From heavy to light and back again

There was a time when light sweet crude was considered the best of the oil-grade bunch.

Easy to process and especially suitable for making gasoline — the fuel of choice for the world’s automobiles — it quickly became the global benchmark for oil prices everywhere.

The only problem for the industry was that there was never enough of it about. A fact which ended up providing the market with a hell of an incentive to find better ways of processing inferior crude types.

Which is exactly what happened next.

Over the course of the last decade, under the mistaken belief that light sweet crude would soon become impossibly hard to get hold of at a fair price, huge sums of money flowed into the development of so-called complex refineries — units capable of processing cheap inferior crudes just as efficiently as light sweet grades.

What no-one saw coming, however, was that the shale-induced light sweet crude production explosion would soon turn the scenario on its head.

Which is where a lot of the US refining industry finds itself today. Namely, facing up to the uncomfortable reality that much of the recent investment in heavy sour crude processing capabilities — geared very specifically towards the efficient processing of foreign crude — may have been redundant.

As Citi’s latest note on the US energy market explains, it’s a scenario which stands to put further pressure on WTI prices in the near-term (our emphasis):

Refineries have jumped on the opportunity to run cheaper crude, but a “crude wall” is coming; the new supply is overwhelmingly light, sweet crude, but Gulf Coast refineries prefer heavy, sour crude. Light, sweet crude imports have all but dwindled to practically zero, but incentivizing refiners to back out heavy sour crude imports would require light sweet crude prices to fall versus heavy sour crude prices to promote switching. In particular, some of this light, sweet crude is ultra-light, with API gravity levels well above 50 degrees. This is, in fact, condensate, and as a particular category of crude oil/hydrocarbon, may be treated differently in the way it is exported (see “Alert: US Condensate Exports”).

So, unless the US is allowed to begin exporting its excess light sweet crude, the price of crude will have to fall below heavy crude types for complex refineries to be incentivised to run light sweet crude again. Which makes sense given the deterioration of crude throughput and light product yield that this shift would cause.

If nothing else changes, Citi postulates that eventually the US refining system will be forced to restructure itself and reinvest in local light sweet crude processing ability again. In fact, this may already be happening:

Even as crude oil exports grow, refinery capacity expansions (and even new greenfield projects, albeit small ones) have been planned to run more of the abundant local light sweet crude supply in the US. With advantaged crude feedstock, plus access to cheap shale gas, refineries can run at high utilization rates to serve the global market. With US petroleum demand declining – particularly in the road transportation sector – exports of petroleum products should continue to rise, as they have already. (An exception would be NGL exports, where homegrown petrochemicals facilities are being built rapidly to utilize cheap local feedstock.)

Just goes to show, you never can tell what might happen next.

Related links:
Why Saudi Arabia’s best bet may be to increase output – FT Alphaville
When the cartel bursts, Brent edition – FT Alphaville
The North Dakota millionaires rocking oil markets – FT Alphaville
Opec compromised; Saudi Arabia becomes lone player - FT Alphaville (Jun, 2012)
Is Saudi Arabia starting to panic? - FT Alphaville (Jan, 2013)
Saudi Arabia resorts to Jedi mindtricks – FT Alphaville (May, 2012)

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