(Editor’s note: adding shutdown of Shell Convent refinery)
Diesel consumers are likely to face an uncomfortable fact that is ongoing and likely to get bigger: The capacity to refine crude oil into traditional diesel fuel is starting to shrink in the U.S. and ultimately the world.
That point was driven home in the last week by the news that independent refiner PBF was planning to close its 160,000 barrel-per-day refinery in Paulsboro, New Jersey, on the east side of the Delaware River. It comes as a growing consensus was on display in quarterly earnings calls from oil company executives that given the drop in demand for transportation fuels worldwide, there is simply too much refining capacity in the world and there will be efforts needed to cull it.
PBF CEO Tom Nibley, on his company’s earnings call with analysts, said he expects worldwide refining capacity cuts to total about 5 million b/d, with about half of that coming from North America. Against a worldwide oil market of about 97 million b/d, down from the pre-pandemic level of 100 million b/d or slightly more, a cut that big is significant.
Some of those cuts in North America are already in place, if as Nibley said he was doing, you include last year’s closure of the biggest refinery on the East Coast — Philadelphia Energy Solutions at 335,000 b/d. A 130,000 b/d refinery in Newfoundland was closed earlier this year; Marathon Petroleum has shut two refineries with total capacity of about 190,000 b/d; Phillips 66 shut a California plant; and a small Wyoming refinery was closed but converted to making renewable diesel. Total those up and the reductions are still way less than the 2.5 million b/d in closures predicted by Nibley, which would mean there are plenty of shutdowns to come.
Shortly after this story was first published, Shell revealed it is closing its 240,000 b/d refinery in Convent, Louisiana near New Orleans.
The problem refiners face was summed up in a recent weekly report from energy economist Philip Verleger. Verleger took the most basic health of refining economics, the 3:2:1 spread. That calculation takes the price of WTI crude on the CME exchange and multiplies it by three. It then takes the price of RBOB gasoline from CME normalized to a per-barrel price, multiplies it by two and adds one barrel of ultra low sulfur diesel. It subtracts the price of crude from the total. What’s left is a far from perfect but very basic indicator of refining health.
As Verleger said in his report looking at recent history, the “golden age” of refining from 2004 to 2008 had an average 3:2:1 spread of about $12/barrel. From 2019 to 2019, it was about $11/b. And this year, it’s been about $8/b.
This sort of movement has an ultimate impact on the price of diesel at the pump. While the price of diesel will always be mostly a function of the price of crude, diesel’s spot market spread against crude is a significant factor as well. It can be thought of as the “final mile” to get to the wholesale and retail price.
And that spread has been weak for months. That weakness is a contributing factor to that decline in the 3:2:1 spread cited by Verleger. Looking at the spread between global crude oil benchmark Brent and ULSD on the CME commodity exchange, it recently has climbed and sustained itself above $8/b for the first time in months. But in the past few months, it also has been below $5 on several days.
The spread a year ago? It was more than $19. For all of 2019, it averaged more than $17/b.
The weakness in diesel and the overall softness in crude recently helped drop the DOE/EIA weekly retail diesel price, the basis for most fuel surcharges, to $2.372/gallon, the lowest since August 2016.
All of this adds up to a market for refining that is contributing to refinery owners deciding to cut back on their capacity. Refineries do close every so often. But an Energy Information Administration list of closures over the years shows that what has happened already, and what is likely to continue happening, is nothing on the scale of the shutdowns that Nibley projects.
The 2.5 million b/d refinery cut in North America that Nibley predicted comes in a region that has what are considered to be the most complex refineries and therefore the ones with the better cost structure to get through tough times. Yet Nibley still projected big cuts.
Where other cuts would come from would be less complex refineries elsewhere in the world and the U.S. On the recent conference call for Phillips 66, Bob Herman, executive vice president for refining, said that between Europe and the U.S., the refineries “run the gamut between really strong and there’s some maybe some weaker assets out there,” according to a transcript of the call supplied by SeekingAlpha.
“There will be assets that will continue to rationalize out of this, and you’ve seen it on both the East Coast and the West Coast, and no doubt, some of the maybe landlocked players,” Herman added. “As time goes on here, we’ll have difficulties as crude (differentials) remain squeezed in the U.S.”
The irony is that even as refiners are talking shutdowns, there have been signs that the weak diesel market may have hit a bottom. Price reporting agencies like S&P Global Platts and Petroleum Argus both reported significant increases in the benchmark spread between diesel in the U.S. Gulf Coast and the ULSD price on CME, a key indicator of physical strength. Combine that with gains on the ULSD CME price and it has sent the wholesale rack price of ULSD in Houston up about 10 cents/gallon over the last few days.
The latest weekly inventory reports showed a particularly large drop in ULSD inventories in PADD 3, which includes the Gulf Coast, down about 10 million barrels in just five weeks. That’s a big decline as refiners have finally been able to slow down their output and get stocks closer to historic norms. They have been historically high nationally by some standards.
Regardless, the fate of a lot of refineries in the U.S. seems clear — they will close. That will be offset to some degree by the production of renewable diesel, but that capacity isn’t even going to be 100,000 b/d anytime soon. Meanwhile, if North America loses 2.5 million b/d of total capacity, and we assume one-third of that is distillate output, that is more than 800,000 b/d. That is a big number that renewable diesel won’t be filling.
More articles by John Kingston
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Diesel inventories have done something in the U.S. not seen for at least 30 years
Drilling Deep: Diesel technology pushes back against the idea that it’s status quo
Mrbigr504
I’m loving the low fuel prices! The fat cats didn’t give a damn about us when the fuel was $4.00 bucks a gallon! They’ve been dick’n us for years so sorry if i don’t cry that your bank accounts aren’t burst’n at the seems as usual! Just glad that the Saudis aren’t the only ones with oil now so thank you Russia and Brazil for that!
Stephen Webster
The refineries need a spread of at least _13.00 cd or almost $10.00 us per barrel. No oil companies can have crude of less than _$65.00 cd or $50.00 us per barrel going to the refinery It fine to electric cars and reefer units maybe with fuel cells or hybrid or natural gas powered. Long term we need minimum freight rates and oil prices in Canada and the U S and Mexico. All imported oil should have a duty to set a minimum price of $50.00 U S per barrel. This will help encourage alternative fuels. In Ontario Canada many people deal the gov should provide a major upgrades to refineries and buy a 40 percent interest in them. We need to set . minimum diesel and gasoline prices.