Driving Discussions: Recent Refinery Revelations

On this episode, US downstream Reporter, Nathan Risser, and Argus’ Blendstocks Reporter, Jason Metko, dive into recent US refinery news.

They discuss maintenance to quarterly earnings, and give a preview on how 2023 might end within the industry. 

Transcript

Jason: From Argus Media, this is "Driving Discussions," a podcast series with a focus on forces that affect North American road fuels. Greetings and salutations, once again. I'm Argus' U.S. Gulf Coast Blendstocks reporter, Jason Metko. And on this episode, we're catching up with Nathan Risser. He's our U.S. downstream reporter. We're talking the fall refinery turnaround season, as well as corporate earnings and refining for the rest of 2023. Nathan, welcome back to the presentation. Good to have you. It is, finally, feeling like fall outside, which means the calendar says it's October, which is correct. And, I know, October means fall turnaround season's underway. How has this year compared to previous years in getting to this point?

Nathan: Hey, Jason, thanks for having me. Yes, correct. Full turnaround. Weather is a bit cooler. Very much enjoying that here in Houston. The big topic, right now, in the downstream is seasonal maintenance. So, so at Argus, we track, we track turnarounds, the ones we've confirmed. And at the moment we're looking at turnarounds that are affecting up to 2 million barrels a day of U.S. and Canadian refining capacity that are set to take place in the remainder of the year with a chunk of that work having already started in September. So, just to be crystal clear on those numbers, what we do is we take all the turnarounds we've confirmed, we add up the barrel-a-day capacity of all those refiners, and we get that number up to 2 million barrels a day of turnarounds through the rest of 2023. Now, some turnarounds they take whole refineries offline, others remain online, but throughputs are curtailed as certain units undergo work so that's why we say up to 2 million barrels a day the number could be lower, the number could be higher, unplanned outages could make that number higher.

We, also, don't know how some of the turnarounds overlap so at what point in the year most of that capacity could be offline. Now, putting this in context, refiners have two main maintenance seasons, the spring maintenance season and the fall maintenance season. This year's spring maintenance season was heavier than normal, following high refinery run rates in 2022. Then what happens in the summer is refiners don't conduct or they try not to conduct maintenance as its peak demand season, and they want to capture those margins, specifically, on gasoline as U.S. consumers are driving more heavily. Then demand wanes into the fall and winter, and refiner start doing the maintenance. And we've already seen reduced run rates, which are clearly underway. So, in the week ended the 29th of September, utilization rates in the U.S. were already down to 87% after running in the mid-90s during the summer.

The reason full maintenance is important or the level of full maintenance for refiners is important is that the back half of the year is when stocks are rebuilt, when gasoline and diesel stocks are rebuilt in the U.S. market. So, the extent of the turnaround activity somewhat dictates how much those stocks can be rebuilt. That's important for product prices because when you have low inventories in the U.S., that puts upward pressure on refined product prices, the same way that low crude stocks globally in the U.S. puts upward pressure on crude prices. And going into the fall maintenance season, gasoline and diesel inventories, particularly, on the U.S. Atlantic Coast are low. So, if we look at the numbers, Atlantic Coast gasoline stocks in that same week ended 29th September were 59 million barrels compared to a five-year average of around 61 million barrels. For distillates, those Atlantic Coast stocks were around 28 million barrels compared to a five-year average of 40 million barrels. So, the gasoline number is a bit closer to the five-year average and they have been rebuilding over the last couple of months, but distillates stocks are still low. And there's, there are two major Atlantic Coast turnarounds happening that could somewhat prevent that typical seasonal stock build.

So, one is, Delta Air Lines's 190,000 barrel-a-day Monroe Energy refinery in Pennsylvania, and the other is Irving Oil's 320,000 barrel-a-day Saint John refinery, which is on the Canadian Coast. Those both began turnarounds in mid to late September. When those started, I spoke to fuel buyers on the Atlantic Coast. Atlantic Coast markets and they weren't, particularly, worried about gasoline or diesel supply during the turnarounds. So, short term there are no worries, but it could be a longer-term factor, meaning that the seasonal stock build on the Atlantic Coast isn't going to be as much as it is in some years. If you think about the Atlantic Coast, there's 900,000 barrels a day of refining capacity without Canada. So, even taking 200,000 barrels a day from Monroe offline could somewhat impact how much they're able to build stocks in that period. That somewhat can give an indication about prices going into the winter.

And then two structural things happening in the background are the war in Ukraine, which since it started has been pulling diesel barrels away from the Atlantic Coast and to Europe. And, also, the colonial pipeline, which pipes up product from pad three, the Gulf Coast is at capacity. So, it's looking like the seasonal stock build on the Atlantic Coast isn't going to be like it has been in normal seasons and that's why turnarounds have been a big area of focus for us at Argus in the last couple of weeks.

