Bob Williams
Senior Staff Writer
U.S. refiners could see gasoline supply shortfalls and price spikes in some regions of the country as they press efforts to market reformulated fuels.
That campaign is crucial for the U.S. petroleum industry as it seeks to head off possible mandates for alternate fuels under emerging federal and state air quality regulations.
The industry has experienced some regional supply crunches in recent years as some states forced gasoline volatility cuts to improve air quality sooner than many expected. Refiners had to scramble to meet octane demand as well as comply with the new standards (OGJ, June 27, 1988, p. 15; June 5, 1989, p. 23).
That pattern could reoccur this summer and likely will worsen under stiffer volatility rules that lie ahead, analysts say.
The situation could be severely aggravated in the growing push to introduce and market reformulated fuels. Although reformulated fuels now command only a small share of the market, refiners will have to grapple with extra logistical problems, added processing costs, and higher transportation costs as the market share for such fuels grows.
Refiners face an unstable market now. Gasoline demand growth has fallen short of expectations so far this year. Gasoline prices are expected to drop in response to the recent plunge in crude oil prices. At the same time, some analysts expect revived cohesion by members of the Organization of Petroleum Exporting Countries to push crude prices up again this summer.
The result: a squeeze on refining margins and profits by autumn, just as refiners need to begin budgeting huge capital outlays for the processing changes required to supply reformulated fuels (OGJ, June 18, p. 33).
Industry is likely to develop the capability to produce enough reformulated fuels, notably gasoline, to meet expected demand. Likewise, it should be able to accommodate growing U.S. demand for octane.
But getting there from here will mean driving a bumpy road that will include higher prices amid generally modest gasoline demand growth.
The real concern, say industry officials, is what will happen to ultimate gasoline demand growth. That growth, especially for high margin premium grades, has proven acutely sensitive to price spikes in the past.
Refiners worry that price increases spurred by reformulating gasoline to meet air quality goals together with gasoline tax increases could squelch demand growth for gasoline, even if the U.S. economy is healthy and crude oil prices are stable.
Changes in the latter two scenarios, however, could mean a severe depression for an industry that lately has enjoyed buoyant margins and profits.
So it becomes imperative for U.S. refiners to press government for more flexibility in timing and fuel formulas to meet air quality goals.
GASOLINE DEMAND
The American Petroleum Institute expects U.S. gasoline supplies to be adequate this summer. The Energy Information Administration projects demand during peak summer months at 7.63 million b/d.
API pegs U.S. summer gasoline supply from refineries, imports, and stocks at 7.86 million b/d. It estimated U.S. refinery throughput at 7.36 million in July 1989 and gasoline imports this summer at 300,000 b/d.
EIA projects U.S. gasoline demand will remain steady in 1990 after falling by 0.1% in 1989.
As the economy continues to be sluggish, highway travel will increase by only 1.9%, the smallest increase since 1980, EIA estimates.
Although moderating after several years of rapid hikes, the growth in U.S. fuel efficiency of 1.9% that EIA projects for 1990 still is not enough to offset the effect of an increase in vehicle miles traveled (VMT) on gasoline demand.
The combination of fewer, less fuel efficient vehicles remaining to be retired, the virtual absence of efficiency gains in new automobiles during the last few years, and steadily increasing road congestion are expected to limit fuel efficiency growth in 1990-91, EIA said.
Further contributing to the lack of demand growth in gasoline this year, says EIA, is an inflation adjusted average increase of 2.7% in retail gasoline prices from 1989 levels.
After 2 years of decline, U.S. gasoline demand is expected to increase 0.4% in 1991 to 7.4 million b/d, the highest level since the record in 1978, EIA predicts.
The demand recovery will stem from a several things: a 2.9% drop in real retail prices, offsetting the previous year's price increase, an improved economy, a 2% rise in VMT, and further moderation in fuel efficiency growth to 1.6%.
Meantime, gasoline grade market shares will continue to be very sensitive to price ripples. Premium unleaded's market share recovered from a spring 1989 price spike to reach by December 1989 a 25% market share-its previous peak in early 1989-but slipped again in January to 24% as retail prices surged again.
