There might be an ongoing commotion in the wider oil and gas world, but in the background a vital shift with profound implications for Western markets is underway – the slow but sure rise of the US refining and petrochemicals industry.
While Europe faces uncertain margins and overcapacity, the Middle East looks regionally inwards, and Asia often processes at reduced returns in a subsidy burdened climate, US operators are marching ahead taking in benefits of low natural gas prices courtesy of the shale gas exploration to fire up sector growth.
Furthermore, US refiners buy domestic crude oil indexed to the WTI at a steep discount to global proxy benchmark Brent, and process it to export just about anything from jet fuel to diesel. Describing available statistics as impressive would be an understatement.
According to US Customs Department data, the country’s refiners exported on average 4.1 million barrels of fuel (including diesel, jet fuel and gasoline) per day in April. That is four times the level noted over the corresponding month a decade ago!
Market data aggregator Platts noted that much of the exports were destined for Canada, Mexico, and wider Central and South America. US fuel exports to Canada and Mexico alone have more than doubled in less than five years, nearly trebled in the case of Brazil. Furthermore, many consignments tracked by Platts and Argus, another market intelligence provider, have landed up in Europe and Asia.
James O'Brien, Chair of international law firm Baker & McKenzie’s Global Energy, Mining & Infrastructure Practice Group, says the positive story has been in the making since the shale bonanza substantially lowered the price of gas.
“Natural gas abundance in wake of the shale revolution powered the US petrochemicals business ahead at a pace the market could not have contemplated 10 years ago. Even if US LNG exports are approved in volumes that shale gas producers crave; it would still keep the natural gas feedstock price for refining and petrochemicals pretty competitive,” O’Brien told me at the sidelines of the firm’s 2015 Oil & Gas Institute in Houston.
Natural gas powers most, though not all, chemical and refining processes. For example, methane is the feedstock for hydrocracking, hydrodesulfurization and ammonia. Additionally, natural gas condensate is an advantaged raw material via ethylene and propylene for bulk of the organic chemicals industry compared to crude-oil-derived naphtha.
“At present, the US petrochemicals business is on a solid footing, especially for those who can put down a plant in proximity of clear, cheap procurement pathways for natural gas. In many cases, this involves being close to shale plays burdened with stranded gas lacking infrastructure to utilize or transport it,” O’Brien said.
Explorers are coming up with ways to utilize the resource rather than flare it, with the petrochemicals business stepping into the breach.
“We’re working on diligence for a large project in North Dakota on behalf of a fertilizer manufacturer where the exact scenario is seen to be playing out. With lack of infrastructure to move the gas, putting a plant down in the said location to use it, works to the advantage of both the exploration company as well as the fertilizer company,” O’Brien said.
Local newspapers in Midwestern and Eastern US are littered with similar examples from Ohio to Pennsylvania, and the logic of competitive advantage has started spreading beyond US shores.
O’Brien points to growing international interest. “Over the last two quarters, we have submitted six project proposals. Of these, three proposals for petrochemical plants are on behalf of non-US companies. The global refining and petrochemicals industry is finding the US to be a very attractive destination for setting up a facility with access to cheap gas feedstock, modern logistics and capital markets.”
On the other hand, with Middle Eastern and Asian operators at least holding their own, the climate for European refining and petrochemicals remains uncertain. Refining margins did start to recover in July 2014 after Brent dipped by over 50%. Over the first quarter of this year, margins in Northwestern Europe averaged $7.6 per barrel, up from $4.1 barrel in the first quarter of 2014.
Yet not a single industry analyst I’ve spoken to in London or Frankfurt reckons these kinds of margins would be sustained. Overcapacity and strong competition from refiners in oil producing countries, including the US, are among the primary reasons they cite for an upcoming decline in margins.
Alex Griffiths, Managing Director at Fitch Ratings, says the current boost in margins has resulted from a circumstantial aligning of factors, and not any marked improvement in the wider dynamic.
“Prices for oil products, such as diesel and gasoline, went down more slowly than crude, which supported European margins over the second half of 2014. Higher demand for refined products in Europe in late 2014 and early 2015 and the lower cost of crude for refineries' own consumption also contributed.
“Then, there were some temporary effects including a cold winter in the US that pushed up demand, unexpected refinery outages in the Americas, and opportunistic buying to capitalize on lower product prices that added momentum to margins.”
Looking ahead to the next 12 months, Griffiths issues a caution for European refiners along a tangent that O’Brien put forward as a positive for their US counterparts. "US oil inventories reached an all-time high in April and Brent–WTI spreads continue to favor refiners stateside. This may lead to higher oil product exports from the US to Europe later this year as American refiners will aim to offload large inventories,” he said.
Fitch Ratings’ research also points to an increase in exports to Europe from the Middle East this year as new refineries ramp up production. Russian refiners may also increase their exports due to poor domestic prices caused by the weak ruble and changes in taxation.
Meanwhile, the US Gulf Coast is positioning itself as a refining and petrochemical hub with ample overseas interest, according to interested parties Baker & McKenzie is dealing on behalf of. There is even talk in Texas of becoming a “global refining and petrochemical superpower.”
As a neutral observer, you can accept the excitement or dismiss the exuberance, but there is no denying that the US refining and petrochemicals business is in a much better shape than most, if not all, of its international peers. The country’s refined product exporters have expanded their global reach and petrochemicals production is grabbing attention worldwide, a combination most in Europe can only dream of.
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