Growing U.S. Light Crude Exports and IMO 2020 Driven Discounts: Who Benefits?

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2 Legal Notice Baker & O Brien, Inc. (Baker & O Brien) prepared this report for the 2018 Opportunity Crudes Conference. The opinions and findings in this report are based upon Baker & O Brien s experience, expertise, skill, research, analysis, and related work to date. This report relies upon public and proprietary data available to Baker & O Brien at the time this report was prepared. All forecasts and projections contained in this presentation represent Baker & O Brien s best judgment, utilizing its skill, and expertise. However, such forecasts and projections are inherently uncertain due to the potential impact of factors or future events that are unforeseeable at this time or beyond Baker & O Brien s control. Baker & O Brien expressly disclaims all liability for the use, disclosure, reproduction, or distribution of this information by or to any third party. PRISM is Baker & O Brien s refinery modeling and database system that includes operational and economic performance details for refineries in the U.S., Canada, Europe, and Asia. PRISM is a trademark of Baker & O'Brien, Inc. All rights reserved. 1

Introduction Capital Project Services Baker & O Brien: Independent Energy Consultants

with business acumen Consulting Staff Consultants average over 25 years industry

Technical and commercial expertise Active over full life cycle of assets: new project

3 Introduction Capital Project Services Baker & O Brien: Independent Energy Consultants Operations Support Commercial Analyses Chemical, mechanical, and electrical engineers with business acumen Consulting Staff Consultants average over 25 years industry experience Experienced problem solvers Overview Independently owned and managed Technical and commercial expertise Active over full life cycle of assets: new project development -> business support -> commercial disputes Mergers and Acquisitions Dispute Resolution 2

4 Marine Bunker Fuel Pollution Regulation MARPOL International Maritime Organization IMO 2020 IMO 2020 Summary Key Questions Can refineries make 0.5% sulphur fuel oil? What will happen to 3.5% sulphur fuel oil (HSFO)? How will commodity prices respond? 3

5 U.S. Crude Supply Trends and Outlook Source: U.S. Energy Information Administration, Short-Term Energy Outlook, August

6 Jan-07 Jun-07 Nov-07 Apr-08 Sep-08 Feb-09 Jul-09 Dec-09 May-10 Oct-10 Mar-11 Aug-11 Jan-12 Jun-12 Nov-12 Apr-13 Sep-13 Feb-14 Jul-14 Dec-14 May-15 Oct-15 Mar-16 Aug-16 Jan-17 Jun-17 Nov-17 Apr-18 Sep-18 MB/D Permian and Eagle Ford Crude Oil Production Permian and Eagle Ford Crude Oil Production 4,000 3,500 3,000 Permian Eagle Ford Current Permian Pipeline Takeaway Capacity 2,500 2,000 Current Eagle Ford Pipeline Takeaway Capacity 1,500 1, Source: EIA 5

7 Existing USGC Onshore Pipeline Infrastructure Denver St. Louis Cushing Wichita Falls Co. City WTG, 340 El Paso Wink Midland Crane Wortham McCamey St. James Refinery/Refining Center Key City/Town Shale Play Bmt/Pt A. Hou/TX City/Freeport Source: Baker & O Brien Gardendale Corpus Christi 6

8 Planned USGC Onshore Pipeline Infrastructure Denver St. Louis Cushing Sunrise Upper, 500 (2020+) Sunrise - Lower, 500 (Q2-19) Wichita Falls Co. City ETP NGL Conversion, 200 (Q2-20) WTG, 340 El Paso Wink Midland Crane BridgeTex Expansion, Wortham 40 (Q1-19) McCamey ETP/Magellan/Delek, 600 (2020) St. James Refinery/Refining Center Key City/Town Shale Play Cactus 2, (Q4-19) Cactus 3, (Est. Q4-20) EPIC, (Q3-2019) Gray Oak, 700 (Q4-19) XOM/PAA, 1,000 (Est. Q4-2020) Bmt/Pt A. Hou/TX City/Freeport Gardendale Corpus Christi Jupiter, 500 (Est Q4-2020) 7

9 MB/D By 2020, Permian Pipeline Bottlenecks are Removed 9,000 Permian Production Forecasts versus Takeaway Capacity 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 To Cushing To Brownsville To Houston/Nederland To Corpus Christi Existing Pipelines and Local Refineries* Jupiter Cactus III XOM/PAA Seminole NGL Conv ETP-Permian Gray Oak EPIC Cactus II Sunrise BridgeTex Exp 90% PAA (6/18) Jeffries-Base Case (4/18) EIA AEO 2018 (1/18) 0 Source: Baker & O Brien Analysis, PAA Note: Existing pipelines and local refineries shown at 90% due to constraints 8

10 Permian and Eagle Ford Production and Pipelines Summary Shale crude oil production from the Permian Basin and Eagle Ford shale plays has grown substantially since 2010 Crude oil pipeline infrastructure was rapidly expanded to accommodate new production but has not kept pace in the Permian Basin USGC refineries are limited on additional light crude processing capability without substantial discounts in pricing or additional refinery capital investments, leaving incremental production for exports 9

Pipelines from the Permian and Eagle Ford are Currently Directed to the

removal capabilities Strategic market location with access to water for

supplying the East Coast and Central U.S.

