Refiner/marketers in the U.S. are chalking up 1992 as a grim year.
U.S. refining/marketing profits were squeezed in the first 9 months of 1992, and it's not clear whether the fourth quarter will mark improvement or further decline.
However, U.S. refiner/marketers hope the hard operating choices they have made this year underpin an improved outlook for 1993 and beyond.
A sampling of U.S. refiners reported an earnings drop of 37% after 3 quarters in 1992 compared with the same period last year. Merrill Lynch reported 1992 refining profit margins have dropped to the lowest levels since 1987.
Special charges for environmental compliance and restructuring, asset writedowns, and refinery maintenance costs played a significant role in depressing refining profits so far this year.
But a major factor in how U.S. refiners performed is the weak performance of the U.S. economy, which has reined product demand growth. And while there is evidence an economic recovery is in progress, it is one of the weakest on record, offering little prospect for significantly higher product demand,
Modest gains in petroleum product demand this year were at least partly offset by increasing crude costs and only slightly higher product values.
OUTLOOK MIXED
Absent a strong showing from the U.S. economy before yearend, most agree the short term outlook for refiners is far from bullish. And the long term outlook is clouded by a number of factors.
Merrill Lynch believes refinery sophistication will be key in future refiner performance. To that end, many companies reported adding specialized process units and expanding distillation capacity that may have crimped earnings this year but set a base for future gains.
Establishing joint ventures for refining and marketing operations is another option put forth for the long term benefit of the sector.
And Chevron Corp. Chairman Kenneth Derr told a group in Philadelphia that the depression that hit the U.S. exploration and production business in the 1980s is about to hit the nation's refining sector.
"No question about it, the (U.S.) oil refinery is becoming an endangered species," he said.
REFINING, MARKETING RESULTS
Generally increased sales and refinery throughput were not able to overcome lower margins for a sampling of U.S. refiners, who saw combined refining earnings fall to $1.63 billion after 9 months in 1992 compared with $2.57 billion during the same period last year.
In general, strong marketing margins buoyed West Coast refining profitability, while excess product supplies stifled refining earnings on the East Coast.
Mobil Corp. said operations in the Northeast and Mid-Atlantic states, where it markets 50% of its U.S. gasoline volumes, were particularly affected by depressed demand and severe competition.
After 9 months, average U.S. refinery throughput for and by Mobil was 782,000 b/d compared with 792,000 b/d after 9 months last year, while U.S. product sales totaled 966,000 b/d compared with 922,000 b/d the prior year.
Mobil is restructuring refining and marketing operations, which should benefit future earnings, the company said.
Crown Central Petroleum Corp., Baltimore, reported a very weak third quarter in 1992 with a net loss of $3.8 million compared with earnings for the same period last year of $1.6 million.
Henry A. Rosenberg Jr., Crown Central chairman, said, "The disappointing third quarter operating results continue to reflect the impact of the longest recession in our country's history since World War II. Slack demand and weak margins for gasoline and petroleum products are being experienced industry-wide. The market has not allowed us to pass through any of the costs associated in complying with new environmental laws and regulations."
And El Paso Refining Inc. saw a 35% increase in sales after three quarters in 1992, but reported a loss of $26.8 million compared with a loss of $16.1 million for the same period last year.
During third quarter the El Paso refinery processed an average of 49,211 b/d of total feedstock compared with 34,584 b/d same time last year, due mainly to an expansion project completed in July 1991.
El Paso Refinery LP filed for reorganization under Chapter 11 of federal bankruptcy laws in late October, and the bankruptcy court ordered the refinery to be shut down (OGJ, Nov. 2, p. 42).
Unocal Corp. said its strong refining performance so far in 1992 is due in part to integration of part of the Carson, Calif., refinery, it purchased from Shell Oil Co. (OGJ, Dec. 23, 1991, p. 26), and higher product margins in the West Coast market. Unocal sales of petroleum products averaged 393,000 b/d in third quarter 1992 compared with 425,400 b/d in third quarter last year, due mainly to the phaseout of motor fuels marketing in the U.S. Southeast.
Shell's refining results in the third quarter declined due to lower margins, but results after 9 months were slightly better than the prior year.
The company said it significantly improved manufacturing reliability and utilization and reduced operating costs, but those benefits were mostly offset by the weak economic conditions and soft demand, which kept product prices from keeping pace with rising crude costs.
U.S. refining and marketing operations for Chevron Corp. earned $73 million in third quarter 1992 compared with a loss of $10 million in third quarter last year, when it logged a $53 million charge for environmental provisions.
