US refinery spend to rise in 2016-2020 on low oil price, EPA rules

Petroleum refiners in the United States and Canada are projected to spend about $6.7 billion on new capital projects in 2016, up from $5 billion in 2015, said Chris Paschall, vice president of global research for the petroleum refining industry at consulting firm Industrial Info Resources.

Out of that, refiners in the US and Canada have scheduled about $1.3 billion of maintenance spending in 2016, and the number of scheduled refinery turnaround projects is expected to increase in 2016 after it fell sharply in 2015 as refiners delayed projects to process the flood of inexpensive crude oil, according to Paschall.

Despite slackened crude oil prices, analysts project US petroleum refinery capital spending to rise over the next three to five years as refiners race to prepare facilities to meet new rules from the US Environmental Protection Agency (EPA) and take advantage of cheap domestic feedstock, and as the North American region exports more petroleum products.

Crack spread critical for project development

Vast supplies of crude oil unlocked from the nation's shale resources have contributed to lower oil prices, and in return, better margins for large, integrated refiners, as well as smaller, independent refiners focused on gasoline and refined products.

Paschall said that crack spreads, a good indicator of refiner profitability, will influence which type of capital projects move forward.

Gasoline crack spreads hit several-year highs over the summer on the back of low crude oil prices, robust US gasoline consumption and exports, as well as higher-than-expected demand for liquid fuels in Europe and some countries outside the Organization for Economic Cooperation and Development (OECD). 

Historical RBOB futures prices and crack spread. Source: EIA, Short-Term Energy Outlook October 2015.

“Refining has always been a low-profit margin business. As the margins increase, owners will look to reinvest capital to improve efficiency and meet regulatory requirements,” said Steve Cabano, president of project management and consulting firm Pathfinder LLC.

On November 3, Alon Partners reported in its Q3 earnings statement that the higher crack spreads had helped generate solid margins, which would drive decisions on future capital projects.

On October 28, Valero Energy reported a better-than-expected third quarter profit, helped by robust demand for refined products and lower crude costs.

Meanwhile, Marathon Petroleum Chief Executive Gary R. Heminger said on October 29 that the company had captured strong crack spreads in Q3 2015, while lower customer fuel prices helped boost demand for its refined products.

US crude oil production is double what it was a few years ago, making for long naphtha supply. In 2010, the US produced an average of just over 4 million barrels/day of crude oil compared to nearly 10 million barrels/day at the start of 2015.

US crude oil inventories hit record highs of 456 million barrels in September, compared to just over 300 million barrels the same time last year, according to the US Energy Information Administration (EIA).

Refinery utilization rates are higher than in previous years as a result 2015 mid-year refinery rates were in the mid-90%, compared to the mid-to-low 80% range in 2013 and 2014.

However, Paschall and Cabano cautioned that refining capital spending in the mid-term will depend as much on market dynamics as on political results over the next year, which are currently hard to predict.

Even with the US presidential elections coming up in 2016, no major changes will happen right away as the world waits to see how the next elected official will handle US energy policy. Things will remain in status quo for the next one to two years, Cabano said.

More spending expected for gasoline projects

Paschall projects that changing market fundamentals may prompt more spending on gasoline-related projects going forward.

“Capital spending is likely to continue from 2017 to 2020 as well,” he said. “Oil prices will stay low, keeping gasoline prices low. This will spur consumption. Refiners are steering projects to meet demand in places where we have not seen demand in the last two years.”

Some $2.7 billion will be spent on major US refinery construction projects by the end of 2015, with the majority $2.1 billion going to crude units, according to Industrial Info Resources projections. An estimated $495 million is projected for diesel-directed plans, and $110 million for gasoline projects (see graph below).

Republished with permission from Industrial Info Resources.

US refiners will also likely spend more on gasoline projects than in recent years in order to meet more stringent condensate, naphtha, octane loss and Corporate Average Fuel Economy (CAFE) standards.

The 2017-2015 CAFE standards, in particular, require that automakers significantly ratchet up the average mileage of passenger cars and light trucks sold in the US.

As auto manufacturers build more high-compression engines to comply with the CAFE standards, more octane will be needed in the long term in the domestic gasoline pool to fuel these higher-performance vehicles.

This could push up the spending on reformers and alkylation units at US oil refineries to increase the octane output, Paschall said.

Marathon Petroleum and Valero Energy have both said they are considering adding alkylation capacity to their refining systems to meet future demand.

Spending on retrofits in the US

Most of the US refineries are tooled to favor heavy, sour oil imported from Latin America, but changes in dynamics are pushing companies to decide whether to retrofit for different types of crude – especially light, sweet oil from abundant domestic shale resources – and whether to export or keep the product on US soil.

“Some refiners still think this is all a short-term trend and don’t want to spend the money to make changes, but refiners need to think long term,” Paschall said. “Most refiners on the US Gulf Coast are trying to take advantage of light tight oil.”

While imports of medium and heavy grades of crude oil have remained steady in the US Gulf PADD 3 region, imports of light oil have dropped substantially, from more than 1 million barrels/day in 2009, to 55,000 barrels/day in 2015, according to the US Department of Energy (DOE).

Refiners have a cheap feedstock and high inventory, and this continues to keep pressure on the benchmark West Texas Intermediate (WTI) prices. Medium and heavy crude refiners in the PADD 3 area are currently costing the switch to lighter crude.

“A crude unit revamp, or a new condensate-processing unit build, using this light tight oil can range from $10 million to $600 million, and involve a wide slate of units: LPG/gas plant processing expansion, process steam, rail car unloading, crude blending and tankage,” Paschall said.

A conversion to use heavy sour crude could cost up to $1 billion and involve modifications to the crude/vacuum units, coker capacity, hydrotreater/h2/sru, and off-site utilities, Paschall added.

Projects take from 12 months to up to five years depending on the complexity of the project.

“Margins are low, feedstocks are low, companies are producing product, but they have to invest in refineries to keep them running,” Pathfinder’s Cabano said. “The value proposition is still there, but the cost to execute it is another issue.”

Race to meet the Tier 3 rule

Regardless of the market dynamics, basic spending will be up in 2016 to meet environmental regulations, especially the US Environmental Protection Agency’s (EPA) Tier 3 gasoline mandate, Paschall said.

The Tier 3 rule mandates that the sulfur content of gasoline must be further reduced from 30 parts per million to 10 parts per million on an annual average basis by January 1, 2017.

Refiners estimate that the proposed new rules will push up the cost of gasoline because refining systems will need additional hydro-treating equipment, as well as revamps and expansions to existing hydrotreaters, to remove sulfur.

Phillips 66 plans $1.2 billion of capital expenditures in refining in 2016, some 70% of which will be invested in reliability, safety and environmental projects, including compliance with the new Tier 3 gasoline specifications, the company announced in mid-October.

HollyFrontier has said it plans to spend $325 million during 2015-2018 to expand and modernize operations at its five existing US refining centers. 

By Heather Doyle