A challenging commodity worth atmosphere and increasing fuels laws will combine to maintain U.S. refiners underneath pressure in 2017.
By Matt Flanagan
The 2016 U.S. refining market proved to be a really difficult surroundings, as evidenced by refining margins roughly half of their 2015 levels. A few impartial refiners experienced losses in 2016. Demand for refined merchandise, particularly gasoline and diesel, remained generally flat over 2015 levels, nor did the U.S. see an overly sturdy summer time driving season.
The provision facet of the downstream market was the basis of refinerschallenges in 2016 because the availability of advantaged Bakken, Canadian and shale crude gave refiners the misplaced incentive to provide. Utilization charges remained well over ninety%, successfully at full capacity. Nonetheless, without elevated demand the markets noticed a dramatic improve in gasoline stocks via the primary half of the 12 months.
Refiners obtained a bit of a market reprieve with the Colonial Pipeline outage in September, impacting about 1.Three MMbbl/d of product supply into PADD (Petroleum Administration for Defense District) I (U.S. East Coast). So while total gasoline stocks are nonetheless above anticipated levels, inventories in PADDs I and III (U.S. Gulf Coast) did drop in the third quarter because the market sought any means possible to bring supply into the East Coast markets.
Vertically built-in downstream companies—those with advertising channels, as well as midstream operationsfared better in 2016 than the pure-play service provider refiner selling on the rack. Entrepreneurs noticed strong margin uplift by means of their branded channels and midstream operations supplied ratable income.
Renewable Identification Numbers (RINs) proceed to be a lightning rod for the trade as estimated prices for the refining trade are $1.8 billion, making Renewable Fuels Customary (RFS) compliance the largest working expense for refiners. And, given the margin strain in 2016, refiners not totally RFS-compliant will likely be careworn to satisfy compliance deadlines.
2017: The place is the U.S. refining cycle?
Absent the refined product stock drawdown skilled in the fall of 2016, U.S. refiners would clearly be taking a look at a really tight market highlighted by harassed margins. The product export market may absorb some of the surplus inventories, however with lowered demand in Asia, uncertainty with Europe and potential departures from the EU publish-Brexit, it’s not anticipated that product demand will rise.
Regardless of stock ranges going into 2017 there are several themes emerging around the 2017 U.S. refining market.
Intensified deal with cost reduction
Refiners relentlessly handle capex and opex spending, and 2017 will be no completely different. Companies will search to do “less with moreand many will increase the use of outsourcing of non-core functions, including in some cases portions of their business actions (i.e., middle workplace, threat, and many others.). Whereas not early adopters of technology, refiners have been adept at leveraging data techniques to streamline their business features and optimize headcount the place potential.
Should an prolonged low refining margin cycle persist some refiners can be finest served at using zero-based mostly budgeting to proper measurement their organizations to be leaner. Low-hanging fruit in organizationsnormal and administrative budgets tends to suffer annual 5% to 10% or extra reductions, but many downstream organizations would do effectively to start from a zero-basis and construct to a minimal needed to run the business.
RFS, RINsimpression on margins
With out adjustments to the existing RINs markets, specifically sensible mandates and elevated transparency of the RINs market itself, U.S. refiners will proceed to be quick-squeezed. Greater mixing mandates proposed by the federal government for 2017 will lead to higher RIN costs subsequent yr. The federal government proposes to increase the 2017 mandate in comparison with 2016. The upper mandate makes it tougher for blenders to comply, requiring them to make use of RINs from prior years, putting upward strain on prices.
Worth chain integration
With the arrival and speedy growth of a number of unbiased refiners (i.e., Tesoro, HollyFrontier, PBF Power and Delek) over the past 5 to 10 years, most now find themselves with a way more geographically diverse asset base to handle and optimize. Many have leveraged MLP structures to drop down midstream operations, including truck racks, rail services and even individual refinery processing units. Almost all have invested vital money and efforts to establish an IT platform to assist commercial and accounting actions.
With extra numerous assets and markets to serve these downstream organizations have much more commercial optionality. Optimizing crude sourcing, storage “playsand even logistics alternatives all create opportunities to drive greater shareholder value. Enabling these alternatives will require downstream organizations to foster cross-purposeful collaboration and decision-making, supported by a shared view of current and forward markets, prices and production capabilities.
Value chain integration might imply downstream or upstream. On the downstream side, firms similar to Tesoro will likely proceed to invest of their advertising and marketing channels, which thus far has resulted in stronger margin uplift.
Shifting upstream could afford downstream organizations the choice to turn into non-operating curiosity holders in selected oil producing belongings, which comprise a portion of its ratable crude slate. With E&P asset valuations nonetheless at historic lows, and plenty of E&P corporations themselves on the brink of bankruptcy, this continued pressured oil market may present a buying opportunity for a subset of the refining market.
Expanded trading capabilities
The U.S. gasification downstream market is characterized by a variety of provide and trading capabilities; in a single sense are organizations which might be primarily provide features with buying and selling personnel “procuringcrude for his or her refineries, and in another are more robust asset-backed buying and selling houses with an potential to take positions in multiple commodities whereas nonetheless serving its refining needs.
In an try and grow earnings in a depressed downstream cycle some organizations will look to expand their provide capabilities into conducting extra asset-backed trading. This obviously creates capital requirements on those organizations together with an elevated need for commodity and financial danger administration, controls and governance.
Continued M&A in downstream
Expect the U.S. refining market to see continued divestment of non-core downstream property by the majors in 2017 with several sites having been on the marketplace for years now. Bid-ask spreads remain broad for selected assets and new entrants to the refining space current sellers with new choices. Of explicit be aware will be a continued press by worldwide players to enter the U.S. downstream market through refining opportunities or through extra traditional advertising and marketing channels.
Refiners are accustomed to the margin cycles and the way manufacturing rates and inventories impression markets. The “golden eraof unbiased refiners may be waning, however opportunities to construct and operate commercially successful downstream businesses is alive and effectively. The secret’s to function effectively, exploit vertical integration options and leverage scale when doable.
Matt Flanagan is a associate with Opportune LLP in Houston. Flanagan’s major focus areas embody mergers and acquisitions, power trading and threat administration, provide chain optimization and business transformation initiatives.