Jason: He is our U.S. downstream Reporter, Nathan Risser. This is another edition of "Driving Discussions." Nathan, let's talk money and finances here for a second. One of the great talents about Nathan, by the way, is he's a tremendous writer, and he's been writing a lot about second-quarter earnings. And Nathan, one of the things I noticed is that for a lot of these companies, they took a pretty big hit compared to the same quarter last year. What was the driving force behind that? Is there a commonality there?

Nathan: Thank you, for the kind words, Jason. I'm not a very good writer. I just have a very good editor. He's, also, my boss so I have to say that. Yeah, let's switch things up and talk about the finances. We're heading into earning season at the end of this month, with Valero kicking things off on Thursday the 26th. And there's been a bit of a souring on refinery stocks from an investment perspective over the last couple of months. Now, here at Argus. We don't really care about that as we're more focused on what moves commodity prices. But it's interesting to see the reasons why some analysts at banks are downgrading refiners.

So, as you mentioned, those second-quarter earnings bit of a drop. Let's start with the recent history. So, in the second quarter, every major refiner and, also, the refining segments of integrated energy companies like Chevron and Exxon, they all posted a drop in earnings from a year earlier, from the second quarter of 2022. That decline was driven by narrower refining margins, which had been moderating from these near-record highs a year earlier. Those near-record highs were driven by this demand surge that happened post-COVID as the economy recovered, perhaps faster than expected and demand ticked up. And, also, that other factor we mentioned in terms of Atlantic Coast stocks, which is the war in Ukraine rerouted refined product flows to Europe, depleted stateside inventories, kept those margins for refiners nice and wide.

One thing that happened in the second quarter as well, as margins were declining, was refiners who were geared to process heavier crude grades. So, this is LyondellBasell, Marathon, Valero, Phillips 66. They saw a narrower spread between heavy and light oil grades which, effectively, increased their refinery feedstock costs and left less room for them to capture profits. They'd been benefiting from this wide, heavy, light, crude spread for the 12 months running up to that period. So, they saw this narrowing which affected their profits.

And then as always, planned maintenance and unplanned outages curtailed profits for some refiners during that period. HF Sinclair was an interesting one to look at whose second-quarter 2023 throughputs were down by 12% compared to the second-quarter of 2022. And then the other big one would be Marathon, who had a major fire at its Galveston Bay, Texas refinery in May. And that cut about 2.5 million barrels of throughput during the quarter. We'll, also, be watching them in the third quarter earnings because they recently took a hit at their Garyville refinery in Louisiana that had a major nap the tank fire in August. So, that was the second quarter, bit of a bit of a tightening bit of a narrowing in margins which led to lower profits but despite that we always have to remember U.S. refining margins are above historical levels for this point in the economic cycle. And the commentary given in those second-quarter earnings calls was that the expectations, the forecasts were for margins to widen and for profits to get better in the second half of the year.

I remember PBF's chairman, Tom Nimbley, said on the call that he very much expects the heavy light crude spread to widen as we head into a busy maintenance season. And there's some other factors driving that as well, such as increased heavy crude production from Western Canada who come out of their own upstream turnaround season around now, and increased production from Venezuela which with all that extra influx of supply on the market, they think will lower the cost of heavier grades around now and through the rest of the year. Marathon and Valero, who I said are geared to process those heavier grades, also, unsurprisingly, mentioned that they expect a better heavy-light differential for the rest of the year. So, it looks like a good picture, but Bank of America, they downgraded their outlook for refiners in an August research note, and they were arguing that these recently wide refining margins, kind of in reference to the 2022 margins, were peaking and as refinery outages across the U.S. are resolved and facilities transition to winter-grade gasoline production, we should expect a narrowing of margins. They said that this is the case despite these ongoing low gasoline inventories that with margins having peaked in summer driving season and that coming to an end, and refineries switching over to blending cheaper winter-grade product, that's going to outweigh those low gasoline inventories and margins are going to compress a bit.

So, they downgraded Philips 66, Marathon, Valera, PBF, and HF Sinclair too to neutral from buy ratings. So, they didn't downgrade them all the way to a sell, extremely negative outlook, but their view of the sector has cooled a little bit. Always good to remember that Bank of America have this long-term thesis about U.S. refiners which is heavily followed in the industry and much talked about what they call the regional golden age of refining thesis which I think they first published in around March 2022. And they argued that U.S. refiners are have structural tailwinds behind them at the moment. They're poised for higher than average profitability because they have access to very cheap indigenous natural gas in the United States, and they are operating in a market where facility outages and closures since the onset of the COVID-19 pandemic have, basically, kept the balance of supply and demand very tight. So, in summary, some headwinds in the second quarter may be a little bit of an anomaly in margins. The trend for the last 12 months is definitely a narrowing of refiner margins, crack spreads, and therefore refiner profitability, but it's too early to call the end of the good times for the refining industry in the U.S. at least.