The company said higher product sales margins and improved refinery operations contributed to the earnings increase in third quarter, but scheduled maintenance downtime and Hurricane Andrew related shutdowns reduced refinery throughput. Total sales volumes decreased slightly from the 1991 third quarter, but gasoline sales increased 4%. Chevron said West Coast gasoline prices have recovered from the fierce price wars of 1991.
Phillips Petroleum Co. noted higher crude costs in third quarter lowered petroleum products profits, but were partly offset by higher gasoline sales volumes and lower operating costs. For the 9 months, petroleum products earnings declined because lower sales prices more than offset the benefit of lower feedstock costs.
Ashland Oil Inc., with a fiscal year ended Sept. 30, said while it was modestly profitable before accounting changes and special charges, overall performance was disappointing mainly because its Ashland Petroleum Co. refining and marketing unit performed poorly. Ashland said the effects of weak margins and soft demand were worsened by strengthening of heavy crude prices and weakening prices for asphalt and other heavy oil products. "In summary, fiscal 1992 was a difficult year," said John R. Hall, Ashland chairman.
SPECIAL CHARGES
Restructuring charges, asset writedowns, environmental provisions, and unit downtime hit earnings this year for a number of companies.
Chevron said special items in 1992's third quarter included asset writeoffs and environmental provisions totaling $21 million, partly offset by a favorable adjustment to litigation reserves.
ARCO's refining and marketing performance during the first 9 months of 1992 included a $30 million after tax charge in the third quarter for personnel reductions and future environmental remediation costs.
Scheduled refinery downtime associated with the tie-in of Mobil's $300 million Beaumont, Tex., refinery expansion and upgrading project hurt earnings in third quarter but are expected to benefit future results.
Citgo Petroleum Corp. said earnings were hit by reduced production while a catalytic cracking unit at its Lake Charles, La., complex was being repaired.
And Marathon said its decline in refining, marketing, and transportation earnings was exacerbated by maintenance costs booked in the third quarter for turnaround activity at its Garyville, La., refinery.
WEAK ECONOMY
Slow growth in the U.S. economy has dominated the scene for refiners in 1992.
Estimated U.S. gross domestic product, in constant 1987 dollars, in third quarter 1992 was $4.925 trillion, up just 0.4% from second quarter 1990. Economic growth for this year is expected to be at best 1.8-2% compared with typical growth rates during previous recovery cycles of 5-6%.
The slow pace of economic recovery in the U.S. has resulted in only modest growth in energy consumption and demand for petroleum products.
Energy Information Administration estimated total U.S. demand for petroleum products at 16.929 million b/d for the first 324 days of 1992, up 1.5% from the same period last year.
And the supply and demand committee of the Independent Petroleum Association of America forecasts 1992 U.S. refined products demand will average 16.941 million b/d for the year, up 227,000 b/d from the year before. IPAA projects demand for the most profitable product, motor gasoline, at an average 7.263 million b/d in 1992, a 1% increase from 1991.
EIA estimates motor gasoline consumption year to date has averaged 7.269 million b/d, indicating refiners have marketed an added 75,000-80,000 b/d in 1992 compared with last year. IPAA projects U.S. distillate demand will increase 2% in 1992 to average 3.121 million b/d, and the latest EIA data show distillate demand averaging 2.999 million b/d so far this year, up 3.3% from the same period of 1991. Partly offsetting these gains has been a modest drop in consumption of aviation fuels. EIA estimates year to date demand is down 1.1% from 1991 at 1.453 million b/d, and IPAA pegs demand for the year at an average 1.457 million b/d, down 1% from 1991.
U.S. demand for residual fuel oil has dropped sharply, due in part to severe competition from natural gas. Demand for resid year to date has averaged only 1.065 million b/d, down 6.9% from a year earlier. Consumption for the year is expected to be off 7.2% from 1991.
However, the decline of 79,000 b/d in resid consumption has been more than offset by an increase in demand for other petroleum products, which has moved up 181,000 b/d over the 1991 level. The other product category includes asphalt, petrochemical feedstocks, and lubricating oils, among others. Demand for these products has moved up along with increased activity in petrochemicals, construction, and manufacturing.
CRUDE OIL PRICES
Crude prices, which refiner acquisition costs tend to mirror, have followed a contraseasonal pattern in 1992-lower during the peak demand heating season and higher during the warmer months of reduced demand.
This atypical pattern stemmed from Organization of Petroleum Exporting Countries production changes and the way companies have managed stocks in 1992.
According to Energy Information Administration, the average world export price of crude in January 1992 was $16.30/bbl. The price rose to an average $19.68/bbl in June and remained close to or above $19/bbl from June through late October then started to slide. The price for the week ended Nov. 20 was $18.04/bbl.
