In the next couple of years, collapsing Russian supply of
straight-run fuel oil (SRFO) will undermine foreign supply of
feedstock to the Gulf Coast. Gulf Coast refiners currently rely
more than ever on imports of vacuum gas oil (VGO) and SRFO to
feed their cracking units. Russias refineries have
developed into the top source of this feedstock, thanks to an
oil export duty regime that encouraged the production and
export of feedstock. That is changing, though, due to new
export duties imposed by the Russian government.
Reduced feedstock supply adds another layer of complexity to
the feedstock choices confronting Gulf Coast refiners. Until
now, Gulf Coast refiners have compensated for increased intake
of domestic light crude by backing out barrels from West
Africa. Now that the last barrels of light crude imports are
being backed out of the market, refiners that absorb more
domestic light crude will turn to heavier crudes and SRFO
imports to generate feed for their cracking units. However,
shrinking availability of SRFO from Russia means imports are
likely to fall. This scarcity will lead to marginally higher
demand for heavy crude to generate the feed for cracking
The scarcity of feedstock will lead to rising
prices, which may lead to a deterioration of cracking economics
and constrain cracker utilization rates. At the same time, the
scarcity of Russian supply will boost profitability for other
suppliers of SRFO and VGO.
Addicted to imports
In 2013, Gulf Coast refiners imported a record 410,000 bpd
(410 Mbpd) of feed for their cracking units, more than half of
this from Russia. Imports of heavy gasoil account for 295 Mbpd
of that amount. The remainder was generated from imported SRFO.
Assuming that 60% of the SRFO is converted into VGO, the 195
Mbpd of imported SRFO generates another 115 Mbpd of feed for
cracking units, resulting in the combined 410 Mbpd of imports
shown in Fig. 1. Imports rose 100 Mbpd in the
last two years and now account for one-eighth of the feed used
by Gulf Coast cracking units.
Supply of VGO and SRFO from one source, Russia, accounted
for the growth of Gulf Coast imports. As Fig.
1 shows, Russian SRFO and VGO accounted for 220 Mbpd
of imported feedstock in 2013, 55% of all imports.
1. Texas and Louisiana Gulf Coast
fresh feed imports.
Growth of cracking capacity has fueled the demand for
imports. Between 2010 and 2013, hydrocracking and catalytic
cracking at Texas and Louisiana Gulf Coast refineries increased
200 Mbpd, from 3 million (MM) bpd to 3.2 MMbpd. A nearly
400-Mbpd expansion of capacity enabled this
growth, illustrated in Fig. 2.
More capacity additions, though on a smaller scale, suggest
that processing will rise further in the next few years. The
60-Mbpd hydrocracker at Valeros St. Charles refinery in Louisiana, completed in
the second half of 2013, will contribute to higher
hydrocracking throughput in 2014. Two more 20-Mbpd units will
be commissioned in the next two years, one each in 2014 and
2015. The forecast in Fig. 2 assumes a 50-Mbpd
increase in processing to 3.25 MMbpd in 2016. If there were no
change in domestic supply, this implies that imports of fresh
feedstock from Russia and other
sources would increase another 50 Mbpd. However, supply from
Russia will actually fall.
2. Texas and Louisiana Gulf Coast
catalytic cracking and hydrocracking fresh
feed supply and processing.
Export duty reform
In recent years, Russia exported about 500 Mbpd of SRFO and
a little more than 200 Mbpd of VGO. Beside the 190 Mbpd of SRFO
supplied to the Gulf Coast, the bulk of the 130 Mbpd of FO that
China imports from Russia is straight-run. Europe is also a significant
consumer. With 135 Mbpd of imports in 2013, Gulf Coast refiners
also absorbed the bulk of Russias more than 200 Mbpd of
Up until now, Russias oil export duty regime
encouraged these exports. Oil export netback prices, the
international price less the export duty, are the basis of
Russian refining profitability. Over the
last decade, under various structures, export duties on
products have ranged between 40% and 90% of the crude export
duty. Until early 2011, the FO export duty was equal to 40% of
the crude oil export duty. In 20102011, the small duty on
FO relative to crude increased the export netback price of fuel
oil relative to Urals. The 3.5% fuel oil was priced at a $9/bbl
discount to Urals Med. But, in Russia, the export netback price
of 3.5% FO was $12/bbl higher than the Urals export netback
price (see Fig. 3).