11 Pipelines from the Permian and Eagle Ford are Currently Directed to the USGC, Providing Access to Refineries and Waterborne Export Markets USGC is home to 8.4 MMB/D of refinery capacity with significant deep conversion and sulfur removal capabilities Strategic market location with access to water for imports/exports, regional trade through large interstate pipelines supplying the East Coast and Central U.S., integrated petrochemical facilities, and business friendly environment Sources: Capacity data is from Baker & O Brien PRISM. Inset refinery map is sourced from the EIA. 10

Hypothetical Two-Train Complex Refinery Train 1 Low- Sulfur Crude Oil Atm Crude Unit To FCC SR Naphtha SR Naphtha SR Distillate LVGO Vac Crude Unit HVGO LSR Naphtha Naphtha HDS Hydrogen HDS 1

12 Hypothetical Two-Train Complex Refinery Train 1 Low- Sulfur Crude Oil Atm Crude Unit To FCC SR Naphtha SR Naphtha SR Distillate LVGO Vac Crude Unit HVGO LSR Naphtha Naphtha HDS Hydrogen HDS 1 Hydrogen HDS 2 LCO from FCC Isomerization Blending Reformer Hydrogen Naphtha Isomerate Hydrogen Reformate Butane Distillate Blending Gasoline Blending Train 2 High- Sulfur Crude Oil Atm Crude Unit LVGO Vac Crude Unit Vac Resid SR Distillate HVGO Vac Resid Heavy Fuel Oil (HFO) Blending Coker Naphtha Asphalt Coker Coker Gasoil VGO Hydrotreater Hydrocracker Coker Hvy Gasoil Petcoke Atm Resid LCO to HDS2 or Hydrocracker Hydrocracker Diesel FCC C3= C5+ Naphtha Hydrogen for Hydrocracker, HDS units C4=, IC4 Cat Poly ETBE Alkylation H2 SMR Plant Nat Gas 11

13 MB/D Additional Light Crude Processing is Constrained at Gulf Coast Refineries Quality of crude oil produced in the Eagle Ford and Permian Basin is typically light (40+ API) and sweet (<0.5%S) USGC refineries are limited on additional light crude processing capability without substantial discounts in pricing or additional refinery capital investments 4,000 Only major Gulf Coast project announced is the expansion of ExxonMobil s Beaumont refinery by 350 MB/D Texas Gulf Coast Imports of Foreign Crude Oil by Quality* 3,500 3,000 2,500 2,000 1,500 1, Light Sweet crude oil imports backed out of USGC by 2013 Light Sour and Medium Sweet crude oil imports declined by 250 and 150 MB/D respectively vs 2008 Light Swt Light Sr Medium Swt Medium Sr Heavy Swt Heavy Sr (YTD July) *For Corpus Christi, Beaumont/Port Arthur, and Houston Source: EIA Company Level Imports, Baker & O Brien Analysis 12

14 MB/D U.S. Gulf Coast Crude Oil Exports Have Increased Rapidly 2,000 1,800 1,600 1,400 U.S. Gulf Coast Crude Exports by Port USGC refineries are not configured to process 100% light crude oil Congress lifted the long-standing crude oil export ban in December 2015 and since then exports have increased rapidly The Houston Area (Houston, Texas City, Freeport) surpassed Corpus Christi exports 1,200 1, Hurricane Harvey LOUISIANA BEAUMONT HOUSTON AREA CORPUS CHRISTI BROWNSVILLE Source: ClipperData, Baker & O Brien Analysis 13

15 U.S. Gulf Coast Crude Oil Exports to Europe and Far East The delivered value of U.S. Light Tight Oil has absorbed freight costs to become the incremental crude in global markets Freight (1H 2018) $13.79/tonne 80 dwt $8.25/tonne 135 dwt ~$1 1.80/B Freight (1H 2018) $17.90/tonne 130 dwt $15.52/tonne 150 dwt ~$2 2.40/B 14

