In this episode of Sound Off, Joe Perino discusses the changing US refining landscape.
Some of the key topics discussed in this episode include global refining trends but with a focus on the U.S and North America.
Joe also talks about the number of refineries, size and capacity, complexity, utilization, the crude slates that they are processing, the ownership picture and then finally their business models.
I think we all have something to learn from someone who starts the discussion with the following comment:
I started my career in refining at Phillips Petroleum, in Kansas City, Missouri in 1975 and boy, how things have changed since then.
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Listen to Sound Off with Joe Perino below:
Hello, I am Joe Perino, and welcome to Soundoff. This podcast is part of the EKT Interactive learning network and is brought to you by Oil 101, a free ten-part introduction to the oil and gas industry.
Today we’re going to talk about the changing refining landscape. Now, I started my career in refining at Phillips Petroleum, in Kansas City, Missouri in 1975 and boy, how things have changed since then.
We’re going to cover a number of topics in discussing the changing refining landscape. First we’ll talk a little bit about global trends but we are going to stay primarily focused on the U.S and North America. We’ll talk about the number of refineries, size and capacity, complexity, utilization, the crude slates that they are processing, the ownership picture and then finally their business models.
Let’s begin with what’s happening on a global basis. Who’s growing and who’s shrinking?
Well, Europe, Australia and Canada have been shrinking in terms of the number of refineries. The Middle East to the Asia are growing especially China and India. Japan is consolidating and most of their investment is going outside of Japan into Southeast Asia.
Africa is stagnant, Russia has many ageing refineries and Latin America is generally struggling under low oil and low commodity prices. The U.S has actually lost three refineries in the last few years but, the capacity has grown a little bit to now over 18 million barrels a day processed.
Now, in terms of the total number of refineries in the world, a few years ago, in 2006, we were just over 700, we’re now down to 650 as we speak here in 2016. Most of the closings have been Europe. Another interesting tend is the size and capacity of refining and the rise of mega refineries and mega hubs, and I’ll explain what I mean by mega hubs.
Generally, mega refineries are those that are at least 3 to 400 thousand barres a day or larger. The largest refinery in the world, by the way, is the Jamnagar refinery in India, with a capacity of over 1.2 million barrels a day. What we’re seeing in these larger mega refineries that have been primarily built in the Middle East and in Asia, is that they are being built because they have three advantages; One, the economy of scale; they are very. Two, they have an ability to produce a wide range of products and third, they can handle up to 100 different crudes. This gives them tremendous flexibility.
These refineries are also relatively complex, I’ll address that a little bit later. You’ve seen large refineries and mega refineries. They are also organized around, what I mentioned to be, mega hubs. We have 3 or 4 hubs where supply and demand come together, around the world.
The best known of these is in Rotterdam, in the Netherlands, in North Western Europe, Singapore anchors the Asia-Pacific region and really the third one is the U.S gulf coast, although here in the U.S, we also have three or four areas that might be called hubs of activity. These are groups of refineries are feeding a supply and demand zone.
The others in the U.S are the upper Mid-West, Illinois, Indiana, around Chicago and Detroit, the West-Coast, Los Angeles, San Francisco, Seattle and then we do have a sprinkling of refineries in the Mid-West in the Rocky Mountain areas.
We used to have a bit of a hub on the East-Coast but with all the closings that have occurred over the many years, they’re now down to about four or five refineries that are not very large and not very complex. They are importers of gasoline and fuels from Europe as well from other parts of the United States.
Now, you might ask, when was the last refinery in the U.S built?
This is a good question and that depends on your definition of a refinery. If we’re talking about a small refinery, a topping facility or a hydro skimming refinery or a condensate processing facility then we built these most recently in 2014 and 2015, but if we’re talking about the typical large integrated refinery, then it’s been sometime. The last one was built in 1977 in Garyville Louisiana by Marathon. It started out at 200, 000 barrels a day and today is now over 500 in 20,000 barrels a day.
This is an indicator of what’s been happening. We haven’t built wholesale new grassroot refineries, we’ve been adding capacity at existing sites and therefore literally doubling some of these sites or tripling them in size.
Today the largest U.S refinery is Motiva’s refinery in Port Arthur, Texas, at over 600, 000 barrels. Now, a moment ago I mentioned two types of refineries; Topping and Hydro skimming. In order to understand refinery complexity, let’s talk about the four types of refineries and then something called The Nelson Index.
The first type of refinery is the topping refinery. This is the refinery that only has a crude unit and some treating of the products from the crude unit.
The second type is Hydro skimming refinery. It has a crude unit and a catalytic reformer plus treating.
The third refinery, which is the more common one, is the conversion refinery. It has a crude unit, a catalytic reformer and a fluid catalytic cracker. It may also have additional units such as a hydro cracker and an alkalation unit plus several treating units.
