SPECIAL REPORT: Shifting global product specs push more refinery investment

March 19, 2007
Refiners throughout the world are increasing investments to deal with changing specifications for gasoline and diesel fuel.

Refiners throughout the world are increasing investments to deal with changing specifications for gasoline and diesel fuel.

The global refining sector has begun to emerge from a short period of tight capacity and high margins with refining investments being made all over the world. After a year of remarkably profitable margins, refiners are facing a somewhat more bearish marketplace. Meanwhile, petroleum product demand continues to grow even as the specifications for transport fuels in particular become more complicated.

The once-fungible petroleum product markets are increasingly fractured and “Balkanized.” The evolution of petroleum product demand, both in terms of quantity and quality, and the concomitant expansion of global refining will determine the demand for crude oil not only by volume but also by quality.

This article focuses specifically on signals from gasoline and diesel markets that will influence refining investment and the further effects of that investment on crude demand.

The most important developments on the demand side are in the three main consuming regions-the US, Europe, and Asia.


US demand will continue to dominate the global gasoline market, representing slightly more than 40% of global demand through 2020. The region with the fastest growth will be Asia, but because this region is starting from a much smaller base, Asian demand will still be less than half of US demand by the end of the forecast period. Finally, Europe will continue to see gasoline demand erode, with 2020 demand just 70% of its current level.

For all three regions combined, demand should grow by 5 million b/d during the next 15 years, or roughly 1.4%/year.

The global gasoline picture becomes more complex, however, if one overlays changes in quality specifications. For the sake of simplicity, this analysis focuses strictly on the sulfur content of gasoline and divides global gasoline demand into four different categories based on sulfur content.

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Fig. 1 shows that the highest-sulfur gasoline (Category 1-greater than 1,000 ppm) is disappearing rapidly and should be eliminated from the market shortly. At the other end of the quality spectrum, demand for low-sulfur gasoline (Category 4-less than 30 ppm) is rising quickly, reaching 15 million b/d by the end of the decade.

The significant shift in gasoline volumes from Category 2 (200-1,000 ppm) to Category 4 is largely due to the mandated reduction in gasoline sulfur content in the US in 2005. Another shift in demand by quality is anticipated in 2014-15 when China and a number of African and Asian developing countries are expected to move from Category 2 (200-1,000 ppm) to Category 3 (30-200 ppm).

Fig. 1 shows that, after representing 100% of demand in 2001, Categories 1 and 2 fall to less than 10% by 2020.


For the global diesel markets, demand growth will be even stronger than for gasoline. In fact, global diesel demand will exceed global gasoline demand by 2020, whereas in the current market, diesel demand is more than 2 million b/d less than gasoline demand.

Diesel demand will likely grow in every region during the forecast period. The fastest growth will be in Asia, which will see demand rise by 150,000 b/d/year through 2020. The next fastest growth will be in North America, which should see yearly demand growth of roughly 125,000 b/d.

Even the slowest growing regions such as the FSU and Africa will experience average growth of more than 25,000 b/d/year. Altogether, global diesel demand will likely rise to 26.25 million b/d by 2020.

Like gasoline, diesel is in the midst of a worldwide shift to primarily low-sulfur specifications, though not as completely as in the gasoline market.

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Fig. 2 shows, with the US shifting to 15 ppm ultralow-sulfur diesel (ULSD) this year, and the EU following by the end of the decade, diesel demand in the lowest-sulfur category (Category 4-less than 15 ppm) will climb to nearly 12 million b/d by 2020, becoming the largest category.

Demand for the next cleanest category (Category 3-15-50 ppm) has risen to nearly 5 million b/d, but when Europe moves to ULSD it will drop off sharply. Demand for Category 2 (50-500 ppm) diesel has dropped sharply in recent years and will remain near current levels of 4 million b/d through the forecast period.

Demand for Category 1 (500-3,000 ppm) diesel will remain the second largest, between 7 and 8 million b/d. Many large consumers in Asia and Latin America will remain in this less stringent group.

Finally, demand for the highest-sulfur diesel (Category 0-greater than 3,000 ppm) will fall to about 2.5 million b/d. Clearly, there will continue to be demand for a variety of diesel qualities, even as the largest category of demand becomes ULSD.

Required refining investment

After several decades of structural overcapacity, the recent tightness in global refining capacity, combined with healthy demand for cleaner fuels, has led to strong refining margins in recent years. This, in turn, has triggered a surge in investment.

ESAI estimates that global distillation capacity rose by about 2 million b/d in 2006, nearly double the pace of growth in 2005 (Fig. 3). 2007 will see a brief pause in growth, as expansions fall to just 775,000 b/d. The pace should then accelerate, with capacity rising 1.7 million b/d in 2008.

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After 2008, this trend increases and refiners will add nearly 2 million b/d of distillation capacity in 2009 and a whopping 3 million b/d in 2010. This will be followed by more expansion-roughly 1.9 million b/d in 2011 and 2.5 million b/d in 2012.

