Doubt looms over U.S. refining upturn

Assets of Shell/Texaco Combination [69346 bytes]

There is a fundamental, cyclic recovery under way in the U.S. refining industry.

The recovery is 4-5 quarters old and will reach midcycle in 1998-99, when financial returns will meet or exceed previous mid-cycle averages.

These are the views expressed by James Clark, director of Credit Suisse/First Boston, at the National Petroleum Refiners Association (NPRA) annual meeting last week in San Antonio. Other industry observers were less optimistic in their views.

Daniel Yergin, Cambridge Energy Research Associates (CERA), said, "Supply/demand fundamentals will keep spot refining margins in the range of the last few years." Yergin believes it will be difficult to beat the current industry average of 5-7% return on capital.

Terrence Higgins, NPRA technical director, believes a slack market in European and futures markets both will rein U.S. refining margins.

Clark says below-average capacity growth in 1998-99 will contribute to the expected upturn. In addition, the light-to-heavy differential should widen in coming years. "As long as capital spending trends, both in the U.S. and worldwide, remain under control, there is a good chance that upgrading margins will improve on a cyclical basis," he said. Refining margins (3-2-1 basis) will be back up to $3.50-3.60 at midcycle."

The retail end of the business will have better long-term returns than refining, said Clark, although retail capacity growth may exceed demand growth.

Shell/Texaco merger

As if to punctuate Yergin's remarks, Shell Oil Co. and Texaco Inc. disclosed at the meeting the signing of a memorandum of understanding to combine major elements of their midwestern and western U.S. refining and marketing activities, and all of their U.S. transportation, trading, and lubricants businesses. The new company will market under both the Texaco and Shell brands.

The companies say they have made "significant progress" in discussions with Saudi Refining Co. regarding combination of eastern U.S. refining and marketing businesses and expect to reach an agreement in the second quarter.

Under terms of the agreement, the limited liability company will be owned 56% by Shell and 44% by Texaco. Final formation is expected following regulatory review. Shell and Texaco expect to achieve substantial efficiencies by sharing management systems, business processes, and support functions and by adopting best practices of both. These savings don't hinge on closing refineries or other major facilities, Texaco said.

Refined products

In recent years, U.S. refineries have been adding light products capability in excess of demand.

Combined with capacity creep, which generally adds 0.5%/year to distillation capacity, the industry is long on gasoline and naphtha and balanced on kerosine and distillate.

CERA's Kevin Lindemer said global refined products demand growth will be 1.8-2%/year on a sustained basis. Sixty percent of refined products demand growth will take place in Asia, 20% in Latin America, and only 10% in the U.S. and Europe combined.

Half of this growth will be in the jet/kerosine/middle distillate range and 25% in the gasoline/naphtha range. Only 4% will be in bottom-of-the-barrel streams.

"This is heading off in a different direction than the supply barrel," said Lindemer.

NPRA's role

Roger Hemminghaus, chairman of NPRA and Ultramar Diamond Shamrock Corp., San Antonio, listed these priorities for NPRA for 1997:

Ensure that the refining industry is seen as a safe and environmentally sensitive industry focused on satisfying consumers' needs at minimum cost.
Encourage useful dialogue and cooperation between trade groups on common issues.
Be persuasive and insistent that new, costly environmental, health, and safety regulations are based on good science, sufficient data, and good benefit/cost ratios.
Work together with automotive manufacturers to ensure that the driving public is well served while minimizing costly fuel specification changes.
Make NPRA an effective training and information exchange resource for its members.

"Due in large part to the millions spent by this industry, air quality across this country is improving as we speak," said Hemminghaus. "Yet the EPA, without sufficient data, is now proposing tighter ozone and particulate matter regulations that will cost this industry and our consumers many more billions."

Hemminghaus called for grassroots employee efforts to object to EPA's proposed changes in national ambient air quality standards for ozone and particulate matter. "We're going to lose this one unless you get involved," Hemminghaus told delegates.