Then fourth, we have what we call the deep conversion or heavy processing refinery. This is a conversion refinery with the addition of coking.
Now, back in the 1960s, Nelson developed a complexity index to quantify the relative cost of components that make up a refinery, at that time he was working for the Oil and Gas journal.
The Nelson Complexity Index is a cost index that provides a relative measure of the construction cost of a particular refinery based on its crude and upgrading capacity.
It assigns a complexity factor to each major piece of refinery equipment based on its complexity and cost in comparison to the crude unit, and that’s assigned a complexity factor of 1.
Adding up the complexity values assigned to each piece of equipment including crudes, determines the overall complexity number on The Nelson Index.
The U.S has an average index of just over 11, which is the world’s highest. Most of the other world’s refineries fall between 6 and 8 and that’s due to a large number of Hydro skimming and simpler conversion refineries that we typically find outside of OECD countries; Africa, Latin America and much of Asia, and even many of the refineries in Russia.
The U.S also has the most coking capacity in the world. In fact, 80% of the U.S gulf coast refineries have coking. You might say well, “Why is this?” Well, that is because U.S crude production dropped off from a high of around 9 million barrels a day in early 1970s and it dropped down to between 5 and 6 million barrels a day. That mean we had to import more oil to back fill that void.
Well, 3 of our largest suppliers of crude oil; Canada, Mexico and Venezuela, all supply heavy crudes. We modified our refineries to take these heavy crudes and so over the last 20 to 25 years, we’ve added a lot of coking capacity and upgrading capacity, not only to the Gulf coast but generally to the other hub areas; Chicago, Detroit, San Francisco and Los Angeles, so they can import crudes from these countries.
Well, obviously that landscape has changed somewhat now, because in the last few years with the shale oil revolution, we’re now producing a lot more light crude. In fact, when you look at the U.S refineries in aggregate, we can pretty much handle any type of crude and we’re very, very flexible, so we’re fortunate in that aspect. One note, the mega refineries that I mentioned earlier, usually are in the 12 to 15 range, which means they have almost every type of unit included in the complex.
Now, let’s move on to utilization.
What do we mean by utilization, when we say how much of the refinery is used? Well, you look at the actual physical capacity of the refinery and then you say, how reliable is it or how much time is needed to do maintenance and that gives you the available capacity.
Let’s assume that you have a refinery with a value of 100 and you need 5% of the time to do maintenance, that would give you 95% available. Then the question is, how much of that 95% is being used? That’s the utilization rate.
Now, the U.S, also is fortunate, that we maintain, on average, the utilization rates in the world, we’re very well run. As we enter the first quarter of 2016, our rate is just over 92%.
If we look at that, compared to the rest of the world, most of the western countries are in the high 80s but many others are in the low 80s and some even lower. By way of contrast, there are four refineries in Nigeria and their average utilization rate is only 14%! Wow!
Now, utilization also varies with seasons, and you may have heard about the word turn-around and the summer-winter cycle. Turn-arounds are a process where the refinery takes down one or more units for major repairs or up-grading. They do this typically every 3 to 4 years. They normally schedule those in the spring when they move from producing distillate and fuel oil for the winter and before they start producing more gasoline and diesel for the summer driving season.
We’re just entering that period now in the first quarter of 2016 where they are shifting over, and once they get these turn-arounds behind them, they want to maintain a very high utilization rate through the summer months.
The other factor, of course in the U.S is that, we have so many different formulations of gasoline that we need to make in the summer time due to the temperature and due to varying regulations in the States, in the Federal government, that they are very challenged to make this complex set of mixtures. Some of these are up to 100 different gasoline formulations, and so they want to make sure the refinery is running at full capacity to be able to take advantage and supply the fuels to those people who need them.
Now, we’ve been talking about utilization, complexity, the number of units.
What about the type of crude oil that we’re bringing in to the U.S?
I mentioned a few minutes a go that, when our production dropped in the U.S, when we started importing more crudes, initially was very heavy crudes. Canada, Mexico, Venezuela have heavy crudes, and we also brought in heavy crudes from other parts of the world, so we added the heavy processing or deep conversion units to our refineries.
Well now, we can handle almost any crude, as I mentioned, we actually import and export crude and refined products to over 75 countries.
Many of our destinations for our refined products are Latin America and the Caribbean, which are near-by. Almost all those countries import refined products. We also send gasoline to Europe, diesel to Europe and Europe sends us gasoline.
Approximately 46% of the crude oil refined in the U.S is imported, and that’s down from over 60% in 2006, when our crude production bottomed out on 5 to 6 million barrels a day. Now, we back up and today we’re producing, as I mentioned, about 9 million barrels a day and we’re importing about 7 million barrels a day.
The difference there is that, we also produce about 2 million barrels a day of natural gas liquids, that are feed stocks to the refineries as well as the petrochemical industry.
Where do we get these crude oils?