3. Russian refining: Impact of FO
duty change on gross margin.
Essentially, the low export duty on FO was a boon to simple
refineries in Russia. The FO yield of a simple Russian refinery
is typically 40% to 50%. Some of Russias biggest
refineries fit into this category. The profits on FO
underpinned high refining margins for these refineries.
Fig. 3 shows the gross refining margin of a Russian simple
refinery producing 44% FO, with
naphtha and middle distillate accounting for the remainder of
output. Those margins, which were already high in the years
leading up to 2010, exceeded $15/bbl in 20102011.
Able to sell FO at a premium to crude, refiners maximized
utilization rates and investment continued to flow into crude
distillation capacity. These profits
were a disincentive to installing deep-conversion units.
Refiners with vacuum units were in no rush to add units to
process VGO into clean products. With so much crude
distillation capacity and few secondary units, the biggest
result of increased throughput was higher SRFO supply and
But the government is about to upend the flow of feedstock supply to the Gulf Coast.
Its objective in structuring oil product export duties was to
make simple refineries profitable so they could generate the
revenue necessary to invest in deep-conversion processing. In
the past few years, the government became frustrated with the
slow pace of refinery modernization. To increase pressure
on oil companies to accelerate investment, the government
decided to set the FO export duty equal to the crude export
duty beginning in 2015.
The transition to a higher export duty began in late 2011,
when Russia increased the FO export duty to 66% of the duty on
crude. Even with the higher fuel oil export duty, gross
refining margins were still quite high in 2012 and 2013. The
government planned to raise the rate to 75% in 2014, but a
resolution issued over the New Year holiday left the rate
unchanged at 66% in 2014.
However, the same resolution confirmed plans to raise the
rate of the FO duty to 100% of the crude duty in 2015.
Fig. 3 shows the impact of this change on the
fuel oil discount to Urals in Russia and the gross refining
margin of a simple refinery.
Given a gross refining margin that shrinks to zero, refining
expenses and the costs of transporting product, Russian
refineries with high fuel oil yields will no longer be
Russian supply collapse
To adapt to the oil export duty reform, which transfers refining profits from the bottom to
the middle of the barrel, Russias refineries have been
accelerating investment. The construction of new crude distillation capacity has ground to
a halt. Many refineries are racing to add hydrocrackers and
other units that will help them cut production of fuel oil in
favor of middle distillate and other clean products.
This investment has significant implications for the roughly
500 Mbpd of SRFO Russia exports. With few exceptions, SRFO
exports from Russia originate from refineries with no upgrading
units. These refineries will be all but extinct after the FO
export duty increases. Russias biggest producer and
exporter of fuel oil just commissioned a deep-conversion
complex. Until the final quarter of 2013, the Kirishi refinery
produced 200 Mbpd of SRFO, but recently added a vacuum unit and
56 Mbpd of hydrocracker. The Taneco refinery in Nizhnekamsk also just
commissioned a 56,000-bpd hydrocracker in the first quarter of
These projects are just the tip of the
iceberg. By 2020, the ratio of hydrocracking and catalytic
cracking capacity to crude distillation will expand from about
10% to 25%.
In some cases, by special arrangement, refineries that have
upgrading units segregate SRFO. A few short years from now,
these refineries will be the only potential source of SRFO, and
Russian SRFO will be a scarce commodity. Those refiners that
are willing to export SRFO will command a premium.
VGO exports will also be subject to an export duty equal to
100% of the crude duty. The majority of Russias bigger
refineries will add deep-conversion processing that will result
in higher production of clean products, while some smaller
simple units will go out of business. However, a handful of
refineries unable to invest in cracking and coking capacity may be viable by
adding vacuum units. VGO exports will also fall sharply,
although Russian VGO exports will not disappear altogether.
Reed is principal of ESAI Energy and the
author of a new study, From Russia without
sulfur: Russian oil tax reform upends global petroleum
product markets. Mr. Reed is a specialist in
Russian and Caspian energy, with considerable
experience living and working in that region. He speaks
fluent Russian. Mr. Reed heads ESAI Energys
coverage of the Russian/Caspian region and middle