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Should Refineries Cut Crude Rates

By Ralph Laurel

Dec 13, 2014
 

Discussing whether refiners should consider reducing utilization in a falling crude market.

 
 

Similar to the crude market plunge in 2005, refineries this year had the ability to respond to falling crude prices. Since the decline continued over a period of several months, every refinery had the option to reduce utilization, especially with year-end LIFO implications looming for North American refiners.              

 

 

Despite a consistent $10 / bbl decline month over month, many refiners maintained utilization.


This was not an economic decision for many refineries as several regions in the US and NW Europe indicated relatively low refining margins during the 4th Quarter of 2014.

 





So let’s do the math. If refining margins are less than $10 /bbl in the East Coast (PADD I) and the Gulf Coast (PADD III), and there is market backwardation of $10 /bbl for 4 months in a row, that means refineries are losing money in those regions during the 4th quarter of 2014. This is particularly true because of two additional factors:

 

  •  
Many refineries consume long-haul crude (i.e. take more than 1 month to deliver).
 

 

If a refinery’s supply chain takes 2 – 3 months for crude to transit from origin to destination, there is a $20 - $30/bbl loss resulting from the declining crude market since refineries pay for crude when it’s loaded for delivery. Some of the crude market loss was buffered by a sticky product market (i.e. product prices did not decline as fast as crude prices).

 

 

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Most refineries have declining margins with increasing utilization
 

 

Since many refineries have downstream unit capacities (i.e. FCC, Coker, etc…) that are lower than Crude Unit capacity, refining margins typically decline as refinery utilization increases. For many facilities full refining margins start to decline beyond 80% utilization. This can be a degradation of $5 - $10 /bbl compared to the regional margins indicated in the graphic above.

 

  

Given the discussion points above, why did very few refineries pro-actively cut utilization over the past several months? Companies certainly do not like losing money!

 

I refuse to accept the notion that markets are volatile because even the most unsophisticated refiner could have guessed that demands decline and inventories bloat during the winter. Instead, I suggest that most refineries maintained utilization for 3 primary reasons:

 

 

1.    Refinery optimization groups don't account for market structure

 

Majority of the refineries in the world use Linear Programs (LPs) to determine economic drivers and run plans. While LPs are the best guiding tool to use, the issue is that many of the inputs are designed for steady state operations.

 

Refinery linear program runs utilize a variety of inputs, ranging from price forecast, demand forecast, refinery constraints, to seasonal product specifications. Since LP users rely on efficient collection of all the inputs in order to properly set up LP cases, there is seldom any time to account for abnormal condition changes.

 

Refinery LP users know how to account for refinery margin shifts when crack spreads change; however, when crack spreads remain constant, but crude market structure shifts, LPs are not set up to manage.

 

 

2.    Refinery organizations are inexperienced

 

Most companies continue to manage shifting workforce demographic challenges. With boomers continuing to retire, many companies have accelerated career development for the remaining workforce to manage succession planning.

 

This has created inexperience in all levels of the refining organization for most companies. The result is that most people do not even understand what is currently happening.

 

The market crash of 2008 was only 6 years ago, but I can assure you that most refining companies have changed over 75% of their refinery planning and supply chain personnel during that time. 

 

 

3.    Refinery Management teams focus on the wrong metrics

 

While I fully support the use of leading and lagging metrics to steward a business, I often take issue with companies that do not establish some sort of flexibility in their metrics.

 

Ok - you can maintain diehard metrics around Safety, Environment, and Health performance, but for the sake of holy-friggin common sense, DO NOT establish hard metrics around Refinery Utilization! Too often do I see refinery managers get caught up on the literal aspect of a metric and lose sight of the objective. We are here to make money, not adhere to metrics!!

 

With year-end bonuses for most refinery managers tied directly to utilization, we incentivize stupid behavior.

 

 

It’s likely that many refineries are currently scrambling around trying to figure out how to place their excess production into the market. If you earned your lesson from 2008 you could have avoided this situation. Now you will just have to answer to your board of directors on why you are hemorrhaging cash during this volatile period.

 
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  • Marcelo Viotto :   From my point of view, Linear Programming deal with the next lead time of planning. If the business lead time are, e.g, 60 days, the next 60 days are the scheduling period; after these 60 days, for risk management, the planning cover the multiple of 60 days after the scheduling time and the regular is the 180 days planning. The strategy of planning & scheduling could improve margins, as marketing people know the deals in product markets and the paper derivatives protection, as well the terms of the buying / selling contracts. The inventory of products is an opportunity to explore spot / rack cargoes. The Linear Planning must be develop by Operational (including Maintenance), Logistics & Marketing (including Buy / Sale team) teams. As you know, the main oil producers do not allow buyers to resell oil cargoes, in order to keep the control of the market. At this moment, refineries from Gulf of Mexico are selling ULS products to South America (Brazil and Venezuela) in order to supply the lack of refining in these area. The complex of Manifa is just to start, refining 900 kbpd of clean products to supply China and Europe markets. Completing the economic logic, it is better make money now and prepare for maintenance in the first quarter.

    Dec 15, 2014

  • Paul Stobbe :   Let's not be too quick to blame the LP. Isn't getting the price forecast right really the key in this market? The LP will (should) take the refinery charge to zero or some unit minimum and show negative marginal values under the economic scenerio described.

    Dec 15, 2014

  • John Huggins :   In defense of planing professionals, they collectively are not idiots. Most LP models are configured based on incremental variable costs, those costs that go up and down with refinery throughput. Unfortunately most of a typical refinery's operating costs are fixed. This difference in cost structure can make a set of good short range decisions for individual refiners into a bad decision for an industry, using 20/20 hind sight.

    Dec 16, 2014

  • Dave :   All good points. Another consideration is crude is purchased well a ahead of the time it is refined, as was noted in the blog. When it reaches the refinery in these current times, the margin based on the purchased could be very low or negative. Cutting runs is option but is it the best option? In many cases it is not because the crude has to go somewhere. So selling the crude at the distressed price may be worse economically versus converting it into products.

    Dec 19, 2014

  • Isambard101 :   All good points. My experience of LP people having spent lots of time with them and at times having been one, they are all very smart people. All things being equal, an LP will give the right answer for the data that has been input, but that is the rub. It is a forecast and the issue for any organisation is what time is spent with the "right" people challenging the direction. We have all seen the silos that can happen in organisations, add to this the politics of who will get the blame for cutting runs, the approach that the head office says... , the personal bonus drivers for people; this all makes it into a challenging decision. In my experience, LPs are just a reliable calculator, the skill and artistry and profitability of a business is to interpret the LP, anticipate and forecast the market by taking an holistic view and then most importantly have the courage to act. The courage is I fear where many will be found wanting, even if they do the analysis. Who has not seen a company do a dumb thing like spend or not spend money because of budget, independent of economic sense. So not cutting runs and praying that someone else will so that the margin is restored for the "last man standing" is just part of the rich tapestry of oil refinery management. :-)

    Jan 04, 2015

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