1. 2004: Sign of the Future for Refiners? Joanne Shore John Hackworth Energy Information Administration NPRA Annual Meeting March 2005 www.eia.doe.gov

2. Perspective “In the business world, the rearview mirror is always clearer than the windshield.” Warren Buffet (1930- ) “The trouble with our times, is that the future is not what it used to be.” Paul Valery (1871-1945)

3. 2004: A Year of Highs High Prices High Price Differentials High Margins

4. Shifts in Crude Oil Price Levels Source: Bloomberg West Texas Intermediate Crude Cushing spot price

5. Shifts in Light-Heavy Crude Oil Price Differentials Source: Bloomberg spot prices

6. Shifts in Margins Note: 3-2-1- spread assumes 3 barrels of crude oil produce 2 barrels of gasoline and 1 barrel of distillate. Source: Bloomberg spot prices Gulf Coast conventional gasoline, No. 2 heating oil, WTI

7. Questions What drove crude prices up in 2004? What caused the light-heavy crude price differences to change in the short run? What role did refinery capacity and heavy crude oil production play in 2004 light- heavy crude oil price differentials? Are higher refinery margins going to continue in the future and what lies ahead for refinery capacity?

8. Drivers Behind Crude Price Increases Tight markets: Demand outpacing supply Little spare crude oil production capacity

9. Significant OPEC Production Growth Required in 2004-6 To Balance Demand Annual World Oil Demand Growth Annual Non-OPEC Capacity Growth Source: EIA; Forecast Short-Term Energy Outlook, February 2005

10. World Market Balance was Tight, But Similar to 2003 Source: International Energy Agency, Data Base 2/10/05 Venezuela

11. Surplus Crude Oil Production Capacity Shrank in 2004 Source: EIA Estimates

12. Available Crude Capacity Affects Price Source: Bloomberg WTI Spot April 1999-Jan 2005; EIA Calculations

13. Surplus Crude Oil Production Capacity & Inventories Explain Price Source: EIA

14. Questions What drove crude prices up in 2004? What caused the light-heavy crude price differences to change in the short run? What role did refinery capacity and heavy crude oil production play in 2004 light- heavy crude oil price differentials? Are higher refinery margins going to continue in the future and what lies ahead for refinery capacity?

15. General Market Factors Affecting Differentials

16. Heavy vs. Light Price Differentials Rise As Crude Price Rises Crude Oil Price Increases Light Product Prices Increase Residual Fuel Prices “Flat” Light Crude Oil Prices Increase Most Heavy Crude Oil Prices Increase Least

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

18. Light-Heavy Product Price Differential & Crude Oil Price Source: Bloomberg spot prices – GC - Gulf Coast, NWE-Northwest Europe ARA Barge, WTI – West Texas Intermediate Cushing

19. Light-Heavy Crude Price Differential & Crude Oil Price Source: Bloomberg spot price

20. Light-Heavy Price Differentials Source: Bloomberg spot price

21. Questions What drove crude prices up in 2004? What caused the light-heavy crude price differences to change in the short run? What role did refinery capacity and heavy crude oil production play in 2004 light- heavy crude oil price differentials? Are higher refinery margins going to continue in the future and what lies ahead for refinery capacity?

22. Theories on How Capacity Constraints Drove Light-Heavy Differentials Overall world refining capacity limit Constraints on conversion capacity

23. Theory on Overall Capacity Limit Constraints Assumption Light product demand is increasing World refining capacity is running at maximum utilization Refiners desire to substitute light for heavy crude oil But additional light crude oil not available Results Light product stocks drop sharply Price for light products rise sharply Product price pulls crude prices up and pulls light crude up more than heavy Additional heavy crude oil won’t be used

24. Evidence to Support Hitting Capacity Limits? Did light product stocks drop & price spike? Any signs that incremental heavy crude oil production was not used? Was world refining running at maximum utilization?

