US refiners have successfully managed a large number of product quality changes related to sulfur reduction while at the same time processing higher sulfur crude oils. Elemental sulfur itself has gyrated through a wild price cycle over the past 2 years.
More changes to US refined-product sulfur qualities are coming on the heels of gasoline and transportation diesel fuel improvements already implemented.
The largest impact will be in the marine sector, in which portions of traditional high-sulfur residual bunker will be replaced with distillate. More reductions are likely for Northeast US heating oil markets.
Sulfur pricing
Sulfur is considered a by-product of refining and not generally a valuable product. It is costly to remove from crude oil and certainly not sought after. As have many commodity prices, sulfur's has gone through a dramatic rise since 2003 and even sharper decline. Fig. 1 represents an estimate of the US Gulf Coast price based on a benchmark pricing source and adjusted for handling costs to remove the sulfur from the refinery.
Sulfur supply is relatively inelastic with most on-purpose production shutdown long ago and by-product sulfur accounting for the majority of supply. Historically, surplus sulfur was stockpiled in remote locations, such as Alberta, as the cost of transportation was more than the end-market value. Through midyear 2008, demand for sulfur rose steadily, driven by increased sulfuric acid and fertilizer demand in both the developed and developing markets.
Ethanol and biodiesel production accounted for part of the increase, but higher protein diets in developing markets form the primary driver. Increased demand reduced sulfur inventories, and remote stockpiles were depleted rapidly.
In response, sulfur prices rose quickly through 2007 and into 2008. The financial crisis in late 2008, however, pushed down sulfur prices sharply. The product now has little value and some refiners are paying to have sulfur removed from their plants.
Once the economy recovers, higher costs in the sulfur industry are likely to keep prices higher than historical levels, although lower than recent peaks. New supplies of sulfur from sour gas fields in Abu Dhabi and other Middle East locations could add major new supplies that would restrain any long-term price increases even as demand for sulfur remains strong.
Crude quality
From a refiner's perspective, the location of sulfur in the crude oil is important.
In most cases, sulfur is concentrated in the heavier distillations. Sulfur removal by hydroprocessing becomes increasingly difficult as boiling point increases, requiring higher pressure, temperature, and residence time. Fig. 2 illustrates the sulfur distributions for several benchmark crude oil grades.
As shown, the highest concentration of sulfur lies in the vacuum residue portion of the crude. While the US refining system is probably the most complex in the world, there are still substantial volumes of vacuum residue that are blended to fuel oil and bunker fuels.
Even as refining margins remain weak, product-quality requirements are shifting and nimble refiners will move to capture these opportunities. Before addressing the product quality, it's useful to consider refinery "supply" of sulfur by examining recent crude-quality changes.
Much has been made of the precipitous drop in Maya crude production, which is an important element of the US crude balance. As a result of the drop in US product demand and crude runs, refining crude residue yields have declined as the crude slate has lightened and as less crude is processed through the crude unit. An almost unthinkable result has occurred—spare coking units.
Along with drops in key Latin American supplies, Middle East production cuts alone have removed an estimated 280,000 b/d of vacuum residue from the global market this year through production cuts by the Organization of Petroleum Exporting Countries. This drop in heavy and sour crude supplies has had a similar impact on the refinery sulfur intake.
Fig. 3 shows calculated tons of sulfur in US refinery crude runs. The total sulfur level peaked around 37 million tons/day in June 2005, but hurricane-related and other refinery outages have reduced the value for the next 3 years. Refinery crude run reductions coupled with a lower sulfur crude slate have reduced the value to near 32 million tons since January.
Gasoline
Environmental legislation has moved rapidly over the past several years to reduce sulfur in many but not all refined products. Automotive gasoline sulfur was reduced to 30 ppm in a phased program starting in January 2004.
There are no current plans by the US Environmental Protection Agency to reduce gasoline sulfur further, although European and other markets are at 10-ppm sulfur levels. Refinery naphtha and natural gasoline have no legislative limits, but high-sulfur products can have a commercial price discount if above typical levels.
Jet fuel
There has been discussion in the environmental and scientific community regarding the reduction of jet-fuel sulfur. Environmental agencies have studied the issue but at this point, no firm regulatory action appears evident. Based on our understanding of the issues and the science, the benefits of sulfur reduction in jet fuel are modest compared with transportation or stationary fuel sulfur reductions.
That said, there are some benefits to sulfur reduction of jet fuel, and it appears logical that jet-fuel sulfur would be reduced to lower levels at some point in the not too distant future.
Jet fuel is one of the most globally harmonized fuels with common specifications around the world for the vast majority of consumption. The two primary specifications, US ASTM D1655 and UK DEF STAN 91-91, are the bases for most country specifications with a few exceptions.
