Refining earnings news signals Tier 3 margin squeeze
Some news from recent refining earnings reports:
Cenovus (CVE) reports low refining profitability
Cenovus attributed low 4th quarter refining profits to a major turnaround at its Lima, Ohio, refinery and to post-turnaround challenges with secondary processing units:
“In the US manufacturing segment, refinery utilization averaged 72% in the quarter. This reflects the impacts of a planned turnaround at the Lima Refinery. The Lima turnaround was a major one in every five year event, involving planned outages at the crude unit and the cat cracker units, with a total cost of around $145 million. Following the turnaround, we encountered some challenges with secondary processing units, which impacted run rates beyond the initial six to eight week planned timeline extending through December and into January.
Alex Pourbaix – President and Chief Executive Officer, Feb 8, 2022
Cenovus takes $1.9 billion write-down of US refining asset value
The write-down of refining asset value is attributed to 3rd party forecasts of future crude prices, crack spreads, and RIN prices.
We recorded a $1.9 billion impairment in the US manufacturing segment this quarter. The impairment related to the carrying value of our assets in US refining and changes in current independently derived commodity price outlooks, specifically around crack spreads, RINs, and the WCS differential.
Alex Pourbaix – President and Chief Executive Officer, Feb 8, 2022
“Commercial reasons” and crack spreads weigh on CVE margins
In the Q&A segment, Cenovus pointed to commercial reasons and cracking margins as additional factors in low utilization:
. . . we did execute a 45-day turnaround in Lima. The actual execution of the turnaround was quite good. The total cost, as Alex mentioned, was about $145 million. We did struggle with the Isocracker and the reformer coming out of that turnaround but the Lima refinery is now up to normal rates of operation. We expect it to run through 2022 at normal rates of operation. What we have seen in the past is utilization has been lower than historic due to largely commercial reasons, so as the cracks continue to justify, we will continue to take those rates of utilization up.
Jonathan McKenzie – Executive Vice President and Chief Operating Officer, Feb 8, 2022
The reference to commercial reasons suggests low margin capture was not caused solely by Lima turnaround-related reasons and that low margin capture may dictate running the refineries at less than full utilization for economic reasons.
Margin forecasts dictate lower value of CVE US Refining assets
When asked to elaborate on the write-down, CVE executives said the write-down is based on third-party forecasts of crude, product, and RIN prices:
. . . this really reflects third-party price lines and where those currently sit in, and that’s really the driver. And as you can see in the upstream, similar to what we’re seeing in the downstream is, it’s really their reflection of the IQRE prices, so we had the reversal. So number one, it’s a reflection of that, Dennis, and that really drives a lot of evaluation in changes with those third party price lines.
Jeffrey Hart – Executive Vice President and Chief Financial Officer
IQRE was a new acronym for me. With some research, I came to believe IQRE means Independent Qualified Reserves Evaluators, which are a category of commodity price forecasts used in asset valuation. My interpretation of this answer is that one or more third-party forecasts of commodity prices suggested CVE’s US refineries are likely to produce lower margins in the future
PBF Energy may restart idle Paulsboro units
PBF reported net income of $157 million for the quarter and pointed to increasing demand and refining rationalization as favorable factors for refining margins. PBF is considering starting up some secondary units at their partially-idled Paulsboro refinery to improve clean product yield, relieve “constipation”, and improve margin capture:
there are some things we are planning to do on the East Coast with some secondary units that will improve our clean product yield. . . . So, we will be starting up some secondary units, specifically in Paulsboro.
Matt Lucey – President
and this was embellished by Tom Nimbley:
. . . as we started to see demand recovery and growing up our utilization, particularly in Delaware to take advantage of the market opportunities, we found ourselves getting constipated, if you will, in Delaware because of the intermediates being transferred from Paulsboro to Delaware when we shut down the cat cracker, the coker, etc. So, what we’re really doing now is we’re starting up a couple of units, not the big ones as Matt said, that is basically going to reduce those transfers significantly, Paulsboro will turn them into finished products. Not a significant increase in clean products production, but some high-value products production and a better capture rate.
Tom Nimbley – Chief Executive Officer
These comments indicate a relative shortage of product quality, versus product yield resources, to achieve optimal margins; selective addition of quality-improving unit capacity will enable improved refining margin capture.
Tier 3-triggered impacts
The above observations align perfectly with our theory that Tier 3 has triggered a product quality, vs. yield, squeeze that selectively hurts the profitability of refineries not well-equipped for it.
All the above observations are consistent with out theory that Tier 3 has triggered a product quality, vs. yield, squeeze that selectively affects the profitability of refineries not well-equipped for it.
Mere compliance or profitable compliance?
On the surface, Tier 3 seems a non-issue because everyone is complying with it. But that is a false impression. Tier 3 was never an issue from a mere compliance standpoint. The only question was cost of compliance. Below the surface, there are big, important differences in cost of compliance for different refineries, which ranges from near zero for some refineries to well over 10 cents per gallon for others.
I think Tom Nimbley has a better metaphor (constipation) for what I I called “handcuffing” when I said that “Tier 3 will handcuff our ability to capture the crack spread which is how we make money. Yes we can make things work, but at what cost?”
“Tier 3 will handcuff our ability to capture the gasoline crack spread which is how we make money. Yes we can make things work, but at what cost?”
George hoekstra, in “TiER 3 gasoline, a wolf in sheep’s clothing”, opis fuels and octane forum oct 24, 2019
In the same presentation, I predicted the Tier 3 squeeze will cause (like constipation) a domino effect, which in a refinery appears in the form of more unplanned downtime, purchase of costly gasoline blend stocks, downgrades and restrictions on intermediate quality, low refining margin capture, and reduced crude flexibility, all of which are surfacing in earnings reports today. These symptoms, and others I have been documenting, align perfectly with the analysis in our reports of how Tier 3 would trigger shifts in refining margin capture once it takes hold.
Conclusion
- Cenovus’ explanations of poor refining margins and asset value write-down align with our predictions of Tier 3 impacts on refining profitability
- PBF’s explanation of the possible re-start of Paulsboro’s secondary units align with our predictions of Tier 3 impacts on refining profitability
An unpopular opinion
My opinion on Tier 3 impacts remains highly unpopular. It continues to draw hoots and howls, including, this week, “SHEEEEESE”, and “OH PUULEEZE”, which I have heard for years from those caught up in conventional wisdom. Meanwhile, I continue to respond to all rational rebuttals.
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