Refined product demand in the US has been upended, forcing refiners to cut production and pipelines to slow.
What happens next? How are refiners dealing with uncertainty in the marketplace? John Demopoulos, Argus’ VP for North America refined products, and Elliott Blackburn, senior reporter for downstream and fuels, discuss this and more, including refining economics, maintenance and RVP issues.
John: Hello and welcome to this podcast episode from Argus, a leading independent provider of energy and commodity price benchmarks. Today, we want to give an overview of the continued disruption to U.S. refining and petroleum product supply chains resulting from the COVID-19 outbreak. I'm John Demopoulos, Argus' Vice President for North American refined products. And with me, today, is Elliott Blackburn, our senior reporter for downstream and fuels.
So, I think we really wanted to start off with the idea of demand destruction in the United States. Of course, we know that people aren't driving at the moment. Many, if not most, of the United States is on what people are calling "lockdown." People are stuck in their homes for the most part or in many instances. How are we seeing that translate into a drop in demand for road fuels and fuels more generally?
Elliott: Well, it's really early days for that, and a lot of what we're seeing is anecdotal. And, you know, it's a really uncertain period right now for U.S. fuel demand other than to know that it's down. You know, previous events, such as, you know, when you think of a hurricane or a major storm, they've had clearer end dates, and they've also had much more limited geographic effect. This is a global event. U.S. refiners have outlets all over in all U.S. regions that are being affected by this and their export markets are affected as well. So, this is much less-charted territory.
We do know that Colonial Pipeline, last week, warned that this week, they would likely cut their capacity on the two main fuel lines that head into the East coast by 20pc. And that's not because there's a lack of supply like we might see in hurricane season; that's because there's simply not the demand needed to pull that product off the pipeline. Magellan, today, which is a major midstream fuel distributor all across the mid-continent, said that they had so far seen about a 10pc reduction in gasoline demand, diesel demand was flat, and jet fuel demand was down about 15pc in the 15-state area that they cover. So, we are seeing some very clear indications of falling gasoline demand, especially. It's just gonna take a little bit more time for us to get really specific idea of how far this is going down.
John: The pipelines, of course, in some cases, have come and told their customers that they need to be mindful of the requirement to actually take their product off the line in a timely manner. Is that correct?
Elliott: Right. Again, when we think of these disruptions, or at least what we've seen in the past, a lot of the focus has been on suddenly there's an interruption to the supply going across the line. And what's unique about this event, again, is that there's just not the appetite to take the fuel off the line, and, of course, that means that terminals and storage tanks are gonna be filling up and the pipelines as well. So, they have to be very careful about balancing what's going in and making sure that they can, you know, continue to use their assets and flow them off. They can't just have refiners continue to push product somewhere that won't come out.
John: Now let's look at the refining end of the pipeline where the fuel's being injected, where the fuel's being produced. How are we seeing the economic signals for refiners changing, I guess, over the past couple of weeks? Some of those refining margins have really changed dramatically, right?
Elliott: Sure, and this is definitely where we've seen, kind of, the starkest numbers on clues that we have toward what's happening in fuel and specifically gasoline and diesel demand. When we look at, kind of, just very roughly try to think about what fuel's profitable, one of the simple ways to do that is to look at how much they can sell gasoline for versus how much they would pay to get crude to make that gasoline. It's called a "gasoline crack." It's a very simple tool. It's not very specific to any refiner, it's more of just a snapshot.
And what we can say very clearly is that in pretty much every region in the U.S., you know, a refiner can expect to sell a barrel of gasoline, a benchmark barrel of gasoline that Argus assesses, for less than they would pay to buy the crude to make that gasoline. So, gasoline is very sharply in the red. We see deep red on the West coast and the Los Angeles and San Francisco markets. Well, of course, California, last week, already went into some of these more restrictive efforts to mitigate the coronavirus pandemic. We also see some pretty deeply negative gasoline crude relationships on the East coast. And the Gulf coast, it's been a little bit less negative, a little bit more of a narrower spread between gasoline prices and benchmark crude prices.
Conversely, diesel, as you can imagine, there's still plenty of trucks, thankfully, and moving around supplies around the country. There's still lots of pretty steady diesel demand. And diesel cracks are very strong. The diesel margin, the same kind of diesel relationship to their respective crudes, is much stronger in every single region and particularly strong in the Gulf coast.
John: So, this time of year, of course, refiners would typically be gearing up to produce gasoline for the summer driving season. That's not happening right now. Gasoline is the loss leader, as you were saying. Presumably, right now every refiner is trying to the extent possible to minimize their gasoline output, minimize their jet output for the very well-known reasons of reduced aviation demand, and maximize diesel to the extent possible and relative to those others. Is that the right way to think about this?
