900,000 b/d. This projected increase in gasoline demand is roughly equal to the increased refinery gasoline supply during the 1990-97 period.

Although the majority of incremental 1990-97 production came from increased utilization, it is doubtful that output from existing refining facilities can be increased significantly without major debottlenecking and expansion.

If met by only U.S. refineries of typical modern configurations, the increased demand requires a 12% increase, or an additional 1.9 million b/d, of crude distillation capacity with associated downstream capacity (690,000 b/d catalytic cracking, 170,000 b/d hydrocracking, and other alkylation, hydrotreating, and hydrogen processes). For new facilities, this represents a capital cost in the order of $10 billion.

Changing product yields to increase gasoline conversion capacity does not appear to be an option for future supplies. Demand for jet fuel and other distillates is projected to grow at a greater rate than that of gasoline. New crude units and new downstream facilities will be required by U.S. refineries to supply the incremental products.

As was the case the previous 7 years, oxygenates can also play a role in incremental gasoline supplies. Oxygenates have provided about 20% of the incremental U.S. gasoline production since 1990. Nearly all of the increased oxygenate supply, however, has been in response to the winter-oxygenate mandates and RFG requirements.

Increased oxygenate requirements for future RFG demand will likely be less than 25,000 b/d. Some additional use, however, may occur as a result of more stringent Phase 2 RFG specifications and the possible introduction of lower-sulfur gasolines. Under recent oxygenate economics, this is expected to result in about a 100,000 b/d increase in oxygenate use over the 1997-2004 period.

Imports of gasoline offer a likely source of additional incremental supplies. Areas outside of the U.S. have historically supplied product during peak periods of U.S. demand. Many areas outside of the U.S. have excess available capacity and have even experienced periods of surplus gasoline.

On a monthly basis, net imports of gasoline and gasoline-blending components have been as high as 550,000 b/d, but the maximum historic, annual import level of gasoline plus gasoline-blending components was only slightly above 400,000 b/d. Even the traditional peak import level is only about 150,000 b/d over the 1997 annual average, or about 16% of projected incremental U.S. gasoline required to meet demand growth through 2004.

In the future, gasoline quality could also limit the availability of imports. As U.S. specifications become more stringent, less volume on the world market will be compliant unless foreign refiners change their gasoline quality as well.

Gasoline production outside the U.S. is often lower in quality (higher sulfur and benzene). Other areas of the world are still going through lead phasedown or are considering their own gasoline reformulations, both of which will place additional demands on the availability of high-quality blending components abroad.

Barriers to future supplies

Existing environmental regulations and new fuel-related environmental initiatives exert pressures on U.S. refining flexibility and supply capability. Phase 2 RFG regulations, scheduled to become effective Jan. 1, 2000, will dramatically alter RFG quality, requiring further reductions in Rvp and sulfur content, along with possible changes in benzene, aromatics, olefins, and the percent of fuel evaporated at 200° F. and 300° F. (E200 and E300).

In addition to Phase 2 requirements, individual nonattainment areas are considering requirements for "boutique" low Rvp, low-sulfur fuels. Individually, such requirements may be small, but if the trend expands, supply capability will be further reduced. The boutique fuels can also have adverse impacts on the distribution system, limiting supply capability, particularly during peak demand or seasonal transition periods.

Recently, the U.S. Environmental Protection Agency (EPA) Office of Enforcement and Compliance Assurance announced its intention to change its enforcement policy, a move which would result in a substantial change in existing gasoline volatility and RFG regulations. Again, the result would dramatically limit domestic and imported gasoline supply capability.

In the case of Phase 2 RFG, operating flexibility will be reduced roughly in half under the announced enforcement policy. For other conventional gasoline, the changes in volatility regulations will back out additional high-volatility components from U.S. and imported gasoline.

Finally, impending gasoline-sulfur regulations will have potentially the most severe impact on gasoline supply capability. In response to environmental needs of states and EPA consideration of Tier 2 vehicle standards, the U.S. refining industry recently developed a proposal to reduce gasoline sulfur to about 50% of 1990 levels-reducing the sulfur to about 150 ppm from the 1990 average of about 340 ppm.

The petroleum industry's proposal will require roughly $3 billion in investment for sulfur-reduction facilities. This investment is beyond those required to expand and debottleneck facilities discussed above. Some refiners may not economically be capable of the required level of investment.

Fortunately, the industry proposal provides a regional approach which would be less restrictive for more rural areas often served by smaller, less-sophisticated refineries that are not now required to produce RFG. This will somewhat minimize their financial burden.

Automobile manufacturers, some states, and others have called for a nationwide reduction to 30-40 ppm from the 1990 average of about 340 ppm. A 30-40 ppm national fuel requirement would add about $6 billion to refiners' capital investment requirement, potentially raising the hurdle beyond the reach of a number of refineries. The 30-40 ppm nationwide proposal puts the full investment requirement on all refiners.

The impact of lower sulfur requirements on traditional gasoline imports would be significant. Most imported gasoline comes into PADD 1, which for the most part would be limited to 150 ppm under the industry proposal. Less than 50% of traditional imported volume would be suitable for import under the industry proposal.

Under a stringent 30-40 ppm limit, even less current imports would be suitable for the U.S. market. Given the average gasoline content outside the U.S., as well as in areas which now supply the U.S., no obvious traditional sources of 30-40 ppm gasoline are available.

In fact, the recent trend towards the use of blending components vs. finished gasoline imports may be an indication of limited higher-quality gasoline supplies. Continued or increased participation by international refineries in the U.S. gasoline market will require reformulation.

The Author