Summary
During the middle of the summer in 2006, refining economics began to be turned upside down. NYMEX Heating oil futures prices and cash diesel prices were higher than NYMEX gasoline prices. This phenomena ended in February of 2007 but reappeared once in again by August and have remained with us since. Consequently refiners have maximized distillate production setting all sorts of production and yield records in 2008. In addition, distillate exports also reached a record level and had it not been for this arbitrage, the USA would be overflowing with distillate inventory.
Analysis
Nothing helps refiners change their operations like changes in economics for sustained periods of time. Historically, gasoline prices were higher than heating oil in the summer and the reverse was tru in the winter. That all began to change in the summer of 2006.
There are many reasons that brought on this change: More diesel cars hitting the road, increased demand in Asia, diesel for power generation in South America and the Arabian Gulf. Add to that the new regulations for diesel requiring the use of ultra low sulfur diesel in 2006 and the switch of non road locomotive marine diesel from high sulfur to 500 ppm in 2007.
The question is can the USA refinng industry support growth in diesel market share. The article pie chart uses data from the DOE during 2006. At that time, distillate yield, i.e. diesel plus heating oil was 22% per barrel of crude. The DOE does not distinguish between high sulfur and low sulfur diesel in this data: I will not make the distinction either, but it should be noted that one exists.
As the economics changed in 2007, refiners began making operational changes. Given that the hardware exists, there are several changes that can be effected within the refinery. Often times, the simplest is changing what are know as distillation cut points. This is relatively simple to do and takes place on the crude unit or other downstream units where fractionation takes place. Catcrackers can run at less severe conditions and produce more distillate blendstock. Hydrocrackers that consume distillate can reduce rates while hydrocrackers that produce distillate can slightly adjust operations to increase distillate yield at the expense of jet fuel and/or naphtha.
The next step to increased refinery distillate production is with new invesments in hydrocracking to process vacuum gasoil sunch as being done in Europe or increases in coker capacity that upgrade residuum or bottoms of the barrel.
The result was that in 2007, refining yield of total distillate increased to 26.1%. From August 2007 through the present, the economics prohibitively favored distillate production and for the first eight months of 2008, refinery yield increased to 27.3%, hitting a record 28.3% in August 2008. Clearly refiners can increase distillate yield.
Meanwhile the total barels per day of distillate production has also steadily increased over the years. During August of 2006, distillate production was approximately 4 million barrels per day. In July of 2008, that number had increased to 4.7 million barrels per day.
The flip side is that USA demand in 2008 has recently declined compared to 2007, down approximately 9% year on year in July and August. Refiners have been greatly helped by exports to South America and Europe to keep inventories under control. In fact, in August, refiners exported a record 849 MBD distillate, representing 19% of distillate production. Distillate inventories were little changed over the month, less than 2 million barrels. To be fair, exports consisited of both diesel fuel and heating oil.
Without an arbitrage window, USA inventories would have been nearly full going into Hurricane Gustav and Ike. One conclusion is that USA refiners are well positioned to meet growing USA diesel demand. On the other hand, given the connectivity in the world oil markets through arbitrage, the USA diesel supply can still be strained in the future as growth overseas, via transportation fuel or power generation increases.
