Spooky Scenario: The Changing Face of the US Oil Industry
TORONTO, Oct. 31, 2013 /PRNewswire/ - PF Group Inc. is pleased to announce the results of its latest study. Data released by the US Energy Information Administration (EIA) over the past several years have pointed to a compelling shift in the strategic context of US oil markets that may emerge in coming decades. The interwoven threads of pipelines, railways, carbon emissions, and political maneuvering are joined together in the loom of US refiners.
Incremental increases in US refining capacity over the past twenty years have roughly kept utilization rates in the mid-80% range, with fewer than one million barrels per day of idle capacity, while at the same time that overall refiner output has grown by approximately 25%. This increase in output has roughly kept pace with population growth on a year-over-year basis.
Since the turn of the century the quality of crude oil used as feedstock for refineries, as measured by sulfur content and API gravity, has been relatively stable. Prior to this period, however, there was a material change in crude oil sourness and density, with average sulfur content rising by ~50% and API gravity falling by ~10%.
Although US crude oil production has increased since the mid-2000s, the EIA is forecasting crude oil production shortfalls of ten (currently) to twelve (after 2019) million barrels per day compared to US refining capacity; the US will demand substantial imported crude oil into the foreseeable future. Consequently, Canadian pipeline and railway access to the US will remain a major policy issue. If Canadian oil production doubles as projected, escalating conflict over transportation of Canadian crude oil may dominate Canada-US relations with a spillover effect into Canadian trade arrangements outside of North America.
However, of more interest are the recent developments in US oil product end market sales. In particular, growth of US refinery output has outpaced US domestic demand for refined petroleum products, leading to a tripling of US petroleum product exports since the financial crisis. This suggests that US refineries supplying non-US demand for refined oil products are driving a portion of US oil import demand; compared to domestic demand, US refiners have excess capacity.
Refining overcapacity may attract the attention of environmental constituents and become the new carbon battleground, displacing current attention focused on crude oil transportation. As long as US refiners have capacity and an end market they will demand crude oil. Combatting the transportation of oil to refiners, whether by pipeline, rail, or ship, is similar to squeezing a balloon full of water - market forces, like water, cannot be compressed and undue external pressure will cause them to expand outside of the pressure zones.
Instead of fighting the multiple transportation effects of US refinery demand, the strategic context may shift to the single proximate cause, refining capacity itself. If refining capacity were to be statutorily limited to supply of domestic demand, either by limiting refined product export in the same manner as crude oil, or by decommissioning excess capacity (with the caveat that environmental and national security concerns could more directly collide), then there would be a ripple effect across global oil markets.
In this scenario, as US import demand wanes a corresponding shortfall in accessible global refining capacity would increase the economic importance of non-US refining operations. To the extent that North American oil production quality deviates from that of imported oil, low quality North American oil production would become stranded or the cost of refined products would necessarily increase in dollar and carbon output terms. There may be other knock-on effects that are difficult to predict, similar to anticipating where exactly the water filled balloon will expand when squeezed.
Sound far-fetched? Consider the impact of Ultra-Low-Sulfur-Diesel (ULSD) legislation. Since the implementation of ULSD in the US a decade ago, distillate production with sulfur content below 15 ppm has risen from 0% to over 90% of total distillate production, which has grown approximately in line with overall petroleum products. Any additional cost of refining lower sulfur distillates seems obvious, but there was also a knock-on effect that impacted global graphite markets and possibly electric car production.
Increasing distillation to reduce sulfur content requires a heat source, and to minimize costs refiners cannibalized their production of marketable petcoke, effectively recycling a byproduct of the distillation process by feeding the petcoke back into refineries. Total petcoke production since ULSD has been relatively stable, but the amount of petcoke supplied to end markets has fallen dramatically.
Marketable petcoke serves as a feedstock for synthetic graphite, which is used in multiple products including lithium-ion batteries. The negative supply shock in the synthetic graphite market caused a reciprocal demand shock in natural graphite markets, and a corresponding jump in natural graphite prices.
Capital markets responded with a redeployment of capital to Greenfield graphite projects, and a simultaneous marketing effort that erroneously identified the demand shock culprit as demand from electric car producers. Ironically, the longer-term effect of reducing sulfur emissions may be to hinder more attractive electric car pricing, and thereby overall reduction in carbon output and fossil fuel reliance.
What will be the ultimate impact of recent changes in US oil markets? Only time will tell, but historically change has signaled opportunity, with greater change opening the door to greater opportunity.
About PF Group Inc.
PF Group Inc. is a specialized consulting firm that provides bespoke strategy and analytical consulting services. The principals of PF Group have a wide range of experience in capital markets, corporate strategy, and research. For more information please contact Patrizia Ferrarese +1.416.554.6443.
This research is provided for information purposes only and does not constitute an offer or solicitation to buy or sell any designated investments as may be referred to herein. This material is prepared for general circulation and does not have regard to the investment objectives, financial situations or particular needs of any person. Investors should obtain advice based on their own needs for the purpose of making an investment decision. PF Group Inc. does not accept any liability whatsoever, any direct or consequential loss relating to any use of the information contained in this research.
SOURCE PF Group Inc.