Recent price declines in the futures market indicate that average export prices will continue to fall in December. The world export price is estimated to average $18.07/bbl for the year, up from $17.82/bbl in 1991.
In the U.S., the average West Texas intermediate crude oil price followed a similar pattern this year.
EIA reported the spot price at Cushing, Okla., averaged $18.78/bbl in January and increased to $22.39/bbl in June. It has been slipping recently and was down to $20.01/bbl the fourth week of November. For the year to date, WTI has averaged $20.66/bbl compared with $20.46/bbl in 1991.
U.S. refiners' crude acquisition cost is a good indicator of the movement of refinery feedstock costs, and EIA reported refiners' acquisition costs averaged $16.47/bbl in January and $16.46/bbl for the first quarter this year. It increased in the second quarter to an average $18.82/bbl and peaked in July at $20.10/bbl, averaging $19.75/bbl for the third quarter.
Through the first 3 quarters this year, refiners' acquisition costs have averaged $18.34/bbl, down from $19.06/bbl the year before.
PRODUCT PRICES
U.S. product prices have not kept pace with rising crude oil prices during 1992, which has tended to weaken refining margins as feedstock costs move up more than product revenues.
Thus, while the trajectory in product prices was not as pronounced as for crude, first half 1992 product prices tended to follow crude oil price movements, starting low then climbing through the first half of the year.
A survey by Computer Petroleum Corp., published in the Oil & Gas Journal, shows the U.S. average wholesale price of motor gasoline started at 61.27/gal the first week of the year, slipped to 59.20/gal the first week of March, then climbed to a peak of 71.54/gal the second week of June. The price has dropped in recent weeks and was 61.30/gal the fourth week of November.
The average pump price for the year is down slightly from the level a year ago. OGJ data show the motor gasoline pump price has averaged $1.131/gal the first 11 months of 1992, down from $1.158/gal in the same period a year earlier.
EIA reported the spot price for No. 2 fuel oil averaged 51.6/gal in January, increased to 61.3/gal in June, then slipped to 58.3/gal in August. The spot price increased to 62.7/gal in October, the start of the winter heating season-however, recent quotes from the New York Mercantile Exchange futures market indicate price weakness in heating oil.
Resid prices during 1991 followed a pattern similar to distillate fuel oil, with the spot price for New York 1% sulfur residual fuel oil at $12.50/bbl the first week of this year and increasing to $17.75/bbl the last week of July.
Resid slipped to $15.50/bbl the last week of August but rebounded to $18/bbl in October as consumers prepared for winter. The price slipped to $16.50/bbl the week of Nov. 23.
REFINING MARGINS
Increased demand, higher throughput, and a higher utilization rate all have been beneficial to refining margins so far this year, but the benefits have been more than offset by the shrinking margin between crude costs and product values.
Refining margins are not solely dependent upon the changing differential between crude oil prices and product prices. Sales volumes and refinery utilization rates also can affect margins. Higher product demand boosts sales and increases refinery throughput and utilization rates. And higher utilization rates tend to lower unit product costs of refining and improve margins.
This year there has been a modest improvement in product demand. And inputs to refineries have increased in 1992.
American Petroleum Institute reported U.S. inputs to crude oil distillation units averaged 13.625 million b/d for the first 10 months of this year, up 0.7% from the same period last year.
Operable refinery capacity has slipped to an average 15.566 million b/d, down 0.9%, yielding a 1.5% improvement in refinery utilization rate, which has averaged 86.5% for the first 10 months this year.
Wright Killen & Co., Houston, calculates a monthly Gulf Coast cash operating margin, published in OGJ, that shows the regional average Gulf Coast refining margins averaged $0.87/bbl of crude run for the first 8 months of 1992 compared with $2.16/bbl for the same period of 1991 and $2.21/bbl in 1990.
The Wright Killen data show refining margins started weakening in the last quarter of 1991 and never recovered in 1992. Average monthly margins this year have ranged from a high of $1.56/bbl in June to a low of 18/bbl in July. Last year margins ranged from a high of $2.78/bbl in March to a low of 56/bbl in December. With the exception of December 1990, these Gulf Coast cash operating margins have remained positive since March of 1990.
STOCKS AND OPEC OUTPUT
During the summer months this year oil stocks in the U.S. and in other Organization of Economic Cooperation and Development countries were well below levels a year earlier.
A sharp drawdown of industry stocks in OECD countries in the first quarter left total inventories well below levels the previous year, and in the U.S. there was a slow stockbuild in the summer months.