Jason: Couple more minutes here with our U.S. downstream Reporter, Nathan Risser on "Driving Discussions." Nathan, we're recording this in October. The end of the calendar year is in sight. It looks like we're gonna make it through hurricane season without a storm hitting a refinery on the Gulf Coast, which I don't think has happened in quite some time. What other things are you looking at here the rest of the year? Any key areas of concern or interest for you?

Nathan: Yeah, one area of interest related to almost the Gulf Coast and the hurricanes there, it's kind of a different problem. It's been the extreme heat that's happened this summer along the Gulf Coast. Some analysts attributed summer spikes in retail gasoline and diesel prices to extreme heat, those curtailing refinery throughputs, and we were really interested in Argus and talking about that. But we didn't see a dip in utilization on the Gulf Coast that supported that explanation. So, I'll be really looking forward to an upcoming earnings calls, whether the refiners talk about and can maybe put some facts behind that narrative of how much extreme heat, actually, affected refinery operations. And, therefore, we have some kind of base in the future to understand if we have a really hot summer next year, what can our outlook be for how much that could curtail throughputs and, therefore, rise prices? Or maybe that's not the case. Maybe that's the wrong explanation.

There's very good reasons why high temperatures make running refinery harder. One part is, that you've got to keep that refinery cool. So, you have these air-cooled and water-cooled units that are designed to regulate temperature and they could reach their limits very much like how the AC in one's car might struggle in a 105-degree day in Houston. You, also, have FCCs, fluid catalytic cracking units, which is one of the essential components of producing gasoline at refineries. They become less effective in high temperatures because keeping it very simple, the air that you use to clean the catalyst, which helps refine the product, the air becomes less dense. The way it works, you effectively blast air at the catalyst and it cleans it. As heat rises, the air is less dense, you get less good at cleaning your catalyst. That unit becomes less effective at producing gasoline.

The heat, also, relates to maintenance. So, it'd be interesting to see whether any maintenance was delayed during the summer because of the high heat. And that's why we're having an above-average turnaround season this fall. Obviously, workers in extreme heat have to take more consistent breaks. So, things take longer. And, also, any cleaning that's required in refineries such as scrubbing down tanks, they have to use less volatile compounds, even sometimes switching to water to clean tanks which, effectively, takes much longer.

So, then something a bit more forward-looking, thinking about for the end of the year and what will likely be discussed on earnings calls quite heavily is the startup of the Dangote refinery in Nigeria which is a 650,000 barrel-a-day refinery when it reaches full capacity. So, we're thinking how is that going to affect U.S. product markets. The officials of the refinery say the start was imminent, but traders in Europe and the market more broadly or apprehensive about the actual startup and at what rates it's going to be running at. So, the consensus seems to be that even if it gets running soon, utilization rates are going to be low and the refinery is more likely to start producing middle distillates before producing gasoline, sometime in 2024. Either way, the reason this is interesting is that the U.S. has benefited from a tight refining market with limited capacity. So, when you have these global upstarts, everyone's interested to see how will that affect U.S. refining margins and, potentially, compress them.

The other thing we're interested in is the rerouting of trade flows. So, Europe sends some barrels of gasoline to West Africa. Will Dangote start-up and reach utilization rates in gasoline production that will meet domestic Nigerian or West African gasoline demand and therefore you have these spare European gasoline barrels? Where do they go? Do they go to the U.S.? And how does that also affect U.S. margins, U.S. stocks, and the refining market there? There are many hurdles before any of this happens with Dangote, right? It's got to start up, it's got to get to producing gasoline, it's got to then meet domestic supply before any of these trade routes change as a result of it, but it's definitely something I expect analysts and companies to be talking about in the upcoming earnings calls and it's sort of a longer-term trend we're watching. Something to bear in mind there is that the Dangote refinery is a single-train refinery. And I believe it has the largest CDU crew distillation unit ever made so when we talk about trade flows and markets changing as a result of this massive refinery upstart, we always have to remember the the production from it could be very lumpy in the future because if some major issue happens or they have to take that CDU down for maintenance, the whole facility is going to go offline. So, we've got to be careful in making predictions about how that's going to affect markets in the coming one, two, three, three years.

Then just wrapping things up, we'll be looking for the usual things for the rest of the year, especially, during the earnings calls. What effect are crude prices and OPEC production cuts having on refiners from a corporate perspective and, also, the market? How are heavy light crude spreads looking? And we're always looking out for commentary on refining margins going into the winter season. What are refiners' expectations for how cold the winter it's going to be? How are stocks looking compared to demand? That's what we're going to be focusing on for the rest of the year.

Jason: And he will be having his finger on the pulse of it all, the usual and the unusual. U.S. downstream Reporter, Nathan Risser, thanks as always my friend for doing this, we'll talk soon.

Nathan: Great, thanks for having me.

Jason: With that, we conclude yet another edition of "Driving Discussions," a production of Argus Media, a leading independent provider of energy and commodity pricing information. This reminder to check out the previous episodes in our series and for more details on Argus' U.S. Products coverage, make sure you check out argusmedia.com/us-products.