As expected, the bulk of this growth will occur in Asia, near the primary sources of demand growth. Chinese capacity alone will likely expand 1.25 million b/d between now and 2010. During the same period, Indian capacity should increase by a total of 1 million b/d. The new Reliance Industries Ltd. refinery alone will represent 580,000 b/d of this growth. Outside of Asia, capacity will grow more slowly.

The other major region for new capacity will be the Middle East, although the new plants there target more the export market than internal demand as do their Asian counterparts. Massive growth will occur 2010-11, when nearly 2 million b/d of capacity will be added in Saudi Arabia, Kuwait, and other countries.

In addition, there will be some steady capacity creep in North America, particularly weighted toward the later years of this forecast. North American expansions will average 500,000 b/d/year in 2010-11. Another source of new crude distillation capacity in these later years will be the FSU, which could see as much as 500,000 b/d of capacity added before 2010.

Regarding expansion plans for upgrading units, hydrocracking capacity should increase significantly. This is unsurprising when one considers the dramatic growth rates in diesel demand.

In 2007, for example, as much as 400,000 b/d of new hydrocracking capacity will come online. A major portion of this additional capacity will be in Europe, while the transport fuel market continues its long-standing transition to diesel. Several refiners such as Total AS, Preem Petroleum AB, and Fortum Corp. have added hydrocracking capacity recently.

A second large source of hydrocracking capacity expansion is in Asia, which has seen strong diesel growth, particularly in China. Future planned expansion is somewhat more modest than recent years, but average global growth of 250,000 b/d/year will continue for 2007-12.

Another growth region will be the countries of the former Soviet Union, which are exporting gas oil to the European market. FSU capacity will increase 230,000 b/d during 2008-12.

Meanwhile, the shift to lower sulfur in transport fuels has encouraged a notable volume of new hydrotreating capacity, with expansions in North America alone rising 2.6 million b/d in the past 3 years (2004-06). This investment was largely fueled by the shift to lower sulfur specifications in the gasoline market, as well as the recent shift to ULSD.

Another major source of new hydrotreating capacity has been in Asia, which has seen capacity rise by 400,000 b/d/year during the same 3-year period in response to tightening regional specifications. In addition, Europe moved to a tighter diesel specification; hydrotreating capacity there rose by more than 450,000 b/d in 2005 and nearly half that pace last year.

Globally, hydrotreating capacity should rise at least 500,000 b/d/year during the next several years, when refiners continue to invest to produce ULSD from high-sulfur crudes.

Finally, with gasoline demand rising more slowly than diesel and with Europe’s gasoline surplus growing, investment in coking and catalytic cracking should be much lower than for hydrocracking or hydrotreating. Coking capacity will likely rise by an average of 200,000 b/d/year through the end of the decade, while catalytic cracking capacity will rise by roughly 225,000 b/d/year.

This growth will largely be in Asia and North America, although Latin America will see some increase in coking as well. This will largely occur in Mexico and Brazil in response to heavy domestic crude production and also target the growing US gasoline market. An increase in catalytic cracking will take place in the Middle East, primarily due to the runaway gasoline deficit in Iran.

Although the pace of expansion in these various downstream units is impressive, it is clearly dwarfed by the pace of growth in distillation capacity. Fig. 3 clearly shows this imbalance.

Although more investment will likely be announced for complex units, investment currently appears quite skewed to crude distillation. This is surprising considering the continuing shift to light clean products.

Crude quality

The future of crude quality or at least the valuation of different qualities of crude oil is influenced from two sides.

On one side is the growing demand for cleaner petroleum products. There is significant investment in refinery distillation capacity to make petroleum products, but the relative underinvestment in refining units that manufacture clean transport fuels. These factors alone will encourage the premium valuation of light sweet crudes, although not to the same extent as experienced during 2003-06 when distillation capacity was in short supply.

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On the other side is the significant growth in medium, light, and heavy sour crude production capacity (Fig. 4). This will also encourage a higher valuation of sweet crude relative to sour.

In sum, the quality spreads of the last few years were extraordinary but due to tight distillation capacity relative to demand growth as much as to petroleum product specifications.

In the next decade, distillation constraint will be largely eliminated, which should ease the light-product crunch and weaken the premium of light crudes. In the meantime, however, investment in upgrading and desulfurization capacity in refining is lagging tremendous investment in distillation. The quality spreads, therefore, will not collapse as sweet crude retains some, but certainly not all, of the premium of recent years.

The author

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Rick Mueller ([email protected]) is a senior oil analyst for Energy Security Analysis Inc. (ESAI). He analyzes the global crude oil markets with a special concentration on the various European product markets. His primary responsibility lies in forecasting global crude supply and demand, and generating a price forecast from this analysis. Mueller also collects and analyzes European product data from nearly every country in the region. He writes ESAI’s monthly Crude Outlook publication, the Europewatch report on European crude and product stocks, and contributes to the Atlantic Basin Stockwatch. Before joining ESAI, Mueller worked for Booz-Allen & Hamilton and PriceWaterhouseCoopers, where he gained experience in international business and emerging markets. He holds a BA from Stanford University and a Masters from the Paul H. Nitze School of Advanced International Studies of the Johns Hopkins University.