International Energy Agency reported total crude and products stocks held by industry in OECD countries at the end of September 1992 were down 105 million bbl from the same period in 1991.
In the U.S., the stockbuild continued through October and into November. As of the week ended Nov. 20, total U.S. industry crude and products stocks were 1.0682 billion bbl, only 10.5 million bbl below the level at the end of November 1991.
Thus, a surge in OPEC production and slow growth in demand have enabled refiners in the U.S. to replenish stocks without a surge in crude oil prices. In fact, in recent weeks, increased OPEC output has tended to weaken crude oil prices.
OPEC countries have attempted to regulate output to meet seasonal demand, but members tend to compete for anticipated incremental winter demand. The result entering the heating season this year has been some excess output putting downward pressure on prices.
IEA reported total OPEC liquids production, including natural gas liquids, increased from 25.7 million b/d in second quarter 1992 to 26.7 million b/d in the third quarter, and 27.4 million b/d in October.
OPEC anticipated that production at this level would balance supply with winter demand. However, sluggish product consumption and the ability and willingness of refiners to operate with lower stocks has softened the demand for crude oil and weakened prices.
The recent OPEC meeting did little to help resolve this problem. The new quotas were set at close to existing OPEC levels and therefore would not reduce output and tighten the market.
It appears that only a surge in winter demand due to colder than anticipated weather will help support prices. With refiners able to add to their winter crude supply at bargain prices, any surge in demand would tend to boost margins and improve profits in the fourth quarter.
WORLDWIDE PICTURE
Economic growth throughout the industrialized world has been sluggish during 1992.
IEA reported the 1992 growth of real GDP is estimated to be only 1% for Europe and only 1.8% in Japan. In Europe this is down from 2.9% in 1990 and 1.8% in 1991. For Japan it is down from 5.2% in 1990 and 4.4% in 1991.
The IEA estimate of average economic growth for all of the countries in the OECD is a modest 1.5% in 1992, down from 2.5% in 1990 but up from 0.8% in 1991.
The recession in the U.S. in 1991 pulled down the average for the OECD group of industrial countries.
The modest rate of economic growth for the entire OECD also has led to only a small gain in demand for petroleum products in 1992.
IEA sees a modest increase in worldwide demand for petroleum products this year. It estimates total worldwide demand at an average 67 million b/d, up only 0.4% from 1991. Through the first three quarters of 1992 IEA pegged product demand at an average 66.6 million b/d, up 0.6% from the same period in 1991.
OECD demand is estimated at an average 38.5 million b/d in 1992, an increase of 400,000 b/d from 1991.
Although demand estimates indicate only a small increase for the year,
OECD Europe product demand moved up sharply in the third quarter. The latest estimates indicate oil product demand was up 4.5% from the third quarter a year earlier, a gain of 600,000 b/d. According to IEA, this robust gain reflected extremely low petroleum product deliveries in third quarter 1991. Most of the gain was seen in middle distillates, mainly heating oil, and in Germany.
German oil demand was up 17%, and Italian demand rose 8% from the third quarter a year earlier.
Demand in the non-OECD areas is estimated to be down 100,000 b/d in 1992 at 28.5 million b/d, due to a 1.1 million b/d decline in product demand in the former U.S.S.R. and a 100,000 b/d decline in eastern Europe.
IEA estimates former U.S.S.R. demand will average 7.2 million b/d in 1992 compared with 8.3 million b/d in 1991, partly offset by a 500,000 b/d increase in demand in non-OECD Asia to 6.3 million b/d.
NEA TERM OUTLOOK
Meantime, with the U.S. economy virtually stalled and demand growth lagging, first phase implementation of the 1990 Clean Air Act amendments (CAAA) started in November.
Other deadlines are scheduled through 2000 at a total price tag to refiners estimated as high as $20 billion (OGJ, Jan. 27, p. 21).
First phase implementation of CAAA calls for oxygenates to be blended with gasoline in certain ozone nonattainment areas, which is causing concern that gasoline supplies might swell further.
Analyst First Boston calculated 450,000-500,000 b/d of oxygenates will be needed to meet winter demand for oxygenated gasoline.
Department of Energy said methyl tertiary butyl ether and fuel ethanol capacity in the U.S. is about 370,000 b/d, with effective capacity less than 300,000 b/d, thus the remainder will need to be supplied by imports or inventory stockdraws. DOE said refiners have built inventories that total 28 million bbl of MTBE equivalent.
First Boston notes that conventional wisdom holds oxygenate inventories will increase gasoline inventories by about 15% from the Oct. 1, 1992, level of 206 million bbl-thus swamping the gasoline market and subsequently depressing gasoline prices and fourth quarter refiner profits.
