Refining Industry Update – Natural Gas Economic Game Changer

  • July 29, 2011
  • Feature
July 2011
By Bill Lydon, Editor
Peg Stein Oil Industry Update
Peg Stein, Director of Marketing in the equipment group at UOP, presented industry information, analysis, and opinion about the oil and natural gas industry at the recent 2011 Honeywell Users Group Americas Symposium.
Oil demand was significantly down for the first time in many years in 2008-2009 due to the recession. The forecast going into 2010 was for recovery and the demand in 2010 exceeded the highest forecasts. Based on the May monthly IEA (International Energy Agency) report, Stein commented, “It appears that demand is going to overshoot the forecast again.” “The 2011 forecast exceeds 2010, up with year to date demand continuing to move forward robustly. I say that with a little bit of hesitation.” She explained that there are a number of upside and downside risks. 
On the downside, the European recovery is tenuous with the risk that something could send them spiraling down again. The latest weak U.S. unemployment figures put some risk into the forecast. The 2011 forecast for developed countries, OECD (Organization for Economic Co-operation and Development) is a slight contraction.  Note: OECD Country List 
The developing countries (non-OECD) are, still growing like gangbusters, with close to 4% growth in 2011.
China alone is growing faster, at about 9.5% in the first quarter of 2011. These emerging countries account for more than half the world that still live in price controlled or subsidized environments. The severe electricity shortage in China is contributing to increased demand. Fifteen (15) provinces in China have been short of electricity since the beginning of 2011 and are moving into the higher summer demand season. China is forecasted to be 30-40 megawatts short of electricity. The expectation is China is going to burn fuel more heavily to meet demand. Compounding this, China is in a drought that is lowering the electrical output of their Hydroelectricity power plants.
Japan is also short on electricity due to the nuclear disaster and they will in turn consume more conventional fuels to generate electricity, with LNG (Liquefied Natural Gas) being the prominent fuel. For a number of years, the Middle East has had severe electrical shortages during the summer months and burns crude oil to meet demand. Russia also has severe shortages of fuels. Brazil is also consuming more fuel due to tremendous economic growth, 11% in the first quarter.
Stein noted that based on forecasts, the emerging economies will be the majority consumers of oil sometime after 2015. 
China is forecast to represent more than 50% of the world’s oil demand increase. Strong growth will also come from other emerging Asian markets, Middle East, and South America excluding Mexico, Argentina, Brazil, Ecuador, and Venezuela. In 2008-2009 none of these areas contracted, they all had continuing positive growth. They do have quarterly cycles of demand primarily driven by electricity production.
Will governments continue subsidies?
A major question exists - will governments continue subsidies? It is becoming increasingly difficult for countries that are not large oil producers to continue to subsidize and effectively control price. 
Both India and China have been trying to shift to a more market driven pricing model.   India has moved primarily to a market pricing structure for gasoline. They still have a great deal of difficulty doing that for gas oils and diesel because higher prices would create a hardship for the farming communities and smaller industries that rely on those fuels. China has been trying to move closer to world oil prices and implemented a scheme in early 2010. If there is more than a 4-5% increase over 22 consecutive days they will change the price of the fuel. There have been about 12 price adjustments over the last 18 months. Since the world market is very transparent, people in China are starting to hoard fuel before the Chinese government price adjustment, making it more difficult to monitor inventory.
Refining Capacity
Nine million barrels of additional refining capacity is forecast to be added from 2012-2016. The majority of this production will be going to emerging countries including China, India, Russia, and Latin America.   Stein noted that today’s refining capacity is more than we need in the world. Nearly 2 million barrels of capacity has been taken offline in the last two years. Stein estimates that about another 4 million barrels per day of capacity needs to be shut down to match demand. Europe has excess gasoline, but has a high use of diesel for transportation. Europe is shipping gasoline to the U.S. The U.S. is now a net exporter of fuel with diesel going into Europe and Latin America where the installation of new capacity cannot keep pace with demand.
Price Trends
The rapid price increase in 2008 peaked at about $147 per barrel and rapidly came back down. Over the last several months, the price is back to the $100-$115 range.   Stein says, “The question is - are we going to see the same thing we did last time? Is the world gong to fall apart?” Stein does not feel this will happen based on production increases.
The typical point where the industry is in a reinvested level of returns is between $6-12 per barrel of margin. Looking from 1995 forward the refining industry was not very profitable for many years.   Starting around 2004-2005 refining margins grew dramatically with heavy demand. Stein says, “This was unprecedented, we call this the golden days.” They were followed by dog days beginning in 2008 when demand plummeted with margins going to zero or negative. In 2010 demand started to pick up and in 2011 margins are improving.
Natural Gas
Hydrofracturing has created a huge Natural gas supply that is abundant in the U.S. and is becoming a net export for the country. Natural gas is significantly cheaper that oil when analyzing the net energy content on a BTU basis.   Stein emphasized, “Anywhere you can make a shift from something that is oil based to natural gas you should do it.”   Stein also noted that about 70% of the crackers in the U.S. have the ability to flex between feed stocks, allowing the U.S. to become the second lowest cost producer of ethanol next to the Middle East. China is claiming to have 5 times more shale gas than the U.S. Stein commented, “Things are going to change because of Hydrofracturing and the abundance of natural gas.” “It’s a game changer.”
Bottom Line
The market is dynamic and flexibility is a key success factor.
Thoughts & Observations
Peg Stein gave an informative presentation and cautioned the audience that this is her analysis of the industry based on studying the data.
When answering questions at the end of the session, Peg Stein commented that with the abundance of natural gas, it begs the question - why is there not a movement in the United States for natural gas vehicles?  It is puzzling to many of us in the industry that we are not pursuing more use of diesel vehicles. Over the last 12 months, I have been in a number of forums where people have asked why the U.S. is not pursuing diesel automobiles. Last year, I attended a meeting where a representative of the Center for Automation Research, when asked about the development of diesel vehicles, commented that the current U.S. presidential administration only has interest in incentivizing electric cars.
Peg Stein touched on the fact that the United States is becoming a net exporter of fuel. The Huffington post has a good article summarizing this - U.S. Becomes Net Exporter of Fuel for First Time in Nearly 20 Years.
This was an excellent session and certainly food for thought.
These are references I thought would be of interest to anyone that wants more industry detail:

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