Making changes to these specifications involves participation of aircraft engine manufacturers, country-level regulatory bodies, technical advisory groups and others, not to mention the refining industry. The global nature of the airline industry and jet fuel hinders quick specification changes. The ability of the air transport industry and regulators to achieve a modest reduction (to say 500 ppm) is more probable than a major shift to ultralow sulfur levels.
Diesel fuel
Only about 60% of the distillate pool is required currently to meet the ultralow sulfur specifications, as it is applicable to on-highway product. Even so, many refiners are able to produce 100% ultralow sulfur product. Ultralow sulfur diesel (ULSD) has penetrated other sectors that consume high-quality diesel fuel, such as the farming and off-highway sectors, as a result of logistic constraints as well as strong marketing.
Changes in the sulfur level of the distillate pool have come from both shifting demand patterns and regulatory mandates. Faster growth in diesel demand relative to thermal consumption of distillate (residential, commercial, utility, etc.) resulted in a growing demand share of the lower sulfur on-highway product since its introduction 15 years ago.
Regulations that became effective in June 2006 require 80% of on-highway supply to meet the 15-ppm sulfur specification, moving to 100% in 2010. Off-road diesel sulfur limits were tightened to 500 ppm in 2007 and will be further tightened to 15 ppm in 2010.
No changes have been made to heating-oil qualities in several decades, but there now appears to be state-level legislative action that will reduce the sulfur content, within a few years, probably initially to moderate levels then to ultralow sulfur levels.
A group of Northeast states has been active in considering the issue and have conducted studies. The general proposal includes a reduction in heating-oil sulfur to 500 ppm followed later to 15 ppm. The legislative action appears imminent enough that the New York Mercantile Exchange has stated it will not list heating-oil futures contracts past August 2012, pending New York and New Jersey's sulfur-reduction proposals.
As Fig. 4 shows, these factors, along with expected spillover of lower-sulfur fuels into high-sulfur consumption sectors, will result in the high-sulfur demand share falling with the 15-ppm product growing rapidly through 2015. Fig. 4 assumes domestic marine and railroad move to 15 ppm in 2012 and heating oil in key Northeast states is reduced to 500 ppm in 2013 and 15 ppm in 2016.
Bunker fuels
The most significant change in refinery fuels' sulfur content comes from the bunker markets. The International Maritime Organization has put forth changes that will affect refinery production of hard-to-refine residual bunker fuels. These changes are discussed presently and the subject of a new study.1 That study addresses the global and regional bunker markets in the context of the broader residual fuel and refining market.
Since 1970, the IMO has controlled and sought to reduce the environmental impact from international shipping. The pollution program comes under the International Convention on the Reduction of Pollution from Ships (MARPOL).
This treaty's impact on shipping over the past decades has focused on reducing ship pollution of oily waste, bilge-water disposal, tank cleaning emissions, and the like. Annex IV of the MARPOL 73/78 treaty includes the "Regulations for the Prevention of Air Pollution from Ships" and was finally ratified and put into force in 2004.
From May 2005 it became a requirement to comply with all the regulations of the new Annex VI including the use of fuel with sulfur content no higher than 4.5% and the requirement to provide a "Bunker delivery note" (BDN) with details of the sulfur content and density of the fuel delivered.
Subsequently, major amendments to Annex IV were ratified in October 2008 that will dramatically impact the refining and shipping industries. The amendments call for the reduction of sulfur oxides (SOx), nitrogen oxides (NOx), and particulate matters (PM) from ships. The sulfur reduction will have the greatest impact on refining but the shipping industry will need to address the other emissions limits as well.
Separately, there are discussions on ways to reduce ship's CO2 emissions, but no formal action has been proposed as of this writing. The amendments call for reductions in two geographic areas:
1. Emissions control areas (ECA or originally SECA for SOx Emissions Control Area).
2. The rest of the globe.
Emissions reductions in ECAs are more immediate and severe with the global requirement coming later. ECAs can specify regulations of SOx, NOx, PM, or a combination. Environmental justification is necessary for the IMO to agree to an ECA adoption. There are two SOx ECAs (SECAs) today, one in the Baltic Sea and the other covering the North Sea-English Channel.
Annex VI calls for substantial reduction in sulfur levels in the ECA and in the broader global market, as illustrated in Fig. 5.
Currently, the ECA requirement specifies that bunker fuel with a maximum sulfur of 1.5% be consumed in the ECA. The sulfur level is reduced to 1.0% in 2010 and 0.1% in 2015. Outside the ECAs, the bunker-sulfur limit is reduced to a maximum of 3.5% in 2012 and to 0.5% in 2020, subject to a study on the supply availability in 2018 that could result in the deadline being moved to 2025.