Elliott: Sure, I mean, I think what the numbers show is just a reminder that this isn't a very straightforward situation that refiners are facing. They need to continue producing diesel. They still have a market for diesel, but they're definitely going to try and manage the gasoline that they're sending out and the jet fuel that they're sending out.
Some of the things that we already know that they're doing is shifting as much as possible, fuel or intermediates, that may have gone into producing jet fuel more into the diesel production. And they're probably going to be, almost certainly, reducing runs on units that would be tilted more towards gasoline production, again, just to make sure that they're not adding and furthering a supply glut of that particular fuel.
But, one thing we know for sure, and this is definitely going to vary, not just by market-by-market, but state-by-state, you know, site-by-site, it's not like there's a big knob that everyone's gonna turn down to 70pc. These are very specific decisions that are made within the fence line of the refinery about, not just to reduce, but what they're reducing.
John: And, of course, while as you say, "There's no knob to simply turn it down to 70pc," if you look at the overall picture, overall margins, you know, taking into account all of the fuels that a given refinery is producing, the overall margin for the refinery in all instances is simply down. And we are, perhaps, likely to see crude units that, sort of, first stage in the refinery reduce throughput themselves and cut the overall refinery throughput down, right?
Elliott: Sure, absolutely. I mean, when we look at another measure called a "crack spread" that kind of combines these two major fuels in a similar way to the margins that we talked about earlier, margins are down across the country anywhere from 20pc to 130pc, basically. They're very deeply down. We're going to see definitely a reduction in crude appetite, but, again, they're going to have to manage that against the diesel production that one, it's profitable, and two, they know that the country needs, and two, you've got health and safety concerns as well when you're running a refinery.
When we start up and shut down units inside a refinery, it can be some of the most dangerous times in a refinery. So, they're gonna be very mindful of, you know, not just the economics of it, but health and safety of employees, about how they're balancing these units and how they're reducing runs.
John: Now, this should be, really, the perfect opportunity for a refiner to carry out seasonal maintenance on their plant. Right? Given that, you know, certain units might be taken down, but my sense is that this year, perhaps, that will not be the case.
Elliott: You know, it's very interesting and it's another way that this event is so much different from other events that we would have mostly considered similar. Yes, you're right. In the past, the economic situation like this, a refinery might take the opportunity to move up some heavy maintenance that they need to do if they were going to shut down anyway and prepare themselves to come back stronger, but those kinds of maintenance events usually involved hundreds, if not thousands sometimes, of contractors and new people to come onto the site to perform that work. And the coronavirus mitigation that we're in today, that's simply not safe.
Phillips 66, earlier this week, already said that they were gonna be pushing back some similar...some maintenance like that into next year partly because of being mindful about how they manage coronavirus risk on their sites. So, you're right. Like, so the normal playbook has changed, you know, in just another way for these refiners on how they're going to respond and how they're going to react to these economic and demand signals.
John: And, finally Elliott, we've talked a little bit about gasoline as being the loss leader. Is there anything that authorities are able to do at this point to ease the logistical constraints, the refiners, and other supply chain participants running into as part of this overhang of gasoline supplies?
Elliott: Sure. One of the things that we're dealing with right now is a change in the makeup of gasoline as we head into the warmer summer months. Winter gasoline has a kind of wider array of things that blend into it to help ensure your car starts in the cold weather and it can also be a bit cheaper. We're moving now, though, into summer-grade gasoline, which is a bit costlier, and it resists evaporation that can interfere with older cars and it contributes to air pollution.
So, this demand slowdown is hitting as pipelines and terminals in many states transition toward that summer-grade gasoline. Lots of markets have moved towards this in March and April, and then nationwide we distribute summer gasoline at the terminal level in May and at retail stores by the beginning of June.
So, these regulations right now are at the state-level. Refiners are making summer gasoline, but the slowdown means that that winter-grade of gasoline is just not leaving storage tanks and pipelines as quickly as the industry expected. So, trade groups and chippers are working with state governments right now to allow this winter gasoline to continue to be distributed in April just to make sure that that winter fuel moves out of tanks even if it's at a slower pace. And then EPA may need to step in in May and June to offer federal relief, depending on the fuel demand that we see at that point.
John: Elliott, thank you, and thanks all of you for listening. We hope to be back again with you soon with another update on the petroleum product markets. In the meantime, you can find more news and content on our website, and you can visit argusmedia.com/coronavirus to see more about the pandemic's impact on markets. You can also find more podcast episodes at argusmedia.com/podcasts or on streaming devices such as Apple Podcasts, Google Play Music, Stitcher, and Spotify. Thanks again.