Keeping up with the times

Just as the spectre of COVID-19 recedes, other plagues bedevil the downstream sector: as demand kicks in with the summer driving season, motorists face epic gasoline and diesel prices.

Several factors are contributing to the high prices but, ironically, a shortage of crude is not one of them. While other jurisdictions scramble to replace sanctioned Russian crude, North America is awash in oil. Oil output in western Canada rose from 3.9 million bpd in 2020 to 4.45 million bpd by the end of 2021. Canada now exports approximately 4 million bpd to the US, and that volume is expected to rise to 4.2 – 4.4 million bpd by 2026. Production from the Texas Permian basin has recovered to pre-COVID-19 levels; output of light, tight crude exceeded a

If pestilence were not bad enough, North America’s downstream sector has war, climate change and shortages to deal with. Gordon Cope, Contributing Editor, details how the oil and gas industry is faring in the face of these challenges.

record 5 million bpd in February 2022, and is expected to reach 5.6 million bpd by the end of 2022, before climbing to 6.5 million bpd in 2023.

The number one reason for high fuel prices is a shortage of capacity. Over the last two years, refiners in the US closed or suspended over 1 million bpd at ageing refineries. Currently, the US has approximately 18 million bpd capacity to produce gasoline, diesel and jet fuel, and the average refinery usage is standing at an impressive 95%. That leaves no wiggle room, however, and planned maintenance shutdowns have been postponed.

A major incentive for the high utilisation rate is surging crack spreads. Starting in the latter half of 2021, the refining profit per barrel has increased dramatically. Refinery margins

are measured using the 3:2:1 crack spread – a hypothetical number that represents the average cost of 3 bbl of crude vs the price received for 2 bbl of gasoline and 1 bbl of diesel. Early in 2021, the spread was around US$10; in June 2022, the NYMEX WTI spread future exceeded US$54.

Unfortunately, while it might seem like an excellent time to build new capacity, anyone wishing to construct a greenfield refinery would face a decade-long battle in the courts with environmental groups. Financers are also reluctant to underwrite multi-billion-dollar projects that might be stranded by regulations mandating the phase out of internal combustion engines (ICE).

Rather, refiners are focusing their CAPEX budgets on two areas: reducing carbon footprint, and incremental additions to existing refineries. Valero, Marathon, Phillips 66 and others have announced roughly US$5 billion in projects to process over 200 000 bpd of renewable diesel at refineries in California. In January 2022, ExxonMobil announced plans to achieve net zero greenhouse gas emissions from operated assets by 2050. The company will expand carbon capture capacity at its facility in LaBarge, Wyoming, adding up to 1.2 million tpy to the nearly 7 million tpy already captured.

US refiners have several expansion programmes underway. ExxonMobil is adding 250 000 bpd of light distillation capacity to its Beaumont complex in Texas, which will have a total capacity of 620 000 bpd when completed. Valero is adding 55 000 bpd to its 395 000 bpd Port Arthur refinery, also in Texas. Marathon is integrating the former BP Texas City refinery with its 593 000 bpd Galveston Bay complex in Texas. When it comes online in 2023, the US$1.5 billion project will add 40 000 bpd new crude capacity and expand residual oil processing capabilities.

Meridian Energy Group is diverging from this trend by building the first greenfield refinery in the US in over 40 years. Since 2013, the company has been seeking permits to construct a 49 500 bpd gasoline and diesel refinery in North Dakota in order to process the unconventional crude that is being produced in the Williston Basin shales. The rationale is simple: rather than shipping crude to the Gulf Coast (which is designed for heavier, sour crude), a smaller refinery that is purpose-designed for light, sweet crude can service the regional market, greatly reducing shipping costs. Meridian expects the project to be completed in 2023. Even though the company touts the project as being the cleanest refinery in the world, it has faced almost a decade of court challenges to gain state and federal permits. Meridian is also planning a similar plant in the Permian basin.