16 Heavy Fuel Oil From Commodity Crudes The next two slides will tell us: The distillation process that creates heavy fuel oil Yields of distillate, gas oils, and resid for three commodity crudes The typical sulfur in: Whole crude Resid Distillate plus Resid and answer these questions: Does a representative heavy fuel oil blend from light sweet crude meet 0.5% sulfur? Can a European refinery simply drop virgin distillate into Heavy Fuel Oil (HFO) to meet the 0.5% bunker fuel specification? 15

17 Vacuum Tower Atmospheric Tower Basic FCC Cracking Refinery Simplified Model BASE CASE - BRENT CRUDE Yield (vol.%) Yield (vol.%) Diesel Sulfur (wt.%) BEFORE HDT Fuel Oil Sulfur (wt.%) 11 Crude Gas Plant -Treating Sulfur Recovery Reforming Alkylation and Isomerization Naphtha Hydrotreating Light Ends Naphtha 450 F 650 F H 2 H 2 S Sulfur Fuel Gas LPG Gasoline H 2 S HDT H 2 Jet/Kero Diesel/AGO 50.0% 40.0% 30.0% 20.0% 10.0% Middle Distillates Yield and Quality 0.0% Diesel/AGO Jet/Kero Diesel Sulfur (RHS ) Brent 37.5 API 0.40 % S Fuel Oil Yield and Quality* 650 F+ VR MCB LCO FO Sulfur (RHS ) Source: PRISM TM 950 F 1050 F 1050 F+ LVGO HVGO 1 FCC LCO MCB/Slurry Vacuum Resid 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Brent 37.5 API 0.40 % S *These blends are representative of many possible combinations

18 Vacuum Tower Atmospheric Tower Basic FCC Cracking Refinery Simplified Model COMPARE CRUDES Yield (vol.%) Yield (vol.%) Diesel Sulfur (wt.%) BEFORE HDT Fuel Oil Sulfur (wt.%) 11 Crude Gas Plant -Treating Sulfur Recovery Reforming Alkylation and Isomerization Naphtha Hydrotreating Light Ends Naphtha 450 F 650 F H 2 H 2 S Sulfur Fuel Gas LPG Gasoline H 2 S HDT H 2 Jet/Kero Diesel/AGO Middle Distillates Yield and Quality 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% Diesel/AGO Jet/Kero Diesel Sulfur (RHS ) Bonny Light 35.1 API 0.15 % S Brent 37.5 API 0.40 % S Arab Light 32.5 API 1.93 % S Fuel Oil Yield and Quality* 650 F+ VR MCB LCO FO Sulfur (RHS ) Source: PRISM TM 950 F 1050 F 1050 F+ LVGO HVGO 1 FCC LCO MCB/Slurry Vacuum Resid 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Bonny Light 35.1 API 0.15 % S Brent 37.5 API 0.40 % S Arab Light 32.5 API 1.93 % S *These blends are representative of many possible combinations

19 Heavy Fuel Oil From Commodity Crudes Roughly, how much Brent-blend based middle distillate do we need to blend into heavy fuel oil to meet 0.5% sulfur? From previous slide Brent-blend based fuel oil is about 1.0% sulfur Brent middle distillates are about 0.25% sulfur At a 66% blend ratio, heavy fuel oil blending will consume all of the virgin middle distillates If ULSD is used (~0% sulfur), then the ratio is 50% Conclusion: Using middle distillates to dilute sulfur in fuel oil will be costly, especially if ULSD supply decreases Can a European refinery blend crudes to meet the 0.5% bunker fuel specification? See next slide 18

20 Vacuum Tower Atmospheric Tower Basic FCC Cracking Refinery Simplified Model CRUDE BLEND WITH VGO DOWNGRADE Yield (vol.%) Fuel Oil Sulfur (wt.%) 11 Gas Plant -Treating Sulfur Recovery Reforming Alkylation and Isomerization Naphtha Hydrotreating Light Ends Naphtha H 2 H 2 S Sulfur Fuel Gas LPG Gasoline Fuel Oil Yield and Quality* VR MCB LCO LVGO FO Sulfur (RHS ) 25.0% Crude 450 F 650 F H 2 S HDT Jet/Kero Diesel/AGO 20.0% H % F+ 10.0% 0.40 LVGO (0.3%) S % 0.20 Source: PRISM TM 950 F 1050 F 1050 F+ LVGO HVGO FCC LCO MCB/Slurry Vacuum Resid 0.0% BL : Brent 50 : 50 BL : Brent 75 : 25 BL : Brent 75 : 25 FCC BYPASS *These blends are representative of many possible combinations

