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Russian straight-run fuel oil supply collapse complicates Gulf Coast feedstock choices

06.01.2014  |  Reed, A.,  ESAI Energy, Wakefield, Massachusetts

In the next couple of years, collapsing Russian supply of straight-run fuel oil (SRFO) will undermine foreign supply of feedstock to the US Gulf Coast.

Keywords: [Russia] [US Gulf Coast] [straight-run fuel] [supply] [vacuum gas oil] [imports] [cracking] [margins]

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. Russia’s 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 units.

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.

  Fig. 1.  Texas and Louisiana Gulf Coast
  fresh feed imports.

Ascendant demand

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 Valero’s 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.

  Fig. 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 Russia’s more than 200 Mbpd of VGO exports.

Up until now, Russia’s 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 2010–2011, 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).

  Fig. 3.  Russian refining: Impact of FO export
  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 Russia’s 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 2010–2011.

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 exports.

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 viable.

Russian supply collapse

To adapt to the oil export duty reform, which transfers refining profits from the bottom to the middle of the barrel, Russia’s 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. Russia’s 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 2014.

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 Russia’s 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. HP

The author 
  Andrew 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 Energy’s coverage of the Russian/Caspian region and middle distillate market.  

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