IMPACTS OF THE IMO SULPHUR REGULATIONS ON THE CANADIAN CRUDE OIL MARKET

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1 IMPACTS OF THE IMO SULPHUR REGULATIONS ON THE CANADIAN CRUDE OIL MARKET CERI Breakfast Overview Allan Fogwill, CEO Canadian Energy Research Institute November 2018

2 Overview Canadian Energy Research Institute Founded in 1975, the Canadian Energy Research Institute (CERI) is an independent, registered charitable organization specializing in the analysis of energy economics and related environmental policy issues in the energy production, transportation, and consumption sectors. Our mission is to provide relevant, independent, and objective economic research of energy and environmental issues to benefit business, government, academia and the public. CERI publications include: Market specific studies Geopolitical analyses Energy Market reports (crude oil, electricity and natural gas) In addition, CERI hosts an annual Petrochemical Conference and supports Argus Energy Week.

3 Core Funders: Donors: In-kind: Ivey Foundation

4 Presentation Outline IMO and the Marine Crude Market North American Refinery Market Methodology Marine and Refinery Market Scenarios Impacts on Canada

5 IMO and the Sulphur Regulation International Maritime Organization established in 1948 original mandate was safety Pollution became part of its mandate after a marine oil spill in 1967 focus on oil tanker safety International Convention for the Prevention of Pollution from Ships (MARPOL) 1973 disposal of liquid, solid and gas wastes Sulphur cap has been getting progressively stricter 4.5% prior to 2012, after 2012 the cap moved to 3.5% for international waters Emission Control Areas North America and Europe sulphur cap was 1.5% prior to 2010, after 2010 it was 1.0% and as of 2015 it is 0.1% New regulation moves the international waters cap to 0.5% effective 2020 Previous changes in sulphur standards have been addressed by new fuel formulations and installation of sulphur scrubbers on ships Source: Bloomberg

6 Marine Crude Market: Crude Production Crude oil production (million bbl/d) World - ref World - High oil price United States World - Low oil price Canada Oil demand increasing annually by 0.7% past Currently sour and medium sour crudes make up 65% of supply Marine bunker fuel accounts for 4% of demand

7 Global Residual Fuel Oil Residual fuel oil market approx. 7.2 mil bbls/day High sulphur resid is approx. 46% of that demand

8 Residual Fuel Oil Consumption

9

10 Middle Distillates Market Diesel and gasoil can replace high sulphur resid Insufficient refining capacity to meet the expected demand for these middle distillates as a substitute for resid. More expensive fuels compared to high sulphur resid

11 CERI s Refinery Model Inputs and outputs of the US refineries by PADD. The various types of refinery configurations currently operating in the United States. Nominal and available refining capacities at individual PADDs. Differences in crude blend flows and product slates at each PADD. Sulphur handling capacities at refineries within each PADD.

12 Refinery Optimization

13 US Refinery Capacity US Region Capacity (bbl/day) Hydroskimming Medium Conversion Deep Conversion - Coker Deep Conversion - Resid HC FCC GO-HC Both FCC GO-HC Both FCC PADD1 1,213, % 66.8% % % - PADD2 4,004, % 17.0% - 1.8% 46.9% % - PADD3 9,621, % 7.9% 1.3% 2.7% 45.0% 0.4% 35.0% 2.6% PADD4 683, % 17.6% % PADD5 2,934, % 9.6% 5.6% 8.6% 37.4% 12.1% 18.9% - US 18,457, % 14.6% 1.6% 3.1% 42.4% 2.1% 27.3% 1.3%

14 Refinery Product Sulphur Specification Refinery Products Notation Sulphur Specs. (Wt.%) Finished motor gasoline FMG Kerosene-type jet fuel KTJF 0.3 Distillate fuel oil DFO Heating fuel oil HFO 0.05 Residual fuel oil (Bunker) RFO Coke Coke 1-6

15 Model Optimization Objectives 1. Find the makeup of a crude blend that minimizes the sulphur content in the Liquid Heavy Ends (Bunker) and Fuel Oil (Heating oil) but maximizes refinery margins 2. Find the makeup of a crude blend that minimizes the produced volumes of Liquid Heavy Ends (Bunker) and Fuel Oil (Heating oil) but maximizes refinery margins 3. For types of refineries that offer superior economics 4. Estimate the economic impacts of increasing capacity factors of the refineries to maximize ULSD yields

16 Refinery Market 60% 50% Product makeup 40% 30% 20% 10% 0% Hydroskimming Medium Conversion Deep Conversion LPG Gasoline Distillate Heavy Fuel oil and other Complexity of refinery determines the product yield. More complex refineries yield higher value products Simpler refineries will now have a smaller market for high sulphur resid. High sulphur resid market = power generation = coal equivalency

17 PADD 2 is Important

18 How CERI Analyzed the Impact Refinery model by PADD to assess refinery margins and crude feedstocks Most high sulfur oil processed in PADDs 2 and 3. PADD 2 has the largest simple refinery capacity and therefore the greatest challenge in selling the resid.

19 Refinery Margins Dictate their Response

20

21 Compliance Scenarios Low non-compliance (Low NC) assumes 80% compliance (20% non-compliance) by 2020 given up to 80% of global trade occurs between regions where ECA is in force and other regions of the world. Moderate non-compliance (Moderate NC) assumes 75% compliance (25% non-compliance) by High non-compliance (High NC) assumes 70% compliance (30% non-compliance) by 2020.

22 Market Responses Refineries invest to further refine and desulphurize heavy sour crude Marine industry looks to replace high sulphur residual fuel oil with: Middle distillates Low sulphur resid Scrubbers LNG Shipper non-compliance enforcement by host countries Current compliance rates above 85% Upgrading by producers?

23 Move to Low Sulphur Distillates Price differential LSD versus resid - $225/MT

24 Residual Fuel Oil Prices ($/bbl) Low NC Moderate NC High NC

25 Diesel and Residual Oil Price Projections

26 Crude Price Projections Crude prices ($/bbl) HSO HSW LSO MED LSW

27 Refinery Margin Differentials due to Sulphur Regulation Medium Refinery

28 Refinery Margin Differentials due to Sulphur Regulation Complex (coker) Refinery

29 Potential Refinery Margin Losses: How will they Compensate? Medium Refineries Low NC Moderate NC High NC Complex Refineries Low NC Moderate NC High NC

30 Historical Price Differentials

31 WCS/WTI Future Price Differentials

32 New Profitability of SAGD Production Expansion

33 Conclusions Complex refineries will see an economic benefit from this regulation Long term price differential will grow with the introduction of the IMO sulphur regulation. Approximately 500,000 bbls of oil sands production at risk of becoming unprofitable (SOR >3) Increased differential improves the business case for domestic upgrading in particular, asphaltenes Look for options to move heavy sour crude away from PADD 2

34 UPCOMING STUDIES: Thank You for Your Time CANADIAN ENERGY RESEARCH ECONOMIC AND ENVIRONMENTAL IMPACTS OF URBAN ENERGY AND TRANSPORTATION SYSTEMS ECONOMIC AND ENVIRONMENTAL IMPACTS OF METHANE EMISSIONS REDUCTION IN THE NATURAL GAS SUPPLY CHAIN AN ASSESSMENT OF A CLEAN FUEL STANDARD

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