SPECIAL REPORT: Middle East condensate production will complicate refining operations

Aug. 27, 2007
Condensate production, especially in the Middle East, will rise substantially in the next few years.

Condensate production, especially in the Middle East, will rise substantially in the next few years. Some concerns about the effect of increased production on the marketability and prices of condensate have led producers to consider investing in condensate processing capacity as an alternative to being at the mercy of the condensate market.

This article examines how the condensate market is likely to develop and whether investments in processing are likely.

Definitions

Condensate is a generic term that many use to describe a variety of light petroleum streams that range from NGLs to light crude oil. Strictly speaking, a condensate is a mixture of hydrocarbons that exists in a gaseous state in an underground gas reservoir but condenses under atmospheric conditions.

This article principally addresses these condensates, which are extracted directly from well fluids (field condensates). It does not consider lighter natural gasoline-type condensates that are frequently recovered from gas-processing operations.

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To assist the definition, Fig. 1 shows a typical gas production and processing chain.

The definition of condensate became highly political within the Organization of Petroleum Exporting Countries because condensates do not fall within OPEC quotas. In 1998 OPEC agreed, for quota purposes, that 50° API was the break point between light crude oils and condensates.

Most condensates are used as refinery feedstocks for the manufacture of products for the fuels markets. Some condensates, however, particularly paraffinic condensates (those with high paraffin content), are suitable as feedstocks for the manufacture of ethylene. Paraffinic condensates used in this way compete with naphtha for this end-use market.

Condensate disposition

In essence, a condensate producer has three main disposition options. The condensate could be:

  • Commingled into a local crude oil stream.
  • Exported as a segregated stream.
  • Processed and the resulting products, mainly LPG, naphtha, and middle distillates from typical condensates, could be exported.

Commingling into crude oil is generally the favored option where possible. Most North Sea crude is handled this way. Condensate may enhance the value and marketability of a crude stream, although with limits.

If condensate addition results in a crude that becomes difficult to process because its yields of light ends or naphtha are too high or its yields of fuel oil are too low, then condensate addition can depress the value of the crude. If crude value is plotted vs. API, value tends to increase with increasing API, but this trend can reverse for crudes with API gravities in the mid and higher 40s.

Processing a condensate by simply splitting it, or splitting and treatment or other processing of the derived products, can be attractive in some circumstances. Certainly it limits condensate supply and produces products that can be sold into deep and established markets.

Finally, the condensate can be exported without any processing and treatment.

Supply outlook

The market for condensates is unusual within the oil industry because, like LPG, it is a supply-driven market. Most markets, including those for crude and most refined products, are demand-led. Condensate, however, is produced as a by-product of gas production and must be moved into the market.

In most cases, secure offtake is more important than price maximization. The question, therefore, for condensate is not whether there is sufficient supply, but whether there is sufficient capacity to absorb the condensate at reasonable prices.

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In 2006 gross worldwide production of field condensates was about 3.6 million b/d; 2.7 million b/d of this total was segregated. About 1.2 million b/d was processed locally and 1.5 million b/d was exported to other locations (Fig. 2).

Our outlook is for global condensate production to rise strongly, primarily due to increasing gas production. The Middle East is expected to account for more than half of this increase (Fig. 3).

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Considerable uncertainties surround this outlook. In particular, major uncertainty relates to the future development of gas-based projects in Qatar, given the current development moratorium and the timing and impact of Abu Dhabi’s sour gas project is also unclear.

Further uncertainty is due to the general difficulty of predicting how Iranian gas projects will develop and uncertainty concerning the extent to which the Saudi gas initiative will result in substantial increases in domestic gas and condensate produced.

Currently segregated condensate production accounts for about 3% of total refining industry feed on a global basis. Most of the remainder is crude. During 2005-20, segregated condensate production will increase to about 4.7 million b/d from about 2.1 million b/d, but this increase will still leave condensate as only around 5% of refinery intake by 2020 (Fig. 4).

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Because condensate is a relatively small proportion of total refinery intake, we have no doubt that condensate will continue to move into the market without undue difficulty. This is not to say, however, that this increase could not have pricing implications.

To a considerable degree, Middle East condensate exports have been sold to buyers that preferred to have some condensate in their feedstock slate. Typically such buyers would have a desire to boost naphtha yields, perhaps because of having associated ethylene-cracking operations.

