EXPECTATION vs REALITY
EXPECTATION AND REALITY
by maryline vuillerod and jeff kralowetz
It may seem intuitive that Canada could gain more benefit
from its crude oil resources by refining them in Canada and exporting refined
products. But this theory fails to account for the structure of global markets,
constraints in infrastructure and geography, and trends in global demand for
refined products.
THE STRUCTURE OF GLOBAL
MARKETS
Any company
considering investing $10 to $15 billion dollars in export refineries must take
into account significant Asian growth that has been matched by rapid building
and even over-building of refining capacity in China, India and the Middle
East. Even there, refinery utilization has fallen.
Any new Canadian refinery would enter a market in which
capacity has been over-built and refinery utilization has been falling since
2006, particularly in the Organization for Economic Cooperation and Development
(OECD) member countries.
Source: IEA, June 2014 Medium Term Market
Report: Market Analysis and Forecasts to 2019
Oceania Constraints in infrastructure
Furthermore, the
world is cutting back on refinery construction projects and closing existing
capacity. Since 2008, 4.5 million barrels per day (b/d) of OECD refining
capacity has been shut down. Source: IEA, June 2014 Medium Term Market Report:
Market Analysis and Forecasts to 2019
The Goldilocks principle states
that reasonable argument falls within certain margins rather than occupying
extremes. Consider the argument over how much refining is right for Canada. One
extreme holds that we should refine all Canadian crude in Canada; the other
that we should refine no crude in Canada.
The former suggests markets for refined products are
unlimited and there is more value in refining crude than selling it as a
critical Canadian commodity. The latter proposes reliance on imported
transportation fuels, exposing Canada to supply insecurity and foregoing the
associated economic and social benefits of refining.
The reasonable position is the middle ground, where market
forces dictate the wisdom of selling and refining crude.
Refining is a complex business and an integral component of
Canada’s oil and gas value chain. The industry provides jobs for nearly 18,000
workers and contributed over $5 billion to GDP in 2014. The industry operates
15 refineries in seven provinces for a total capacity of nearly two million
barrels per day—enough to meet Canadian demand and ensure we are a net exporter
of products.
It is an industry
that has been shaped by the market, if sometimes harshly. Since 1970, 20
refineries have closed; others have increased efficiency and expanded their
capacity to remain competitive and satisfy Canada’s current demand. Production
and demand in Canada are in positive balance, with Canada a modest net exporter
of refined products.
The outlook for demand is flat, which explains why, to date,
investors are skeptical of new refinery proposals such as BC-based Kitimat
Clean and Pacific Future Energy. Kitimat Clean is projected to cost $21
billion—with requests for government loan guarantees in the vicinity of $10
billion.
How will local
declining demand impact the business case? Where are the markets?
Canada’s export refiners must compete on a continental and
global stage to survive and thrive. We currently export refined products where
geography— specifically tidewater locations— makes us competitive. For example,
the northeastern U.S. is a strong and reliable export market served by
refineries in Newfoundland and New Brunswick.
In effect, we have struck a marketbased balance between
selling and refining crude. According to the Goldilocks principle, we likely
have got it just right.
Even in non-OECD countries, refinery expansion and
construction is being scaled back in the face of over-building.
Source: IEA,
June 2014 Medium Term Market Report: Market Analysis and Forecasts to 2019
SHELTERED BUT NOT
IMMUNE
The U.S. has been the
exception to refinery construction cutbacks. Why? Cheap natural gas for fuel,
the U.S. ban on crude exports that keeps feedstocks cheap, and easy access to
Latin American and other export markets for refined products from the Gulf
Coast. But this experience is regional. Over on the U.S. east coast, there has
been 800,000 b/d in refinery closures in last 10 years.
Canadian refiners are
similarly affected, as evidenced by recent refinery closures in Montreal and
Dartmouth. While refinery expansions have occurred, no new refineries have been
built in Canada since the 1980s (a new 50,000 b/d bitumen refinery is now under
construction in Alberta; see next page).
TRENDS IN GLOBAL PRODUCTS DEMAND AND SUPPLY
To complicate matters, North American products consumption
is declining as a result of vehicle fuel efficiency standards, ethanol/
biofuels mandates, a more urbanized population and the growth of online
shopping. This situation exists in all OECD countries. The sole markets where
demand for refined products is growing are non-OECD countries. As a result,
North America is oversupplied with refined products, and the glut is
growing—and will continue to grow at least through 2019.
GLOBAL MARKET
COMPETITION FOR CANADIAN REFINING INVESTMENT
What prevents Canada from competing globally in refined
products markets as the U.S. Gulf Coast refiners have? The answer is that
Canada is constrained by geography. We are located further from Latin American
or Asian markets where refined product demand is growing.
And today there is no way to cost-effectively move crude to
a coast, refine it and compete with a Chinese or Indian refiner running Russian
or Middle Eastern crude that arrived at a lower cost.
Canadian crude availability is located offshore in
Newfoundland and land-locked in the West—away from high-demand areas. We can’t
move closer to clearing markets where the wholesale commodity price is
determined.
North America is
oversupplied with refined products, and the glut is growing – and will continue
to grow at least through 2019.
CONSTRAINED BY
CONFIGURATION
Not all refineries are alike. East coast Canadian refineries
were built to run light crude. American Bakken and Eagle Ford feedstocks are
good options, but most domestic Canadian crude production is heavy. Therefore,
these refineries are not well placed to monetize Canadian domestic crude
resources.
Currently, east coast refineries are refining less than 50
percent of the east coast offshore Canadian grades. And locking into one
feedstock source threatens the profitability of refiners. Building a refinery
solely to monetize one type of crude is perilous, as the light/heavy spread can
change, and margins can contract or even disappear.
Mandating processing in Canada would almost inevitably raise
prices for Canadian consumers. In the end, the best way to achieve optimal
natural resource utilization and fair prices for consumers is to allow markets
to function rationally, allowing market forces to allocate supply where it is
needed. The constraints of inflexible infrastructure and the geographical
challenges of stranded supply pools and scattered demand centers no doubt
complicate the efficiencies that markets could bring. But intervention along
the supply chain will only stop the flow and distort prices in ways we simply
cannot predict.
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