21 Refining Value of Light Sweet Crude Exports Brent Crude is the Atlantic Basin benchmark crude Brent and WTI prices are commonly compared Many European refineries run North Sea/African crudes similar to Brent (sweet) and Urals (sour) European refineries compete with U.S. refineries product exports European refineries are now running WTI and Eagle Ford WTI and Eagle Ford compete with Brent Breakeven values versus Brent set the refining value Breakeven value in Europe minus freight may influence the USGC value 20

22 European Refineries Non-Coking Refineries Coking Refineries Norway Sweden Finland Source: Google Maps, PRISM 21

23 Northwest Europe Representative Refinery Train 1 Low- Sulfur Crude Oil Atm Crude Unit To FCC SR Naphtha SR Naphtha SR Distillate LVGO Vac Crude Unit HVGO LSR Naphtha Naphtha HDS Hydrogen HDS 1 Hydrogen HDS 2 LCO from FCC Isomerization Blending Reformer Hydrogen Naphtha Isomerate Hydrogen Reformate Butane Distillate Blending Gasoline Blending Train 2 High- Sulfur Crude Oil Atm Crude Unit LVGO Vac Crude Unit Visbreaker Vac Resid SR Distillate HVGO Vac Resid Heavy Fuel Oil (HFO) Blending Coker Naphtha Asphalt Coker Coker Gasoil VGO Hydrotreater Hydrocracker Coker Hvy Gasoil Petcoke Atm Resid LCO to HDS2 or Hydrocracker Hydrocracker Diesel FCC C3= C5+ Naphtha Hydrogen for Hydrocracker, HDS units C4=, IC4 Cat Poly ETBE Alkylation H2 SMR Plant Nat Gas 22

24 European Crude Oil Price Analysis What is the refining value of WTI and Eagle Ford versus Brent in Northwest Europe? Using 2017 prices ( Current relationships) Using discounted HFO prices ($15 is similar to 2020 futures) And using increased ULSD prices ($4 is similar to 2020 futures) Source: Baker & O Brien analysis and PRISM TM, Freight is assumed constant, WTI at 42 API, Eagle Ford at 47 API 23

25 European Crude Oil Price Analysis What is the refining value of WTI and Eagle Ford versus Urals in Northwest Europe? Using 2017 prices ( Current relationships) Using discounted HFO prices ($15 is similar to 2020 futures) And using increased ULSD prices ($4 is similar to 2020 futures) Source: Baker & O Brien analysis and PRISM, Freight is assumed constant; Urals at 32 API 24

26 Summary of European Crude Oil Price Analysis Using current price relationships, WTI has about $1/B more value than Brent and about $2/B more value than Urals Likewise Eagle Ford has $1.70/B and $2/B more value than Brent and Urals respectively Using discounted HFO prices and increased ULSD prices: Versus Brent: WTI stays flat and Eagle Ford increases slightly Versus Urals: WTI and Eagle Ford values increase dramatically Source: Baker & O Brien analysis and PRISM, Freight is assumed constant 25

27 Conclusions Post 2020: Distillate and crude sulfur value scales will be steep 3.5% Fuel Oil price will be heavily discounted Complex refineries with residual fuel upgrading (coking) will benefit from high sulfur crude discounts Many European refineries do not have the hardware to upgrade high sulfur residual fuel oil Project schedules to meet 2020 timelines are past U.S. Light Tight Oil will be valued highly in non-complex European refineries to lower volume and sulfur content of residual fuel Assuming unconstrained export logistics by 2020, wellhead prices of U.S. Light Tight Oil will likely be influenced by demand at foreign refineries 26

28 Possible Europe and U.S. Refineries Sulfur Optimization IMO 2020 DRIVING FORCES 0.5% fuel oil production will be challenging for low complexity refineries in Europe Sweet crude will likely displace sour crude in lower complexity refineries in Europe Backhaul freight will lower cost for sour crude and resid to complex refineries in the U.S. 27

29 Key Questions and Studies-in-Progress Why haven t more coker projects been announced? How much sour crude can U.S. refiners absorb? Reversal of today s challenge: absorbing light, sweet crude Can U.S. crude oil export infrastructure support volumes? How much HSFO can be consumed globally for power generation? Will refinery runs increase to meet displaced HSFO? 28

30 Canadian Crude Oil Price Analysis For a similar analysis of IMO 2020 impacts on heavy Canadian crude, see Baker & O Brien s presentation at the Crude Oil Quality Association Conference Looming IMO 2020 and Resulting Impact on Crude October 25, 2018 Curtis Ruder 29

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Compliance with IMO Regulations - New Strategies for Refiners in the U.S. and Internationally

14 th Annual Bunker and Residual Fuel Conference Compliance with IMO Regulations - New Strategies for Refiners in the U.S. and Internationally Aaron Imrie June 20, 2017 Houston, Texas Baker & O Brien,