Are Refiners Entering a Golden Age or a Short Cycle? Global Refining Strategies 2007 Barcelona, Spain April 2007 Joanne Shore John Hackworth Energy Information Administration

Short-Term Cycle or Golden Age? What has driven prices, margins, and light heavy price differentials to current high levels? –How are these three variables related? –What are the main drivers? How long might prices, margins, & differentials stay elevated? Source: Bloomberg spot prices

Outline High Prices: Crude Oil Drivers and Uncertainties Behind Margins and Differentials Other Supply/Demand Factors Affecting Future Petroleum Markets –Energy Efficiency –Biofuels –Surge in Capacity Expansion Plans

The Main Factor Behind High Product Prices: Crude Oil Prices Strong Demand Growth Less Supply Growth Different Prospects for Future than seen in 1980

Forecast Today: Little World Crude Oil Surplus Production Capacity Source: EIA Short Term Energy Outlook March 2007

Source: Bloomberg WTI; EIA Calculations Today: See Typical Economic Relationship Between Little Surplus Capacity and Price

Prospects for Demand Correction Different than Early 1980’s Correction Fuel oil decline will not ease market pressure today as in early 1980s Easy fuel efficiency gains made in early 1980s Large Asian economies account for more growth today Notes: World Excluding FSU, Gasoline includes aviation gasoline & light distillate feedstocks Source: BP World Statistical Review 2006

Today’s OPEC & Non-OPEC Production Requirements Different Than Source: EIA Annual & Monthly Energy Reviews.

Limited Prospects for Non-OPEC Crude Supply Increases in Short Run Fewer non-OPEC exploration prospects, field size declining Most efficient companies have limited access to known reserves Tar sands growth costly and slow Source: Data from Business Week Online Slide Show: Why the Oil Giants Look Weaker May 15, s Known Reserve Access

Prices Expected to Remain Relatively High in Short Term Future uncertain but could stay relatively high OPEC position has strengthened Demand growth has moderated only slightly No large surge in non- OPEC crude or other supply -- and costly Only OPEC can build excess capacity Source: EIA Short Term Energy Outlook March 2007

Drivers & Uncertainties Behind Refinery Margins and Differentials Margins –Growing, but volatile –Shift in gasoline and distillate contributions –Refining utilization – over- emphasized factor? Light-Heavy Differentials and the Importance of Crude oil Price Future Considerations

3-2-1 Spread (Margin Indicator) Grew with Crude Price – But Not Smoothly WTI Spot Spread Source: Bloomberg Spot Data: Gulf Coast Gasoline, No. 2 and WTI.

Distillate Cracks Increased More than Gasoline Source: Bloomberg spot prices – Gulf Coast Conventional & No. 2 minus WTI

World Utilization Up, But Atlantic Basin Utilization Not Changed Much Recently Source: BP World Statistics 2006 (crude runs/capacity) and EIA Annual Energy Review (gross inputs/capacity).

Light-Heavy Differentials Rose Since 2000, But Will They Remain High? Product markets drive light-heavy product prices Impact of total product barrel value on crude value Differential: Incentives for heavy-crude high- conversion refining

Light-Heavy Product Price Difference Increases with Crude Oil Price Source: Bloomberg spot price

Light-Heavy Crude Price Differential & Crude Oil Price Move Together Source: Bloomberg spot prices

If WTI Drops from $70 to $40, Will Differential Drop by 40% ($17-$10)? Source Bloomberg WTI Cushing and Maya.

If WTI Drops from $70 to $40, Margin Relationship Less Certain Note: Three hurricane months excluded (Aug-Oct 2006) Source Bloomberg Gulf Coast product spot prices and WTI Cushing.

Bottom Line: Crude Price Important Indicator of Future Returns Rising price: Increasing margins, increasing differentials Declining price: Decreasing margins, decreasing differentials Price settles within a high price band –Margins lose their boost from rising market dynamics, but may stay higher than seen in the 1990’s –Differentials remain high -- even with more conversion capacity

Other Supply/Demand Factors Affecting Future Petroleum Markets Demand Distillate/Gasoline Shift Energy Efficiency Supply Biofuels Reducing Need for Some Capacity Capacity Expansions – Oversupply? Source: BP World Statistics 2006.