A major concern will be the dampening effect of higher gasoline prices on demand in the face of lower oil prices. Federal and state governments are considering or already have approved hiking gasoline taxes. In addition, reformulating fuels will add to refining costs directly as well as boosting product prices as environmental mitigation efforts strain capacity to meet demand.
CONFLICTING SIGNALS
There are some conflicting signals on the direction of gasoline demand. API noted that gasoline deliveries in May fell 1.3% from a year ago to 7.3 million b/d.
May deliveries appear even weaker when considering the comparison is made against deliveries a year ago, when higher prices dampened demand. Retail prices in May 1989 were about 5% higher than in May 1990, or about 10% higher on an inflation adjusted basis, API said.
API contends there is little reason to believe that underlying consumption weakened in May 1990.
"The economy appears to be continuing at at least a moderate pace, and data on travel, although lagging deliveries data by 2 months, also do not suggest any further slackening in gasoline demand," API said.
"It is true that February's unusually large, more than 5% increase in miles traveled could have been at least partly attributed to unusually mild weather and better than average driving conditions for that time of year. But March's increase was still a solid 3%, roughly in line with the previous trend."
OTHER PRODUCTS DEMAND
EIA expects distillate fuel oil demand to fall by an average 70,000 b/d this year because of milder weather occurring in the first quarter and expected in the fourth quarter compared with 1989's cold weather quarters.
As industrial growth bottoms out, no strong increases in boiler fuel or diesel fuel demand are likely.
In 1991, however, EIA predicts distillate fuel oil demand will jump by about 130,000 b/d with a return to normal weather conditions and an improving economy boosting industrial activity and highway and railroad freight movements. Demand for residual fuel oil is likely to slip gradually in 1990-91 as slow economic growth and normal weather patterns preclude the need for utilities' reliance on swing supplies.
Slow to moderate economic growth and rising air ticket prices will keep airline travel growth moderate, resulting in demand for jet fuel increasing by only 0.7% in 1990 and 2.7% in 1991, says EIA.
PROFITS SURGE
U.S. refining profits are likely to surge strongly in the second quarter as gasoline prices held fairly firm against sharp drops in crude purchase costs.
That is a reversal of the situation in the first quarter, when most refiners saw profits plunge because of strong crude oil price increases.
According to EIA data, major companies disclosing line of business saw U.S. refining income plunge 46% in the first quarter. Seven independent refiner/marketers EIA tracks reported a 33% drop in net income.
Refiners' acquisition cost of imported crude oil jumped to $19.69/bbl in the first quarter from $16.76/bbl the same time a year ago, while retail gasoline prices rose only 12.5% to $1.08/gal. At the same time, products consumption plunged by 2.5% to 17.1 million b/d.
An exception to this situation was on the West Coast, where refiners reported improved margins and profits.
Chevron Corp.'s U.S. refining and marketing earnings jumped to $59 million in the first quarter from only $7 million in the same 1989 period. Chevron noted most of those earnings were realized in January, when product prices, especially for jet and heating fuels, increased faster than crude purchase costs. At the same time, average product sales prices rose about 17% from the 1989 quarter, and sales volumes climbed almost 6%. Chevron's refinery input and capacity utilization improved year to year as well.
Warren Shimmerlik, an analyst with County NatWest USA, New York, contends that second quarter refining earnings could be stronger than generally expected and perhaps even better than second quarter 1989, when the Exxon Valdez oil spill contributed to a sharp runup in prices. He predicts U.S. refining pretax margins will jump to about $4.25/bbl in the second quarter from $1.89/bbl in the first quarter,
"Profitability tends to be seasonally strong in the second and third quarters, but it is particularly good now because of the sharp drop in crude oil prices and extended maintenance at refineries-which has kept inventories relatively low," Shimmerlik said.
He also cited the effect of lower volatility standards on production capacity and current low gasoline stocks keeping margins from falling much during the summer.
On the other hand, Bernard Picchi of Salomon Bros. thinks margins will erode more sharply in the summer as refineries that shut down for maintenance in the first quarter come back on line.
Pegging the Gulf Coast 3-2-1 crack spread at almost $10/bbl in late May, Picchi expects the spread to slide to $3.50/bbl by early September. He cited late May refinery utilization of 88.4%, up from 85% the week before, and a small rise in gasoline stocks at the end of May, the first such increase in almost 2 months.