When condensate production rises, it is likely that producers will have to sell condensate to refiners that have no specific interest in taking condensate and may need to be encouraged to do so by being offered a discount. In this context, a discount is defined as being a discount relative to the theoretical refining value of a condensate.

Condensate processing

The most basic condensate processing is simply to split the condensate through a simple distillation operation and carry out a minimal amount of treating, typically sweetening the LPG and naphtha that contain hydrogen sulfide. Historically, Asian market gas-oil sulfur specifications have been fairly lax, allowing untreated gas oil to be sold as finished product directly into the market.

European and US distillate markets are changing rapidly, however, with the European Union diesel market having to meet a 10-ppm specification by 2009. Although Asian distillate markets are in some cases lagging this trend, the overall shift towards low-sulfur products is ongoing. Fig. 5 shows that high-sulfur distillate demand should fall to 30% of total demand during the next 10 years from about 51% in 2006.

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Distillate hydrotreating is therefore a natural addition to a condensate-splitting project. Similarly, conversion of naphtha into gasoline may be an option, as would the use of naphtha as feedstock to an aromatics production facility or an ethylene cracker. Both of these options, however, are major investments that would dwarf that for a simple condensate splitter.

The extent to which a producer may wish to invest in condensate splitting or condensate refining will, to considerable degree, reflect how the whole condensate would be priced in the market.

Pricing, processing economics

Although some condensates may be used as direct feed to ethylene crackers, by far most condensates are unsuitable for this and will be used as refinery feedstocks. The price-setting mechanism for most condensates is therefore as competition to crudes as a refinery feedstock.

The refining value and, consequently, the market price of a condensate is generally higher than the refining value and market price of a typical light Middle East crude.

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Fig. 6 compares distillation yields for a typical condensate and Dubai crude.

A typical condensate consists of about 65% naphtha, 30% middle distillates, and 5% LPG. LPG is rarely higher than this because otherwise the condensate would be too volatile to ship in standard tankers. In contrast, these components account for around 57% of the yield of Dubai crude, with low-value fuel oil accounting for the remainder.

This simple distillation yield comparison shows why the value of condensate is typically higher than that of a typical crude. Also, the value difference between the two is sensitive to market price differentials between light products such as naphtha, gasoline, and middle distillates on the one side, and heavy fuel oil on the other. When oil prices rose and light-heavy price differentials widened in 2004-06, value differentials between typical Middle East condensates and typical Middle East light crudes, such as Dubai, widened to about $6/bbl from $2-3/bbl.

Naturally, simple distillate distillation yields do not tell the whole story. The chemical nature of condensate, crude, and individual cut qualities also affect values and, therefore, market prices. These are, however, generally of secondary importance in value terms.

Although refining values largely determine the price of condensates relative to crudes, another element is also significant. Refineries are generally designed to process crudes, not condensates. For most refiners, processing condensate as a high fraction of the feedstock slate is technically impossible.

Condensates include too much light material and too little heavy fuel oil. This overloads the overheads systems and inadequate heat input results. Typically, therefore, condensates must be coprocessed with crudes, with the condensate 10-20% of feed.

This means that condensate must be segregated and injected into a refinery feed stream on a ratable basis. This can tie up refinery tankage and reduce operating flexibility.

For a refiner without a specific desire to boost naphtha yields, this is typically an inconvenience that requires some incentive. The incentive is a market discount relative to refining value for the condensate.

An historical analysis shows that refiners in Asia interested in processing feedstocks with high naphtha yields typically processed Middle East condensates. These refiners are favorably inclined towards processing condensate and are willing to pay full refining value. When condensate production increases, it becomes necessary to market condensate to refiners without such interests. Market discounts are therefore likely to appear. With limited production, discounts are nonexistant or minor; these would deepen if production increased substantially.

Deep discounts are not sustainable. They would encourage refiners to invest in additional flexibility to process condensate and would also encourage condensate producers to invest in condensate processing facilities of their own. Long-term discounts are therefore expected but will not be severe.

The naphtha market also affects the pricing of condensates and specifically the extent to which a market discount will apply at any point in time. When the naphtha market is strong and naphtha buyers are concerned about supply security, condensate demand will increase and market discounts, if any, will decline.