25. Is World Refining Capacity Running at Maximum Levels? Sometimes world capacity compared to wrong demand Must look at regional refinery utilizations Will show that world capacity not at maximum utilization, but demand growth is outpacing capacity growth – for the moment

26. Asia is Where Major Increases in Refinery Utilization is Occurring Asian utilization increased, but “Asia” varies immensely China and India are big demand drivers and are adding capacity (soon enough?) Singapore export center utilization increased

27. Singapore Utilization Pattern Source: EIA, IEA, BP

28. World Capacity Utilization Up But Not at Maximum (Percent Inputs*/Distillation Capacity) 199820032004 U.S.95.592.592.8 EU-1594.588.991.3 Latin America81.474.4 Middle East93.087.1 * U.S. utilization calculation uses gross inputs, other regions’ utilizations use crude oil inputs. Source: EIA, IEA & BP

29. Theory: Conversion Capacity Constraints Drove Differentials Assumption Light product demand increasing Refinery conversion capacity running at maximum utilization Increased crude oil supply is heavy sour Results Demand for light crude oil increases Added heavy crude oil run without benefit of conversion Residual fuel oil yield increases Over-supply of residual fuel oil

30. Evidence to Support Being at Refinery Conversion Limits? U.S. Clues Did U.S. complex refiners increase light crude to maximize light products Did they experience a residual fuel yield penalty? World Clues Did world residual yields increase? Signs of a flood of residual supply?

31. U.S. Refineries Run Range of Crude Oil Imports Source: Form EIA-814; includes refineries in Virgin Islands & Puerto Rico

32. Signs of U.S. Preferring More Heavy as Light-Heavy Differential Increased Source: Form EIA-814

33. Complex Refiners Used More Heavy Sour As They Optimize Multiple Crude Types Source: Form EIA-814

34. Crude Mix Changed with Little Yield Impact Product Yields for 9 Gulf Coast Refiners Using Mixed Crude Oils Yields2003 Jan-Nov2004 Jan-Nov Gasoline49.850.2 Light Products80.580.9 Residual Fuel Oil3.33.8 Source: Form EIA-810

35. Aggregate OECD Residual Fuel Yields Did Not Increase

36. Residual Fuel Oil Stock Build Not Overwhelming

37. Still, Light Heavy Crude Price Differences Relate to Refineries without Bottoms Upgrading Hurricane Sources: Yields – IEA Users Guide 2004; Spot prices Bloomberg

38. Crude Oil Price was Primary Factor in 2004 Differential Increase Increase in crude oil price with associated product value impacts is primary driver behind light-heavy crude oil price differentials in 2004 U.S. data support economic choice to use more heavy crude oil as product values shifted –Refiners with upgrading used more heavy sour crude oil and moved to slightly heavier crude oil mix overall –Yet yields not affected much World data do not support refinery constraints with associated desire for light crude oil theory –Residual yields not noticeably affected –Stocks implied no insurmountable supply of residual fuel oil

39. Questions What drove crude prices up in 2004? What caused the light-heavy crude price differences to change in the short run? What role did refinery capacity and heavy crude oil production play in 2004 light- heavy crude oil price differentials? Are higher refinery margins going to continue in the future & what lies ahead for refinery capacity?

40. Margins & What Lies Ahead 2004 margins up – but for how long? Future implications for refinery capacity

41. Margin’s Relationship to Crude Price Source: Annual Average Bloomberg spot prices

42. Future Implications Near Term Crude prices remain relatively high Thus, differentials & margins remain strong Longer Term Future S/D uncertainties Thus differential & margin uncertainties Policy uncertainties – product quality & demand

43. U.S. Refinery Expansion U.S. refining likely to continue to expand But U.S. may also need increases in product imports Still, short-term financial incentives for expansion look favorable –Continued short-term market tightness –Product specifications may increase product import prices

44. World Capacity Expansion While world is not “out of capacity”, there is a need for increases to continue to meet growing demand Expansion plans are being announced Valid concern over timing of completed expansions versus demand growth – both in U.S. and abroad

45. Upgrading Capacity Expansion Potential US upgrading capacity expansion –Expanded more than in other parts of the world –Generally done in partnership with heavy crude producers –Still room for some more Asia upgrading capacity expansion –Perhaps next major expansion area –Required to meet growing light product demand –Partnerships with Middle East? Europe upgrading capacity expansion –Demand not growing strongly –Demand/refinery output mismatch –Need to destroy residual fuel (demand declining)

46. Conclusion 1 Crude Oil Price was Prime Mover in 2004 Crude Margins Differentials

47. Conclusion 2 Refinery capacity’s role in 2004 price dynamics was sometimes overstated, but new capacity is needed. Beware of over-simplifications that indicate crude oil-refinery mismatches are creating serious market bottlenecks. Margins and differentials should favor expansion in the short run. Expansion needs to be sooner rather than later, with U.S. dialogue balancing competing concerns of security, environment, and supply availability.