Well, I mentioned Canada and Mexico and Venezuela, but also Saudi Arabia and Iraq, are suppliers. Then we also get imports from West Africa, from Colombia, from Kuwait, from Ecuador and a series of other countries, but those are the top ones.
Saudi Aramco sends about one million barrels a day to Motiva, which is the joint venture between Shell and Saudi Aramco. Now, if you sit back an look at this, you might say to yourselves, “Well, can we really be energy independent?” No, we’re always going to import some crude oil but, you can see from the names of the oil companies that I’ve mentioned, that we actually have a very secure supply because so many of these countries that are close to us; Canada, Mexico and Venezuela, we’re basically their sole source in terms of supply and we take in most of their exports, particularly from Canada.
We have a very secure supply from these countries.
We import some from the Middle East but we actually could stop importing oil entirely from the Middle east, we do so for reasons of commerce an politics. I mentioned earlier that U.S is now producing a lot more light crude due to the unconventional tight oil revolution.
This lighter oil production has displaced the import of light crude primarily from West Africa, that is Nigeria and from Northern Africa; Algeria and Libya.
We’re also now exporting light crude to Mexico. Why is this? Well, Mexico’s refineries were built 20, 30, 40 years ago, when their crude slate had more of their own locally produced light crude oil. This production has dropped off so now they are primarily producing medium and heavy crude, so they need to make up the light crude which the refineries were designed for, by importing light crude from the U.S. Our laws recently changed last year and so now we’re able to do that export to Mexico.
Let’s move on to the ownership footprint in refining, and this is an area that has changed considerably.
We’ve seen 5 or 6 different things going on here in the last 20 to 25 years; specialization, footprint reduction, growth, mergers and consolidation, vertical integration and foreign ownership of refining here in the U.S.
Now, by specialization I mean, we have seen ConocoPhillips and Marathon speed off or divide and divest their refining business from their upstream business. Now we have Philips 66, a very large refiner and Marathon Petroleum.
In terms of footprint reduction, we’ve seen BP reduce their footprint refining the most, Chevron to a less extent. In terms of growth, the majors used to be the largest refiners but now the largest refiner in the U.S is Valero. Purely an independent refiner.
We’ve also seen some growth in the co-operatives.
In terms of mergers, Holly and Frontier have combined and as we speak, Western Refining and Northern Tier Refining, two refiners who actually not physically connected at all are merging. It may be that, they have great synergy because both of these refiners serve markets where they don’t have a lot of competition from other refiners or from other pipeliners in the area. They have high margins and they also have their own distribution networks.
An example of vertical integration is the fact that Delta Airlines bought a refinery in Treno Pennsylvanian a couple of years ago, and are producing products for their own jet fuel supply as well as others.
Then finally, in terms of of a foreign footprint, Total has been here of many years in the U.S but we also have Canadian ownership by Sanco, by an Israeli Corporation and we have some joint ventures which includes financial companies owning part of the refining business.
We’ve actually a landscape change quite a bit from, where the majors used to dominate along with a bunch of small independents, and we had almost 200 refineries. Now this is now changed in it’s make up, and now we’re down to 140 refineries, yet at the same time our capacity has grown a little bit.
This logically leads to the last topic which is the business model in refining.
When I joined the refining business in the 70s, each individual refinery was it’s own business units.
It brought crudes from nearby supplies, typically on contract and I mentioned to you I worked for Philips in Kansas City, so they had a pipeline in from the crude that was produced in Kansas and they didn’t process that many different crudes, perhaps 5 or 6.
Then they took the refined products, handed them off to the wholesale division and let them take care of distributing that into the wholesale and retail markets.
Now, things have changed.
Refineries have moved from a refinery-centric model to a network-centric model, where the refinery is a nod in a network of supply and demand.
Where supply, planning and trading steer the business, send out the signals as to which products that are needed, how much and where, and the refineries and their network produce to that requirement and the supply and trading people are looking at the margin, not only on the crude side, but all the way through the refinery, all the way through wholesale and to the pump, if they have a retail network.
They are now trying to basically manage the molecule from the crude they buy all the way to the pump and to maximize the margin value all the way across that value chain.
This is much different than it used to be, and this is not only occurring in the hub areas – the Gulf coast, the West coast – but as I mentioned with Western and with Northern Tier, they operate the same way even though they don’t have a whole lot of other competition in their areas.
Let’s step back and summarize the major changes that have occurred.
We have seen refinery size and complexity increase even as the refineries in the world number and in the U.S have shrunk.
We have seen utilization increase as refineries have become more reliable.
We have seen the crude slate change where one time had more heavy crudes and now we have more light crudes and as I mentioned, the U.S refiners can handle pretty much any crude.
We have seen the ownership picture move and change and metamorphosize and finally we’ve seen the business model change from a refinery-centric to network-centric.
If you have any questions or have a comment, on this podcast, we’d like to hear from you. Thank you for listening.