North American Refiners Retool to Process Oil from Shale Formations

---

Written by John Egan for Industrial Info Resources (Sugar Land, Texas)--North American Petroleum Refiners are investing hundreds of millions of dollars in capital and maintenance projects to process the light sweet crude oil produced from the continent's shale formations, Chris Paschall, Industrial Info's vice president of research for the Petroleum Refining Industry, said in an interview.

Roughly 600,000 barrels of crude oil are being produced each day in the Bakken formation in North Dakota, he said. Production is surging there, as well as in other areas like the Eagle Ford and Permian Basin. These formations produce light sweet crude oil, which fetches a premium in the market, because it costs less to process than crude that is heavier or has more sulfur.

"Refiners are retooling to accommodate a different slate of crude oil," Paschall said. "The world changes, and refiners are responding. Year over year, U.S. demand for gasoline is down by about 3% and U.S. demand for diesel is up about 3%. So refiners are also tweaking their processes to produce more diesel and less gasoline. Since the U.S. has huge stockpiles of crude oil and refined products, a lot of the refined products are being exported to Latin America."

For example, he noted that Valero Energy Corporation (NYSE:VLO) (San Antonio, Texas) is spending about $3 billion to increase production of ultra-low-sulfur diesel at its refineries in Port Arthur, Texas, and Saint Charles, Louisiana. A lot of that incremental output will be exported. Other refining companies, including Phillips 66 (NYSE:PSX) (Houston, Texas) and Marathon Petroleum (NYSE:MPC) (Findlay, Ohio), are also making investments to boost the diesel output of their refineries.

North American refiners will begin work on 776 scheduled turnarounds this year, down slightly from 2011, according to Industrial Info's North American Refinery Turnaround Tracker. North American refiners have scheduled 672 turnarounds for 2013.

Click on the image at right for a chart summarizing North American refinery turnarounds, 2009-2013, by season.

Paschall noted that crude oil has been particularly volatile in early May, as the reverberations of elections in France and Greece rattled investors. Both nations cast ballots for national leaders who were sharply critical of the politics of austerity preached by European financial institutions that are worried about reigniting the continent's sovereign debt crisis.

"Crude oil prices, and hence refiner crack spreads, are no longer determined only by supply and demand," Paschall said. "Right now, it's broader macroeconomic factors like the U.S. economy, U.S. unemployment, and the situation in Greece. If you told me a week ago that crude oil would fall more than $10 in a week, I would have said you were crazy. But that's what happened."

Paschall noted that gasoline and diesel crack spreads--the difference between refined product prices and crude oil--have widened in recent months for U.S. Gulf Coast refiners that process West Texas Intermediate (WTI) crude oil. Gulf Coast refiners have benefited from the price penalty the market has imposed on that grade of crude oil vis-à-vis Louisiana Light & Sweet (LLS), a proxy for Brent crude. The market is imposing a price penalty on WTI because there is a bottleneck in crude-oil pipeline capacity out of the hub in Cushing, Oklahoma. Analysts are split about how soon that bottleneck will be relieved. For more on that issue, see April 17, 2012, article - Crude Oil Glut at Cushing May Worsen as New Production Outstrips New Outbound Pipeline Capacity.

Click on the image at left to see U.S. Gulf Coast gasoline and diesel crack spreads.

The average U.S. retail price for gasoline has fallen in recent weeks, but Paschall said there are too many variables in play to predict the price of fuel during the traditional summer driving season. Falling crude oil prices should translate to lower prices at the pump, which may lead to greater consumption. If the U.S. economy grows, that may lead to increased demand as more families take summer trips. But continued instability in Greece, or a coup in Latin America, could offset positive developments within the U.S. "Retail fuel prices are really unpredictable now," he said.

One interesting strategic event that refiners are still processing is Delta Airlines' recent decision to spend $150 million to buy the Trainer refinery in Pennsylvania from ConocoPhillips (NYSE:COP) (Houston, Texas). The 185,000-barrel-per-day (BBL/d) refinery, which began operating in 1900, was slated for closure until Delta bought it.

"Delta's purchase was really 'outside the box' thinking," Paschall said. "This transaction is really worth watching. If it works, I expect more airlines will consider buying refineries, because jet fuel is such a high component of airline costs."

Delta's annual jet fuel bill is said be to about $11.8 billion. The airline reportedly hopes to cut annual fuel costs by $300 million annually by buying the refinery. The airline plans to maximize Trainer's output of jet fuel and swap crude oil or refined products with other refiners and marketers.

One key to making that acquisition work is lowering Trainer's high feedstock costs. Reuters reported that most of Trainer's crude oil came from Africa in 2010. But Delta intends to change that by having Trainer process crude oil produced in the Bakken formation. Since there is no direct crude-oil pipeline linking North Dakota and Philadelphia, Delta reportedly plans to transport the Bakken crude by train to Albany, New York, and then transport it by truck or barge to Philadelphia, an industry source with knowledge of the deal told Reuters.

Paschall noted that construction is scheduled to begin this summer on a 25,000-BBL/d grassroot refinery in Utah. The Green River Refinery, under development for several years and valued at about $500 million, would process waxy crude from the nearby Uinta shale formation. If that project kicks off as scheduled, it could be producing refined products before the summer 2014 driving season. Positive factors behind that project include its limited size, intention to source crude from a nearby shale formation and its plan to serve mainly local markets in the Rocky Mountains.

More ambitious grassroot refinery projects, such as the Yuma project in Arizona, have struggled to move forward because of their size (150,000 BBL/d) and cost ($3.7 billion). The Yuma project has been under development for 20 years, but its prospects seem to grow dimmer with each passing year.

The recent cancellation of the planned Williston Crude Oil Refinery, a $2.5 billion, 100,000-BBL/d grassroot refinery that was scheduled to be built in in North Dakota, shows how difficult it is to break ground on a large greenfield refinery project in the U.S., Paschall said.

"Even during its best years, the refining business is subject to significant challenges, including thin or even negative margins," said Paschall. "Today, it's more volatile than ever. It's been decades since a grassroot refinery has been built in the U.S. A multi-billion grassroot refiner is a bet-the-company proposition that, in this market, I expect, will find few takers."

View Project Report - 44000592 43000024 31000439

Industrial Info Resources (IIR), with global headquarters in Sugar Land, Texas, and eight offices outside of North America, is the leading provider of global market intelligence specializing in the industrial process, heavy manufacturing and energy markets. Industrial Info's quality-assurance philosophy, the Living Forward Reporting Principle™, provides up-to-the-minute intelligence on what's happening now, while constantly keeping track of future opportunities.