VOLATILITY PROBLEMS
U.S. refiners are continuing to grapple with the seasonal problem of supplying enough lower vapor pressure gasoline to meet demand for summertime gasoline in certain regions.
Regional supply shortfalls and price spikes occurred in the past two summers because the Environmental Protection Agency, following the lead of a group of northeastern U.S. states, ordered summertime gasoline volatility trimmed to 9-10.5 psi Rvp from as much as 11.5 psi.
That situation could worsen as industry moves to comply with even tighter standards of 7.8-9 psi to be in effect May 1-Sept. 15, 1992 (OGJ, June 18, p. 22).
"We do see some tightening up and increased gasoline pricing," said Bob Cunningham, analyst with Turner, Mason & Co., Dallas. "it happened last year, and it's happening this year."
Cunningham cited logistical problems and the reduced gasoline supply that stems from cutting volatility in a market that is already tight.
"The biggest problem the industry faces is going down to 7.8 psi," he said. "There are a lot of stabilizers that get the C4S out of gasoline, and it will require modification or replacement to get down to 7.8."
Cunningham explained that refineries have to keep 1.5-2% blending butane in gasoline to control vapor pressure. Consequently, as refiners attempt to cut vapor pressure, those cuts have to come from basic gasoline components.
"This is particularly tough on the guys who have put in isomerization plants, which make a very high vapor pressure component."
Another major problem refiners face today is what to do with excess normal butanes pushed out of the gasoline pool in efforts to trim volatility. The options include alkylation, burning, storage, petrochemical feedstock, and eventually production of the methyl tertiary butyl ether.
Some observers think that in the longer term, n-butanes will be in short supply because of the increased ether requirement and the increased alkylation push in reformulating fuels.
"Because of the seasonal demand-vapor pressure is normal in the winter and very low in the summer-you take a product for which demand already is seasonal and make it more so," Cunningham said.
"Refiners will need a lot more summer storage. Aboveground storage is very expensive. There is little of that available, and the economics are pretty tough for building a plant to provide butane half the year."
REFORMULATED FUEL CONCERNS
One analyst predicts industry will have to spend huge sums to produce reformulated fuels required by air quality rules in the 1990s.
"People don't have the hardware to do all of this now," he said. "They don't have additional distillation capacity that will be needed; they don't have the hydrocracking capability; they don't have the capability for alkylating C5S."
Refiners also will face sweeping changes in processing configurations, "such as cutting up some of the gasolines like the cat crack and the narrower cuts so that you're processing them differently into distillates."
The analyst ticked off process strategies for cutting olefins in gasoline: processing light coker material, alkylation or isomerization after saturation of C5 fractions, isomerization or saturation of C6 olefins, and saturation or isomerization or possibly reforming C7S or C8S.
He also anticipates more logistical problems that will increase transportation costs for petroleum products.
"There's not the tankage in place now to do a lot of individual, company by company storage segregation. People doing reformulation are going to have to (segregate) on their own, get pipelines to segregate it for them, or go by other transportation routes. In any event, it will mean increased transportation costs,"
Pipeline specifications for reformulated fuels will prove another knotty area for refiners. Lower volatility standards in the U.S. Northeast that went into effect May 1 caused problems in the nation's products distribution systems. Pipelines from the Gulf Coast to the Mid-Atlantic and Northeast told shippers high Rvp gasoline would not be accepted after April. Aside from the difficulty shippers faced, some traders on the New York Mercantile Exchange were unable to make physical deliveries on futures contracts.
That is only a taste of the logistical problems that lie ahead for reformulated fuels, another analyst noted.
"California is going to be the real problem," he said. "For example, Los Angeles is a nonattainment area, and San Francisco is not. Let's say refiners there can make only 20% of the reformulated gasoline needed.
"That means the standard gasoline made in Los Angles has to be shipped to San Francisco, and San Francisco has to ship reformulated gasoline to Los Angeles. That is a double transportation hickey."
Resolving these logistical problems are only part of the puzzle refiners must solve as they face perhaps their most daunting challenge to date: retooling to provide the U.S. fuels of the future.
Copyright 1990 Oil & Gas Journal. All Rights Reserved.
