Refining has been one of the hottest sectors since late 2010. The industry has recovered nicely since "The Great Recession", but uncertainties have caused a significant short term pull back. WTI/Brent differentials have tightened, hurting margins. Europe's economy continues to lag, while China's is growing slower than expected, hurting demand. If demand continues to wane it could increase refinery closings. Refining capacity continues to expand in the Middle East and China, further complicating the scenario.
In the attempt to provide clarity, a basic understanding of refining is required. Where refineries are located is very important, but there are other factors to consider. The first is feedstock. This has been very important in the recent success of the United States' refiners. Crude production increases from the Bakken, Eagle Ford, Permian and Western Canada have helped to provide better margins. Crude is classified by density and sulfur content. Density is measured by API gravity. The higher the number, the lighter the crude. Lighter crude is easier to process. Sulfur content is measured as a percentage. Less than .7% is considered sweet. High sulfur crude requires additional processing to meet regulatory specifications. The acid content in crude is measured by the Total Acid Number. Acidic crude has a TAN greater than 0.7, and are highly corrosive to refinery equipment. The Bakken and Eagle Ford produces some of the lightest and sweetest crude in the world. It has sold at a wide differential to Brent, starting from Western Canadian crude which is heavy and sour. The majority of world crude reserves are sour, accounting for 74%.
The refined products can vary depending on the type of crude. Light sweet crude sells for a higher price because it produces a larger percentage of higher end refined products. The opposite could be said for heavy sour. The data in the tables below indicate the inherent yields produced from different types of crude. Keep in mind that generalizing yields is difficult. Different types of crude with similar API gravity can produce a much different percentage and type of refined product. Some crude inherently produces more diesel or gasoline due to its composition.
|Heavy Fuel Oil and Other||35%|
|Heavy Fuel Oil and Other||48%|
|Heavy Fuel Oil and Other||63%|
As the crude becomes heavier and more sour, we see a sharp decrease in the yield from higher end refined products. Refineries pay less for this feedstock, but get less in return. Refineries with a high Nelson Complexity are able to process heavy crude, but this does not guarantee better margins. Additional upgrades are needed to convert lower level refined products. This is also true for light sweet crude.
The refining process initially converts crude oil into intermediates. These are listed below:
|Propane, Butane, and Lighter||Refinery Fuel Gas, Propane, NGLs|
|Straight Run Gasoline (Low Octane)||High Octane Gasoline|
|Naphtha||High Octane Gasoline and Jet Fuel|
|Kerosene||Kerosene, Jet Fuel, Diesel and Fuel Oil|
|Light Gas Oil||High Octane Gasoline, Diesel, and Fuel Oil|
|Heavy Gas Oil||High Octane Gasoline, Diesel, and Fuel Oil|
|Residual Fuel Oil and Asphalt||High Octane Gasoline, Diesel, Fuel Oil, and Lube Stocks|
- 4% Propane and Butane
- 32% Gasoline
- 32% Distillates
- 32% Heavy Fuel Oil and Other
The low octane gasoline and naphtha are converted to higher octane types of gasoline. The high sulfur kerosene and jet fuel are processed into low sulfur types. High sulfur diesel and heating oil are also converted to low sulfur. The vacuum unit produces gas oil and heavy fuel oil. These types of refineries must be upgraded to compete in today's market.
From here, the refinery can be upgraded. This moderate upgrade is catalytic cracking. These types of refineries have a Nelson Complexity around 5. The fluid catalytic cracker takes the gas oil and converts it into light cycle oil and FCC gasoline. Alkylate is also produced after it is place in the alkylation unit. What this means is the refinery can run more sour crude while increasing higher value product yields and volume gain. The list below provides the product yields using this technology.
- 8% Propane and Butane
- 43% Gasoline
- 30% Distillates
- 19% Heavy Fuel Oil and Other
Propane and butane production doubles while increasing the mix of gasoline by 12% and decreasing heavy fuel oil by 13%. Not only do these refineries generate much higher revenues, but margins improve as well by using cheaper crude.
Further complexity is added with a coking refinery. It is equipped to process the vacuum residue into high value products. It is capable of high conversion of fuel oil into distillates and petroleum coke. Feedstocks are medium to heavy sour crude. The heavy fuel oil is converted to coke and higher end products. The hydrocracker takes light gas oil and produces ultra low sulfur jet or diesel fuel and hydrocrackate gasoline. The low cost of natural gas is also beneficial. The product yields are listed below:
- 6% Propane and Butane
- 47% Gasoline
- 33% Distillates
- 14% Heavy Fuel Oil and Other
The data provided is an estimate. Each refinery has a different set up with respect to Nelson complexity, throughput, and type of feedstock. Each variable can change product yields. The estimates given are to show an increase in higher margin products while using cheaper feedstocks.
