Fitch Ratings sees positives for refineries facing US low sulfur regulations

By OGJ editors
HOUSTON, July 22 -- Future US low-sulfur gasoline regulations and on-road low sulfur diesel regulations will be a key issue for motorists and for the US refining industry throughout the next decade, said Bryan Caviness of Fitch Ratings Ltd.

"Despite the high capital costs facing US refiners to meet the regulations, Fitch believes that the changes will prove to be very positive for refineries that remain in operation," Caviness said.

"Unanticipated supply disruptions will drive refining margins wider than historical norms and help make up for the increased investments. A lack of new capacity will further stress supply-demand balances," he added in a recent research note.

Some refiners, such as private companies with small facilities, will not be able to make the investment and will shut down, he said. Other refiners are disadvantaged because of higher sulfur crude slates, but they might be able to make up for the higher investments through cheaper crudes.

Fuel regulations
In 2004, US drivers will begin burning Tier 2 low sulfur gasoline in their cars. This is the first in a series of national regulations intended to reduce sulfur emissions from motor vehicle fuels.

The cleaner-burning gasoline is to be implement in phases to achieve a reduction in sulfur content to 120 ppm in 2004 and 30 ppm by 2006 compared with 300 ppm today.

The Tier 2 on-road low sulfur diesel requires 15 ppm by mid-2006, a 98% reduction from 500 ppm today.

"Petroleum refiners alone are expected to invest in excess of $10 billion for the gasoline and on-road diesel regulations," Caviness said. Automotive and industrial vehicle and engine manufacturers also will have to make investments to meet the regulations.

"In spite of the significant capital costs and strain on free cash flows, Fitch expects US refiners to ultimately benefit from the increasingly stringent regulations as refined product supply is removed from the market," he said.

Although refiners and manufacturers will have to do some belt tightening, much of the costs ultimately could be passed along to the end consumers through higher prices and margins, Caviness said.

"Given the varying degrees of capital required, the importance of maintaining a strong balance sheet will become more critical during this period of primarily nongrowth investments," he said.

Lack of new capacity
For 12 consecutive years, implied gasoline demand has grown an average 2.5%/year. Although distillate consumption dipped in 2002 compared with 2001, distillate consumption has also grown by an average 2.4%/year for the past 12 years.

"Based on these trends, the US could see gasoline and distillate demand grow by 2 million b/d over the next 6 years," Caviness said.

A steady supply of capacity creep projects has offset the loss of the capacity in the early 1990s and the increased demand, he said. There has been a 1.7 million b/d increase in total refining capacity since June 1994.