Demand Factors Impacting Future Atlantic Basin Needs Europe’s growing imbalance between distillate & gasoline U.S. continued growth in gasoline & distillate – with distillate growing more strongly Potential increase in efficiency requirements (greenhouse gas, energy security, etc.) –Europe’s potential mandates –U.S potential policy change –Slow impacts Note: U.S. imports includes blending components is based on January-October data. Source: IEA, EIA Petroleum Supply Monthly & Annual

Biofuels Changing Capacity Needs Europe’s biofuel interest increasing –Biodiesel compatible with diesel capacity shortfall –Ethanol in gasoline exacerbates over-supply situation U.S. seeing diminishing need for new gasoline capacity –Increase in ethanol –Increase in import availability from Europe

Refinery Capacity Poised for Major Expansions Incentives resulted in capacity investment plans Plans cover all areas –Increased throughputs –Increased use of low-quality heavy feedstocks –Increased light product yields –Upgrade to top quartile

U.S. Capacity Expansions 2007 through 2011 (KB/D) 5-Year Expansions Dist.FCCHCCoking Conoco Phillips Flint Hills50000 Marathon Motiva Total00050 Sinclair00030 Valero75000 Other Creep-Closings TOTAL Note: Dist: Crude distillation unit; FCC: Fluid catalytic cracking; HC: Hydrocracking. Sources: Oil & Gas Journal, company presentations, Hydrocarbon Processing Boxscore

Capacity and Complexity Increases Through Next 5 Years Note: Dist: Crude distillation; FCC: Fluid catalytic cracking; HC: Hydrocracking. Source: EIA, FACTS, company presentations, Oil and Gas Journal, Hydrocarbon Processing Boxscore.

Complexity is Increasing Down-Stream Capacity as Percent of Distillation Capacity Jan 1, 2007 and Jan 1, 2012 Note: FCC: Fluid catalytic cracking; HC: Hydrocracking.

Capacity and Consumption 5-Year Changes 2007 through 2011 Sources: Capacity see previous slides; Demand: EIA, BP World Statistical World Review 2006, FACTS, IEA

Not Surprising that Outlooks/Plans Vary GroupRegions Future Market Expectations Refinery Investment Strategy Super MajorsAll Margins revert to historic Maintain top- quartile performance, little expansion need Majors with Large Downstream U.S. & Europe Improved margins with cycles Heavy crude projects & cautious expansion Independent Refiners U.S. "Golden Age of Refining“ but… Expand or upgrade operations Export Refiners Middle East Tight capacity & high light-heavy Expand for export, add bottoms upgrading State & Private India & China High demand growth, better margins Rapid expansion existing & grassroots Sources: Trade press articles, company presentations and press releases.

Potential for Over or Under Expansion – And Does it Matter? Barring calamities: –In the next 2-3 years, capacity will likely remain tight –In next 5-10 years, not likely to see utilizations drop to levels seen in early 1980’s from expansion Expansion that reduces utilization several percentage points not likely to have much impact on margins Regionally, the highest risk for oversupply that might impact Atlantic Basin margins is in Middle East; Atlantic Basin is not likely to over-expand Decrease in residual fuel supply from bottoms upgrading not likely to be enough to push residual fuel prices much closer to crude oil price and significantly reduce differentials. (Demand for residual fuel is declining.) Rising facility construction costs and biofuels use may reduce rate of facility expansion

Looking Ahead: Crude Price Factor Forecast: Fluctuate in band much higher than during the 1990’s (perhaps in the $60-$70 range?) Margin impact: –Lose the boost from being in a “rising” market –But still may support higher margins than in the 1990’s Light-Heavy differential impact: –Remain elevated –Demand for residual fuel is shrinking (e.g., bunker fuel market) –Even with more conversion capacity destroying residual fuel supply, residual price not likely to rise more towards crude oil Uncertainty: If crude oil prices fall, margins and differentials fall

Looking Ahead: Other Supply/Demand Factors Policies affecting biofuels and energy efficiency –Biofuels impact supply mix and volume –Ethanol use in U.S. reducing need for increased gasoline capacity, but U.S. still needs distillate capacity –Biodiesel in Europe may help slow growing diesel supply gap, but ethanol in Europe adds to already excess gasoline supply –Ultimate margin impact may be small – affecting gasoline cracks more than distillate –Energy efficiency improvements have slow impacts – can adjust Will refinery expansion plans result in capacity oversupply? –Seeing U.S. capacity plans shrink –Largest potential for oversupply margin impact is in the Middle East, where could dampen European margins and thus Atlantic Basin margins some

Short Cycle or Golden Age?