Another issue facing the refiners is location. For the refiners north of Cushing, it has been easier. Crude north of Cushing sells at a discount to WTI. This discount has little to do with quality and more to do with logistics. Bakken crude is a great example. The Bakken/WTI differential has mostly to do with the cost of transport to Cushing. This discount has been great for Tesoro's (NYSE:TSO) refinery in Mandan, North Dakota and Northern Tier's (NYSE:NTI) in St. Paul, Minnesota.
Most of the US refineries are located outside its best oil producing basins. The majority of refining capacity is located in the Gulf Coast, as the United States has been a large importer of crude. Crude, both light and sweet or heavy and sour, were refined in the United States' most complex refineries. These refineries include Exxon's (NYSE:XOM) Baytown refinery which processes 567000 bpd, and Marathon's (NYSE:MPC) Galveston Bay refinery with a capacity of 451000 bpcd and a Nelson Complexity of 15.3. The refined products were then sent north. The east and west coast have little by the way of pipelines. The Rocky Mountains are a barrier to pipeline capacity, so the refiners have been forced to either import crude or have it shipped from Alaska. The northeast has a similar situation as these refineries owned by PBF Energy (NYSE:PBF) and Phillips 66 (NYSE:PSX) have relied on Brent and other imports for feedstock.
Looking at the US refiners, location is very important. A close vicinity to domestic oil production significantly decreases feedstock costs. As production continues to increase, these costs could continue lower while selling refined products at the cost of Brent. Below is a list of US refiners and the locations of its refineries.
Northern Tier's St. Paul, Minnesota refinery is well positioned for Bakken and Canadian crude. In addition to its refinery, it owns a light product terminal two miles from its refinery. It also operates 166 and has franchised 68 SuperAmerica stores. The refinery has a capacity of 74000 barrels per calendar day. It has a Nelson Complexity of 11.5. Its refined products are 82% light, while using 44% Canadian crude. The other 56% light sweet crude is mostly Bakken.
HollyFrontier (NYSE:HFC) arguably has some of the best refining assets in the United States. Its El Dorado refinery has a 135000 bpsd capacity and Nelson Complexity of 11.8. It processes mainly sour and heavy Canadian crude. HollyFrontier's Tulsa refineries have a capacity of 125000 bpsd. It has a very high Nelson Complexity of 14. It processes mainly light sweet crude, but has the option to use up to 10000 bpd of heavy Canadian crude. These three refineries have an average product mix of:
- 48% Gasoline
- 29% Diesel
- 9% Jet Fuel
- 6% Other
- 5% Lubricants
- 2% Asphalt
- 1% Fuel Oil
The El Dorado and Tulsa refineries use this percentage of crude and feedstocks:
- 70% Sweet Crude
- 14% Heavy Sour Crude
- 8% Sour Crude
- 8% Other
Its Navajo refinery has a processing capacity of 100000 bpsd and a Nelson Complexity of 11.8. It uses mainly sour and heavy crude oils to produce its light product mix:
- 51% Gasoline
- 38% Diesel
- 6% Fuel Oil
- 3% Other
- 2% Asphalt
Its crude and feedstock mix is:
- 77% Sour Crude
- 12% Heavy Sour Crude
- 9% Other
- 2% Sweet Crude
HollyFrontier's Cheyenne refinery has a processing capacity of 52000 bpsd and a Nelson Complexity of 8.9. It processes mainly sour and heavy Canadian crude. Its Woods Cross refinery has a processing capacity of 31000 bpsd. Its Nelson Complexity is 12.5. It processes sweet crude, but more importantly lower cost black wax crude from the Uinta Basin. These two refineries have a production mix of:
- 55% Gasoline
- 32% Diesel
- 6% Other
- 5% Asphalt
- 2% Fuel Oil
Its feedstock mix is:
- 47% Sweet Crude
- 31% Heavy Sour Crude
- 11% Black Wax Crude
- 10% Other
- 1% Sour Crude
HollyFrontier and Northern Tier are examples of being in the right place at the right time. Going forward, both can capitalize from using either light and sweet or heavy crude depending on what has the best differential at that time. Given the difficulties in starting up new refineries, both companies are good investments going forward. Location and Nelson Complexity are very important. Refineries near cheaper domestic crude will garner the best margins, but complexity is also key given the ability to change feedstocks as economic conditions improve.
I will cover this topic more in part II, and how it will affect other US refiners. More importantly, I will discuss additional refining capacity in the Middle East and China. As capacity is added, we could see older, less complex refineries go offline or be shut down altogether.
Disclosure: I am long TSO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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