The outlook for the naphtha market is also therefore important to the outlook for condensate markets. Asia is a huge importer of naphtha because its olefin business is largely naphtha-based, although the use of LPG feedstock is likely to increase.

Little distillate is used as olefin cracker feedstock in Asia. Naphtha accounts for about 80% of Asian ethylene cracker feed and Asia accounts for almost half of total global light naphtha demand.

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It is interesting to track the yield of naphtha from Asian refineries. Fig. 7 shows that this is approaching a level that represents the technical maximum yield of naphtha from the region’s refineries.

Demand for naphtha in Asia will continue to rise and refinery production will increase much more slowly; Asia naphtha imports will therefore surge during the next few years. During 2006-08, regional naphtha supply deficit will rise to 47 million tonnes from 29 million tonnes.

This will result in a firm short-term market for naphtha, and consequently good demand for condensate. In the slightly longer term, the market will ease due to increasing Middle East naphtha and condensate production and increased use of LPG feedstock in the Asian olefin cracking industry.

Clearly, these trends will have an important bearing on the economics of condensate processing investments. In the longer term, increasing condensate production will result in discounts relative to refining values, though not unduly deep discounts.

In the short term, firm naphtha and condensate markets are more likely; however, the factor not yet discussed is location. A location with local demand for products from a condensate processing operation will have a strong economic advantage compared with a location where most, if not all, of the products must be exported. This is simply a result of tanker transportation economics, which can result in FOB prices for exports of $20/tonne or more below the price at which product can be imported. (FOB: free-on-board; buyer pays freight and insurance costs.)

The most favorable circumstances for a condensate processing operation are for a location that has local condensate available (FOB pricing) and a local deficit in terms of product supply. A location that has the opposite situation will find it difficult to cover cash operating costs.

An extension of this analysis suggests that condensate processing should always occur in a product-importing location rather than a product-exporting location. Typically, condensate from the Middle East is transported to markets in Asia as part cargoes on very-large crude carriers (VLCCs), whereas products from refining and condensate processing operations are typically transported in smaller ships, normally long-range (LR-1; Panamax) and medium-range tankers.

In 2006, for example, transportation in a VLCC was cheaper than transportation in an LR-1 by as much as $1.50/bbl and cheaper than transportation in a medium-range tanker by as much as $2/bbl.

Future considerations

It is difficult to generalize about the attractiveness of condensate processing as a producer option. Location and the existence of local demand for products are important. Timing is also important-general levels of refining margins, which will affect condensate refining or processing margins, also vary with time, as do condensate market discounts and processing facility investment costs.

Investment costs are currently extremely high as a result of supply tightness for construction materials, equipment, and engineering and construction services.

A condensate producer may find local processing strategically desirable, particularly where it is important to guarantee the offtake of condensate. Although marketing condensate is not unduly difficult, selling finished products into deep, liquid product markets will be easier. In any case, a careful evaluation of project economics is clearly essential.

Finally, a conundrum related to condensate discounts must be recognized. If all produced condensate is sold into the market, discounts will occur at a certain level. If producers instead invest in a certain amount of condensate-processing capacity, discounts for the remaining condensate will be reduced. The resulting smaller discounts would then result in reduced returns on the investments made.

The optimum solution may be to encourage others to invest in condensate processing capacity, then to continue to sell condensate at close to its full refining value.

The authors

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Michael Corke ([email protected]) is senior vice-president and manager for Purvin & Gertz Inc., Dubai, responsible for the firm’s consulting activities in the Middle East. Before joining Purvin & Gertz’ London office in 1985, Corke worked for British Petroleum and Murphy Eastern Oil Co., a subsidiary of Murphy Oil Corp., where he was involved in oil trading, refinery construction, joint venture refinery management, and North Sea operations. He holds a BSc in chemical engineering from Leeds University, UK.

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Narayanaswamy Ravivenkatesh is an associate consultant for Purvin & Gertz Inc., Singapore, with responsibility for the firm’s Asian Petrochemical Feedstock Market Outlook service. Before joining Purvin & Gertz in 2005, Ravivenkatesh held numerous positions at ExxonMobil Corp.’s Singapore complex in refining, supply, and petrochemicals. He has also held various positions at Hindustan Petroleum Corp. Ltd. including field, process control, and shift supervisory roles. Ravivenkatesh holds a BE in chemical engineering from Bangalore University, India, and an MBA from Southern Illinois University.