Petrochemicals

The petrochemical sector has experienced major disruptions due to the pandemic, as well as supply constraints and transportation complications. This has caused the price of polyethylene and polypropylene stocks to rise dramatically over the last year. According to McKinsey, prices began to rise in early 2021 due to the polar vortex that shut down significant production in Texas, creating a continental supply crunch.1 Alternative supplies in Asia were difficult to access due to shipping constraints. As a result, prices rose from US$1200/t to US$2200/t. While prices have subsequently receded to US$1600/t, they are expected to remain elevated due to higher shipping and production costs. In May 2022, Henry Hub gas exceeded US$8/million Btu. While still well below EU and Asian prices, this represents a dramatic increase prior to the Ukraine war and subsequent surge in LNG demand.

The slowdown in the construction of petrochemical plants due to COVID-19 restrictions has largely ended. In early 2021, ExxonMobil and SABIC’s petrochemical complex in Corpus Christi, Texas, came online. The joint venture (JV) includes the world’s second largest cracker (1.8 million tpy), and the world’s largest monoethylene glycol unit (1.1 million tpy). The complex also includes two polyethylene plants, each with a capacity of 650 000 tpy.

ExxonMobil is building a new linear alpha olefins (LAO) module at its Baytown petrochemical complex in Texas (LAO is used in plastic packaging, engine oils, surfactants and other chemicals). The module is expected to produce 350 000 tpy when it comes online in 2023.

In 2020, the province of Alberta in Canada launched the Alberta Petrochemicals Incentive Program (APIP) to encourage investments in petrochemical facilities and help diversify Alberta’s natural gas sector. The programme grants up to 12% of eligible capital costs, and several companies have subsequently announced greenfield developments. n In late 2021, Northern Petrochemical Corp. revealed that it was building a CAN$2.5 billion petrochemical plant in northern Alberta. When completed in 2026, the facility will convert natural gas into ammonia and methanol, using a carbon-neutral process. n ITOCHU announced that it would be building a

CAN$1.6 billion blue ammonia plant in central Alberta.

The plant will produce up to 1 million tpy, to be shipped to Japan. n Dow Chemical Canada is proposing a net zero facility in

Alberta that will produce 3.2 million tpy of polyethylene and ethylene derivatives. n In all, the Alberta Industrial Heartland Association estimates that there is an opportunity to grow the sector by more than CAN$30 billion by 2030.

LNG

LNG capacity in the US has been climbing at a tremendous speed. It exceeded 11.4 billion ft3/d in early 2022, surpassing Australia and Qatar as the world’s largest producer. Plants in Sabine Pass, Louisiana; Cove Point, Maryland; Corpus Christi, Texas; and Cameron, Louisiana will all enter service in 2022, adding significant capacity. Much more expansion is planned for 2023 and beyond: in March 2022, for instance, Tellurian began the construction of Phase I of its Driftwood LNG export facility near Lake Charles, Louisana.

The US Energy Information Administration (EIA) had previously forecast that LNG exports would average 9.2 billion ft3/d in 2022, but in June 2022 it noted that exports had surged to 11.5 billion ft3/d for the first four months of the year. The Ukraine war is a major impetus to exports as the EU struggles to replace Russian gas supplies; almost 75% of US production is now destined for Europe.

Greenhouse gas reductions

Downstream activities are major emitters of greenhouse gases (GHG), and both Canada and the US have established net zero-emission targets that will affect the sector.

In 2021, the government of Canada enacted the Canadian Net-Zero Emissions Accountability Act that provides a legally-binding roadmap to achieve net zero GHG emissions by 2050. It also specifies that emissions are to be reduced by up to 45% of 2005 levels by 2030. Additionally, in 2021, the Biden administration announced a target to reduce US GHG emissions by 50% of 2005 levels by 2030. The plan will incentivise all major sections of the economy to reduce emissions through increased efficiency, carbon-free electricity generation, and increased renewable fuel production.

BloombergNEF estimates that the cost of reducing emissions from high value chemicals (HVCs), which includes plastic feedstocks, is approximately US$759 billion.2 HVCs contribute an estimated 2% of global emissions. By investing in electrified crackers and carbon capture and sequestration (CCS), the petrochemical sector could achieve net zero emissions by 2050.

Hydrogen

Hydrogen is expected to play a key role in refinery GHG reductions. The world currently produces around 75 million tpy of hydrogen, primarily using the steam methane reforming (SMR) process, where high-temperature steam is used to strip hydrogen from natural gas. The International Energy Agency (IEA) estimates that GHG emissions associated with the production amounted to roughly 830 million tpy of CO2e.

