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Rough times for US oil refiners

If the US oil refining industry is a roller-coaster ride, it is on a dizzying downward plunge as demand drops and prices rise, writes Anne Feltus

NOT MUCH is going right for the US' oil refiners. Two years after refinery margins reached their peak, refiners are facing a perfect storm of problems that have turned profits into losses.

A weak economy has reduced demand for gasoline, diesel and other refined fuels; the Energy Information Administration (EIA) predicts consumption of petroleum products will fall by 3.7% this year. Growth of global refining capacity has created a market glut. The price of crude oil, refiners' principal feedstock, has climbed steadily since March. Meanwhile, refined products inventories have reached record levels.

And that is not all. In recent years, refiners have invested heavily in equipment for processing heavy, high-sulphur crude to supplement flows of the light, sweet crude that has traditionally supplied the industry. But following Opec production cuts in late 2008, margins on sour oil have been squeezed more than on other types of crude. As a result, its cost advantage has shrunk to less than $5 a barrel from about $30/b in early 2008.

Refiners' profits reflect these dismal conditions (see Table 1). For example, ExxonMobil, which operates the country's biggest refinery – the 0.58m barrels a day (b/d) Baytown, Texas, plant – reported a loss of $203m in its US refining and marketing business in the third quarter, down from a $0.978bn profit in the third-quarter of 2008 (PE 12/09 p26). Chevron, which has five US refineries, announced that third-quarter earnings from its domestic downstream operations had dropped to $34m in the third quarter from $1bn in 2008.

Integrated oil companies such as ExxonMobil and Chevron can offset their refining losses with profits from their upstream operations, but that is not the case with independent refiners.

Valero Energy – North America's largest refiner, with over 3m b/d of capacity – recorded a $1.2bn profit in third-quarter 2008, but lost $489m during the same period this year. And the company expects a similar loss in the fourth quarter. Valero did have some positive news to report. Earlier this year, it acquired seven ethanol plants from bankrupt VeraSun. Buoyed by lower prices for maize (corn) and natural gas, their feedstock and power source, respectively, the facilities generated $49m in operating income during the third quarter, helping to offset some of the company's refinery losses.

Sunoco, the second-largest US refiner, took a similar hit. It reported a $312m loss in the third quarter, compared with a $0.549bn profit in the year-earlier period.

Tesoro managed to eke out a profit. The San Antonio-based independent, which operates seven refineries in the western US, achieved $33m in net profits during the third quarter, but that represented just over 12% of the $259m it earned in the same period last year.

In response to bleak conditions, refiners have been implementing cost-saving measures. After initially projecting a capital budget in excess of $3bn for this year, Valero has scaled this back to $2.0bn-2.5bn and plans to spend at that level in 2010. Sunoco says its capital spending in 2009 will be just below $1bn, about $50m less than it forecast earlier this year. And, despite its profit, Tesoro slashed its budget from $1.14bn to $0.6bn and expects to end up spending even less than that – its 2010 budget is $0.675bn. Sunoco and Tesoro both cut their quarterly dividends by 50% and Valero said it would do the same if industry conditions show no significant improvement.

Some expansion projects have been shelved or delayed. Earlier this year, Valero said it would delay a $250m expansion of a crude unit and coker at its St Charles, Louisiana, refinery for two years and would suspend indefinitely billion-plus-dollar hydrocracker projects at the 250,000 b/d St Charles and at 310,000 b/d Port Arthur, Texas, plant. Motiva Enterprises had planned to complete construction of a $7bn, 325,000 b/d expansion of its 285,000 b/d refinery in Port Arthur in 2010, but has pushed the date back to early 2012.

Several companies are closing refineries, idling units or cutting production to save costs. Sunoco will close its 135,000 b/d Eagle Point refinery in Westville, New Jersey, for an extended period and will ramp up production at its 178,000 b/d Marcus Hook and 335,000 b/d Philadelphia facilities in Pennsylvania to make up for the output shortfall. Western Refining plans to consolidate the operations of its two New Mexico plants, with a combined capacity of 40,000 b/d, by closing one of them in the first quarter of next year, saving it about $25m a year.

In late November, Valero announced plans to idle its 210,000 b/d Delaware City, Delaware, refinery permanently. "Earlier this fall, we shut down the gasifier and coking operations in an attempt to improve reliability and financial performance, but the refinery's profitability did not improve enough," says chief executive Bill Klesse. "We have sought a buyer for the refinery, but feasible opportunities have not materialised. At this point, we have exhausted all viable options."

Tesoro says it might run as low as 77% of its total 0.665m b/d capacity in the fourth quarter because of maintenance and low demand. As a result of closures and production cutbacks, the EIA says domestic refinery utilisation fell below 80% in mid-November, one of the lowest weekly utilisation levels in more than 20 years (see Figure 1). If refinery throughput rates average in the low 80% range, Vienna-based consultancy JBC Energy estimates 4.4m b/d, or about 19%, of expected North American refining capacity will be vulnerable to shut-downs by 2020.

And possible regulatory changes could cause even more pain. Most significant would be climate-change legislation establishing a carbon cap-and-trade system. Valero's Klesse told a Senate committee in late October that this legislation, if enacted, could cost the industry more than $67bn a year. Refiners would be unable to pass their extra expenses on to consumers because of weak demand and competition from foreign refineries that operate in less-restrictive environments.

According to the not-for-profit Energy Policy Research Foundation, the higher cost structure and increased international competition "threatens 2.5m of the country's 17.5m b/d of domestic gasoline and diesel fuel refining capacity with permanent closure".

For refiners that survive, there is a ray of hope. Supply and demand could become more aligned as an improving economy boosts consumption and reduces inventories and as plant closures reduce the flow of product to the market. But, that is not going to happen soon.

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