However, First Boston believes the transition to winter gasoline could provide some refiners an off-season earnings boost for these reasons:
- Total gasoline inventories are likely to decline due to planned maintenance in the fourth quarter, which will keep refinery utilization rates lower than normal.
- Gasoline consumption is likely to remain flat in the quarter, not decline, and if the economy shows unexpected strength, the market could tighten.
- MTBE manufacturing will be limited at 75-80% of capacity because of near term lack of feedstocks. That will speed the oxygenate stockdraw.
Accordingly, First Boston expected gasoline inventories to peak in the fall and not January, as is usually the case, thus tightening the supply/demand balance late in the quarter.
UPSTREAM COMPARISON
As Derr noted, the depression that has hit the U.S. upstream sector, forcing belt tightening moves, may compare with what the downstream sector is facing.
Jess Krider, Chevron Products Co. refining technical general manager, noted an option available to U.S. refiners and used by upstream counterparts is joint venture partnerships.
That option has been employed at least a couple times this year with non-U.S. partners.
In late October, Petroleos Mexicanos SA agreed to purchase half of Shell's 215,900 b/d Deer Park, Tex., refinery, and earlier this year Petroleos de Venezuela SA agreed to buy half of Lyondell Petrochemical Co.'s 265,000 b/d refinery in Houston.
Both deals appear mutually beneficial, Kidder Peabody noted (OGJ, Sept. 21, p. 40). Pemex will underwrite at least half of the expected $1 billion price tag for modernizing the Deer Park refinery, buy 40,000 b/d of the plant's unleaded gasoline for much needed use in Mexico, provide the joint venture with a steady supply of Mexican crude, and allow Shell to monetize a low return asset, freeing funds for other uses. Kidder Peabody cites the Saudi Aramco/Texaco Inc. joint venture Star Enterprise, formed in 1988, as a successful example.
Krider noted, "You'll see more restructuring throughout the industry, especially now that the capital costs for some of these environmental projects are becoming so onerous. And we're still not sure what all will be required. It's a tremendous drain on your resources. If you have problems coming up with the cash to fund those facilities, then you are faced with either going deeper in debt, which most companies aren't eager to do, or shutting the facility down, which doesn't necessarily save you any money because then you face environmental cleanup costs."
LONG TERM OUTLOOK
There does not appear to be immediate relief ahead for U.S. refiners, and there are contrarian views of the sector's long term outlook.
Merrill Lynch expects "meaningful improvement" in the sector once economic recovery gains momentum, because in contrast to previous downturns, current refinery utilization rates are high. While some believe refinery sophistication offers lower rates of return in a weak economic environment, Merrill Lynch said the economics of upgrading will be favorable over time because price differential between low quality and high quality crude and between light and heavy refined products will remain high.
The analyst believes refineries without upgrading capability may not be able to justify large expenses to make cleaner products, so the remaining refineries will benefit from the reduced industry capacity.
Merrill Lynch also expects the trend towards shutting down refineries will accelerate because of increasingly stringent environmental regulations, noting in the past refinery shutdowns were put off due to optimism conditions would improve. Shutdowns in the future will be facilitated in spite of market optimism because of the large capital spending required to meet environmental regulations.
Robinson West, president of Washington, D.C., consulting firm Petroleum Finance Co., said, "You will see no new capacity put on in the U.S., and certainly the marginal operations will be shaken out.
"The question is whether those facilities that are upgraded and survive will then operate at high margins or whether there will be increased regulations and they will never be profitable. There is absolutely nothing to say that this is the last round."
Ashland's Hall said, "Looking ahead, we are cautiously optimistic about the outlook for the majority of our nonrefining businesses. The short term outlook for refining is less encouraging as the industry continues to cope with overcapacity. We believe a refining industry shakeout is inevitable and that the investments we are making now to strengthen our refining operations should put us in a strong position to benefit from improved margins in the near future."
And Citgo Pres. Ronald E. Hall noted, "Citgo's sales volume continues to grow at faster rates than those of the industry. Our operations are excellent, and our safety performance is outstanding. But the margin squeeze the refining industry is experiencing, coupled with the increasing regulatory burden, has not allowed us to realize the full benefit of these excellent operations .... We, as well as the entire U.S. refining and marketing industry, continue to struggle with the increased regulatory burden and its associated costs, which only have limited opportunity to be recovered in the highly competitive marketplace.
"All of us favor cleaner air and water. None of us favors government regulations that dictate how the goals must be achieved. Instead, competitive pressures demand that we be allowed to determine the most economical ways to achieve them."
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
