London, 14 September 2011

Learning from the Yorkshire adage about making money from waste ("where there's muck there's brass") U.S. refiners are making big profits from processing the poorest crudes and unwanted residues from other countries' refineries. Importing low-value oils from refineries in Europe and Africa that cannot process them further to wring out additional fuel oil and gasoline has become an increasingly important and profitable business for the biggest and most complex refineries on the U.S. Gulf Coast.

Problems for European and U.S. East Coast refineries unable to reduce sulphur or crack large molecules have become an opportunity for Gulf Coast refiners, buying crudes and residues others cannot process at rock bottom prices. U.S. refiners have actively sought out heavier crudes and discounted refinery by-products from other countries to capitalise on their greater investment and better technology.

SPECIALIST MARKET

Trade in heavy fuel oils and the residuum from atmospheric and vacuum distillation towers remains a niche market, restricted to a handful of players. But it has been the fastest-growing segment of U.S. refinery inputs over the last decade and plays a vital role supporting the profitability and viability of Gulf refineries.

In 2000, U.S. refineries imported 63 million barrels of heavy gas oils and 24 million barrels of resid compared with 3.3 billion barrels of crude, according to the Energy Information Administration ( EIA), the statistical arm of the U.S. Department of Energy. Heavy unfinished oils accounted for just 2.6 percent of the crude and unfinished feedstock imported by U.S. refiners.

Fast-forward to 2010 and imports of heavy gas oil had risen 64 percent to 104 million barrels while imports of residuum were up almost 300 percent to 95 million. In contrast, crude imports rose just 43 million barrels (1 percent). Residuum and heavy gas oils more than doubled their share of imported primary feedstock to 5.6 percent.

Trade in residual and heavy gas oil is dominated by independent refiner Valero -- which last year imported almost 89 million barrels for its refineries Texas and Louisiana. The company is distantly followed by Exxon with just over 30 million barrels, and Flint Hills, ConocoPhillips and Chevron, which each brought in 12-15 million barrels. These five companies accounted for around 80 percent of imports last year.

More than 40 percent of all heavy gas oil and residuum was sourced from refineries in Russia (83 million barrels) with the remainder from Algeria (25 million barrels) and smaller quantities from a variety of other refineries across Europe, Africa and the rest of the former Soviet Union, as well as the United Kingdom (5 million barrels).

In effect, U.S. refineries with coking units and hydrotreaters for removing sulphur are providing upgrading and conversion facilities for refineries across Europe and Africa without their own desulphurisation and cokers to crack heavy fuel oil and other residues.

PRODUCT/FEED ADVANTAGE

Complex refineries with coking and hydrotreating facilities along the Gulf Coast are uniquely positioned to benefit from three trends:

(1) Increasingly tight product specifications cutting sulphur content in gasoline and diesel sold in North America, Europe and now emerging markets mean that refiners without hydrotreating facilities are restricted to buying (expensive) low-sulphur crudes.

(2) Tough restrictions on sulphur in marine bunkers being introduced by marine pollution regulations (MARPOL) are restricting the traditional market for disposing of (high sulphur) fuel oil and residuum into the boilers of ocean-going vessels.

(3) Growing price differentials between sweet light crude oils and discounted crudes and semi-processed oils with a higher sulphur content and a higher proportion of large molecules pose an increasing challenge to refiners that must rely on light sweet feedstock -- and an opportunity for rivals able to handle heavier sourer inputs.

While refiners on the U.S. East Coast and Europe have scrambled for scarce supplies of low-sulphur light sweet crudes, paying an enormous premium and biting deep into margins, Gulf Coast refineries have been able to process heavier sourer grades, as well as unfinished heavy fuel oils and residues, bought at a significant discount.

In 2010, according to the EIA, Gulf refineries processed crudes averaging three times as much sulphur (1.6-1.8 percent) and heavier (29 degrees API) than rivals on the East Coast (0.6 percent sulphur, 33 degrees API). These figures are for unprocessed crude; EIA does not compile data on the quality of semi-processed inputs in the same way. But it is very likely heavy fuel oils and residuum had an even higher sulphur content and density.

The combination of aging refineries in Europe and increasingly stringent fuel specifications should ensure this market for secondary refining of unusable or deeply discounted by-products continues to grow.

Eventually some of the simpler refineries must close. But until then the trade in their residuum and heavy gas oil will only strengthen the relative competitive position of coking refineries even further.

Ends --

By John Kemp, Reuters market analyst – for Commodities Now.

The views expressed here are his own.