The Refinery Interface - New Refined Product Forecasts

Introduction

Oil refiners had to contend with firm and increasingly volatile crude oil prices through 2006. Brent crude oil traded at an all time high annual average price of almost $65 per barrel, more than two and a half times the average price of the preceding decade. Strong global demand for crude oil leant support to crude oil markets, increasingly influenced by rapidly expanding consumption in Asian economies, most notably China. Supply restrictions were swiftly reflected in surging crude oil prices. Crude oil prices peaked in mid-2006, with Brent crude oil breaking through $75 per barrel, following production restrictions in the United States and fears of disruption in the Middle East with growing political tension. Oil markets eased late in the year as stocks were higher than expected, moving Brent crude back to around $55 per barrel.

Demand for petroleum products, especially light distillates remained robust despite relentless price rises as crude oil costs were passed through to consumers. Refinery operating rates approached upper limits following many years of restricted investment in new capacity. Extreme tightness of global petroleum markets maintained peak margins at complex refineries through 2006 even with relentless feedstock cost pressure of acquiring crude oil. The outlook for refinery profitability remains very favourable, with refined product markets expected to remain firm in the near term, due to limited major investment in new global refinery capacity.

The latest petroleum profitability forecast reports published by Nexant in February 2007 analyse profitability of the oil refining industry and provides long term projections of prices for petroleum products out to 2020. Many petroleum products are critical feedstocks to the petrochemical industry and heavily influence petrochemical production costs. The detailed study of petroleum markets presented in this report forms a critical input to Nexant’s analysis of petrochemical industry production economics and profitability forecasts.

Scenarios

The cost of acquiring crude oil is a fundamental influence of refinery profitability, and is the primary driver of petroleum product pricing. The global refining and petrochemical industry are currently exposed to an environment of high and increasingly volatile crude oil and energy markets. Major uncertainty from many sources including political, market, technological and sociological renders attempts to forecast a single definitive future of crude oil markets and the refining industry futile.

This report does not claim to forecast the future development of crude oil and petroleum prices. Rather it forecasts global refinery profitability and presents the petroleum product prices which would support this profitability under alternative self consistent scenarios, each with distinct assumptions of crude oil price trajectories and the global macroeconomic environment. Three alternative scenarios have been developed, each of which would drive very different long term out looks for relative crude oil prices.

Brent Crude Oil Price Scenarios
(FOB Sullom Voe)

Crude oil prices have surged to an all time high in 2006, with prices climbing considerably above the cost of production from even the most marginal production sources. The market will not be able to sustain crude oil prices at the current peak in the long term. High costs will eventually erode demand whilst very lucrative margins would encourage major investment in new production. Crude oil prices will ease in the future, but it remains uncertain as too how quickly and by how much they will ease. The average Brent crude oil prices assumed for each scenario over the full period of the forecast are outlined below:

High oil scenario: Average $60 per barrel (2007-2025)
Medium oil scenario: Average $45 per barrel (2007-2025)
Low oil scenario: Average $30 per barrel (2007-2025)

Refinery Margins

Global refinery margins climbed to a peak in the early 1990s as the Gulf war raised fears of supply restrictions to refined products. A slowing global economy depressed demand growth though the mid-1990s, whilst investment in new global refining capacity lengthened the supply base. Long refined product markets depressed refinery margins to a prolonged trough sustained for almost a decade. Global refinery margins have strengthened considerably since 2002 as rejuvenated Asian demand, led by voracious demand in the surging Chinese economy, has supported strong growth in global demand for petroleum products. After a decade of low returns, which deterred investment in new global refining capacity, refined product markets moved back towards balance. Refinery margins in all regions climbed to peak in 2005 as heavy demand, particularly for gasoline drove markets extremely tight. Many refineries operated at full capacity following storm damage to refineries in the United States in the second half of 2005.

Global FCC Refinery Cash Cost Margins

Global margins are not expected to be sustainable at current peak levels in the long term, as the associated high cost of petroleum products will eventually dampen long term demand growth. Margins are expected to ease from their current peak over the next five years. Global refined product markets will support average margins considerably higher than the average achieved over the last decade. With global light oil product demand forecast to rise faster than residual fuel oil use, trend-line global upgrading margins will settle above the deep trough of 2002, but below the peak experienced in 2005-2006.

Tight Asian markets for petroleum products have maintained Singapore refining margins at a steady peak since 2004, regularly achieving a margin premium of more than $2 per barrel over the equivalent refinery configuration in Western Europe. Asian margins briefly slipped below margins in the United States in 2005 as hurricane damage to refineries severely tightened North American markets. As capacity was swiftly restored through 2006, Asia resumed its position as the most profitable region for refining. In the near term Asia is expected to retain its position as the most profitable refining centre, setting the ceiling on global refining margins, reflecting projections of the region as the strongest growth centre.

Petroleum Product Price Projections

Despite immense volatility in crude oil prices over history, the value of individual refined products relative to crude oil has remained quite stable. Whilst Brent crude oil prices have explored a vast range, from a low of $13 per barrel in 1998, to almost $65 per barrel in 2006, the ratio of given refined products relative to crude oil has been constrained to a narrow band.

Western Europe Refined Product Price Projections
(medium crude oil scenario)

Refined product prices will continue to follow the trajectory of crude oil prices through the forecast. Petroleum markets are not expected to be able to sustain prices at record high peak values achieved through 2006 in the long term. Under the medium crude oil scenario, prices of crude oil and refined products are expected to remain firm for another year, preserving the peak built up through 2006. Beyond 2007 petroleum markets enter a transition period through which prices steadily ease to adopt a long term trend price by 2012. Prices of refined products will reflect changes in the underlying cost of acquiring crude oil post 2012.

Inter-regional price differences are analysed for all products to ensure consistency with projected trade flows. In order for product to flow consistently from regions of surplus to regions that are in deficit, there has to be some price differential to encourage the flow. The regional price spread must be sufficient to cover freight costs.

Key Inter-product price relationships are examined. The position of individual products within the refined product pricing spectrum is influenced by the relative value of products in competing end use sectors and relative supply demand balance for each product.

The report “Petroleum Profitability Forecasts” is published by Nexant as part of its ChemSystems program. Subscriptions or single copies of the report are available from www.chemsystems.com. For further details please contact Andrew Powell at +44 207 950 1576 or at apowell@nexant.com.