The US Senate ratified the IMO Annex VI treaty following the new amendments added last year. The EPA along with Canada has submitted a proposal for an ECA (SOx, PM, and NOx) that would essentially extended 200 miles off both coast lines and Hawaii. If approved by the IMO's Marine Environmental Protection Committee, expected to be voted on at a March 2010 meeting, the ECA could come into force around 2012.
Mexico has stated it will also seek an ECA soon. California has advanced separate regulations and issued a Marine Notice that only distillate fuels can be used within 24 nautical miles of its shore from July 2009.
Both the IMO Annex VI and the EPA proposed regulations allow for "Equivalents" technologies to be used in lieu of low-sulfur fuels. This opens the possibility that a seawater or closed water/caustic "scrubbing" approach or other technology could be employed.
While this technology is proven commercially in a number of onshore facilities, the application aboard operating vessels is mostly in a pilot-testing stage at present. The pilot results generally appear favorable and Wartsila, a marine engine manufacturer, has recently received a compliance certificate on its scrubbing technology for use in SOx ECAs.2
US bunker market
The bunker market is just part of the greater residual fuel oil and feedstock markets. The total US residual fuel market as defined in Fig. 6 is about 1.35 million b/d, of which more than half consists of refinery feedstocks including vacuum gas oil and straight-run residues.
The bunker market (international plus domestic supplies) varies from year-to-year, averaging about 400,000 b/d over the past 5 years. High-sulfur residual bunker fuel (Fig. 6) for 2008 was 415,000 b/d, not including another 125,000 b/d of marine distillates.
While demand for ECA fuels varies by coastal Petroleum Administration for Defense District (PADD), Purvin & Gertz's analysis of the US vessel port calls, routing of trade goods, and bunker supplied concludes that a sizable portion of the bunker supplied is consumed in the proposed ECA area.
The most immediate question facing US refiners on this topic is how this ECA requirement affects demand and the type of fuel required. Our work supports the idea that nearly all of this demand shifts to distillate fuels by 2015, based on two key factors.
First, the timing of the regulation and the status of the ship-scrubbing technology will probably not allow for a significant number of scrubbers to be installed on the vast number of vessels that call on US ports.
Second, the scrubbing economics are not supported on a vessel that only spends a limited portion of a global voyage in an ECA, based on Purvin & Gertz's forecast. Even a vessel sailing from the Northwest Europe ECA and into the North American ECA would only utilize a scrubber about 20% of the voyage. Most vessels will spend much less time in the ECA area, even multiport container vessels.
Therefore, we predict that marine distillate-type fuels will replace a sizable portion of the high-sulfur residual bunkers supplied in the US in 2015. By the time the global bunker requirements come into force, scrubbing technology and its possible implementation could change the dynamics.
Scrubbing economics on large and medium-sized oceangoing vessels appear attractive in our analysis and could mitigate the fuel-quality changes required once the global requirements take effect. There are some important technological and environmental-related hurdles to overcome. Our study considers two very different outcomes in separate Scrubber Compliance and Fuels Compliance Scenarios.
One thing is clear from our analysis: Shifting ships to low-sulfur fuels affects both the residual fuel and diesel/gas-oil markets because some portion of the shipping industry will shift fuel type, even with aggressive scrubber adoption.
Refining impact
The net result of these quality changes calls for more and higher quality distillate fuels. Additional sectors of the US diesel market will move towards ultralow sulfur levels. Jet-fuel sulfur may eventually be lowered. Most importantly, the marine-fuels markets are going to require more distillate volume as replacements for traditional residual bunker fuels.
None of these changes is immediate and most are 5 years or so from coming into effect. This gives refining and shipping companies time to plan for the changes.
Bunker fuel has traditionally been a low-value product and even considered a by-product. Most refiners may find it difficult to envision investing for bunker-fuels manufacturing, but this is a reality facing the industry.
The changes create both opportunity and risk for refiners. Acting quickly and boldly to produce higher quality marine fuels could be rewarding but might also create stranded investments if bunker markets shift in unanticipated ways.
The shipping industry is facing its own strategic and investment decisions. The complex inter-industry issue calls for more coordination and discussion between refining and shipping industries.
These changes will not aid refiners today that are struggling with chronic overcapacity and dismal refining margins. However, they should help improve longer-term profitability for those assets that are well placed to supply these fuels on a cost effective basis.
References
1. "Residual Fuel Market Outlook: Impact of Bunker Quality Changes on Marine Fuels and Refining," Purvin & Gertz, October 2009.
2. "Wartsila scrubbers first to be certified to combat marine sulphur oxide emissions," company press release, Sept. 10, 2009.
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