When hydrogen is burned as a fuel, however, it only emits water. The key is to purify the hydrogen without emitting GHG. So-called blue hydrogen is made using the SMR process, but the CO2 is captured and sequestered underground. Hydrogen can also be made with electrolysis (running an electric current through water to separate hydrogen from oxygen). If the electricity is sourced from renewable power, such as wind or solar, the output is called green hydrogen. This allows countries that have abundant fossil resources to achieve net zero emissions, as well as countries without resources to reduce dependence on supplier nations.

In March 2022, ExxonMobil announced plans for its first world-scale blue hydrogen plant in Baytown, Texas. The proposed plant would produce up to 1 billion ft3/d of blue hydrogen and include one of the world’s largest CCS projects (10 million tpy). Using the hydrogen as a fuel would allow the Baytown complex to reduce its Scope 1 and 2 CO2 emissions by up to 30%. The project is part of a broad, industry-wide plan to establish the Houston Industrial Hub as a venue to reduce CO2 emissions by 50 million tpy by 2030, and 100 million tpy by 2040. A Final Investment Decision (FID) is expected by 2025.

Cresta Fund Management, a private equity firm, purchased the idled Come-by-Chance refinery in Newfoundland, Canada. The 135 000 bpd refinery, to be called Braya Renewable Fuels, will focus initially on producing 14 000 bpd of sustainable aviation fuel (SAF). Further plans include doubling capacity to 27 000 bpd and incorporating the ability to produce green hydrogen.

Politics as usual

With US mid-term elections scheduled for November 2022, high refinery profits have become a political football. In May 2022, Democrats in the House of Representatives passed a bill making “unconscionably excessive” fuel prices unlawful. The bill would need the support of 10 Republicans in the Senate to become law. Such an outcome is unlikely.

In June 2022, President Biden sent a letter to major refiners, including ExxonMobil, Valero and others, exhorting them to increase fuel production and lower crack spreads. “There is no question that (Russian President) Vladimir Putin is principally responsible for the intense financial pain the American people and their families are bearing,” the letter notes. “But amid a war that has raised gasoline prices more than US$1.70/gal., historically high refinery profit margins are worsening that pain.”3

Mike Sommers, CEO of the American Petroleum Institute (API), responded saying that misguided policy agendas from the White House had a lot to do with the current crisis, and spelled out potential solutions. “I reinforced in a letter to President Biden and his Cabinet 10 meaningful policy actions to ultimately alleviate pain at the pump and strengthen national security, including approving critical energy infrastructure, increasing access to capital, holding energy lease sales, among other urgent priorities.”3

The future

In the short-term, North America’s downstream sector is struggling to deal with post-COVID-19 resurgent demand for transportation fuels. The current utilisation rate (some refineries are at almost 100% capacity) cannot be sustained. Since greenfield refineries are not a viable option, a combination of demand destruction (due to high prices at the pump) and the debottlenecking of existing facilities are the most likely scenarios over the next year.

In the longer-term, the growth in electric fleets and the introduction of hydrogen fuel are expected to dampen demand for fossil fuels. In the meantime, however, the downstream sector can expect to experience healthy margins for the next few years as it optimises assets throughout the continent.

References

1. ‘US polyethylene price evolution and what to expect’,

McKinsey & Company, (1 June 2022), https://www.mckinsey. com/industries/chemicals/our-insights/us-polyethylene-priceevolution-and-what-to-expect 2. ‘$759 Billion Required for a Net-Zero Petrochemicals Sector by 2050’, BloombergNEF, (24 May 2022), https://about.bnef. com/blog/759-billion-required-for-a-net-zero-petrochemicalssector-by-2050/#:~:text=%24759%20Billion%20Required%20 for%20a%20Net%2DZero%20Petrochemicals%20Sector%20 by%202050,-May%2024%2C%202022&text=New%20

York%20and%20Munich%2C%20May,research%20firm%20

BloombergNEF%20(BNEF) 3. ‘Biden tells oil refiners: Produce more gas, fewer profits’, AP News, (15 June 2022), https://apnews.com/article/russia-ukraine-bidencovid-health-f73c882b0664a5d5dd62635a9a65364c