Operating Refineries in a High Cost Environment. Options for RFS Compliance. March 20, Baker & O Brien, Inc. All rights reserved.

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1 Operating Refineries in a High Cost Environment Options for RFS Compliance March 2, 217 Baker & O Brien, Inc. All rights reserved.

2 Discussion Points Introduction Renewable Fuels Standard (RFS) Overview Operating Cost Impacts Associated with RFS Alternatives for Minimizing RFS Impact Conclusions 2

3 Positive (Green) or Negative (Red) Impact on Refinery Operating Costs Major Events Affecting Refiners Through the last two decades, numerous events/regulations have impacted domestic refinery profitability. The regulatory actions shown below have increased a refinery s operating costs. 1.9 RFS2 Compliance Low Domestic Crude Oil and Natural Gas Prices Tier 2 Gasoline Sulfur.3 Reduction.2.1 On-Road Diesel Sulfur Reduction (ULSD) Tier 3 Gasoline Sulfur Reduction

4 Renewable Fuels Standard (RFS) Created by the U.S. Congress in 25 and expanded in 27 (RFS2) Original Intent: Enhance U.S. energy security by replacing some imported petroleum with domestically produced ethanol. Drive investment in renewable fuels such as cellulosic and advanced biofuels Requirements: The RFS program requires renewable fuel to be blended into motor-vehicle fuels and fuels for non-road, locomotive, and marine engines in increasing amounts each year. Refiners must annually purchase a set amount of renewable fuels (renewable volume obligation [RVO]). Refiners are required to submit renewable fuel credits to the Environmental Protection Agency (EPA) to show that they have covered their annual obligations. Renewable Identification Numbers, or RINs, are generated by the production of biofuels one RIN is generated for each gallon of fuel in the RFS program and can be bought and sold by refiners, as well as banked for future use. 4

5 Thousands of Barrels per Day Ethanol Consumption Ethanol consumption from 214 to 215 only increased 2.7% compared with an annual consumption growth rate of 13% between 27 to 214. This reflects the impact of approaching the 1 volume % (vol.%) ethanol blend wall. 1, PADD 1 PADD 2 PADD 3 PADD 4 PADD 5 Ethanol Consumption PADDs 1, 2, 3, 4, and 5 Total - Gasoline Equivalent Basis SOURCE: U.S. DOE/EIA,Baker & O Brien analysis Note: Ethanol heating value of 7% used for gasoline equivalent basis. 5

6 Ethanol Blended into Gasoline, Percent Penetration of the 1 vol.% Ethanol Blend Wall Ethanol consumption has increased to an annual average rate of 13.7 billion gallons per year (BGY), reflective of an average total domestic blend percentage of approximately 1. vol.%. The U.S. remains essentially at the 1 Vol.% blend wall. 12% 1% 8% 6% 4% 2% % Ethanol in Total U.S. Gasoline The 1 vol.% blend wall has been exceeded slightly due to the introduction of E85 and E15 gasoline blends, although their widespread acceptance has been relatively low. SOURCE: EIA 6

7 RFS2 Implications In response to reaching the 1 vol.% ethanol blend wall, it is becoming increasingly more difficult for refiners and blenders to meet the renewable blending targets set forth in the RFS2. Industry/Market implications/responses: Increasing renewable identification number (RIN) prices. Prices spiked in 213 and again in 216 and remain above prior historical trends. Introduction of 15 vol.% ethanol blends (E15). Little nationwide adoption of the new gasoline blend has resulted. EPA responses: Reducing RFS requirements. Encouraging more E85 use with corporate average fuel economy (CAFE) and greenhouse gas (GHG) credits for automakers. Incentivizing high-octane (E3) vehicles through Tier 3 (1) air pollution regulations. Note: (1) In March 213, the EPA issued a proposed regulation to lower the gasoline sulfur specification in gasoline. This proposed regulation is referred to as Tier 3. The new EPA regulation reduces the maximum sulfur specification to 1 parts per million (ppm) on an average annual basis beginning January 1,

8 Billions of Gallons Renewable Fuels Requirements To address the infeasibility of the RFS2, the EPA has responded by reducing the original targets set forth by Congress. For 216, the EPA required over 4 billion gallons less renewables to be blended into gasoline and diesel compared to the original RFS2. While this 18% reduction has helped, it has not prevented a significant rise in RIN costs RFS2 Renewable Fuels Blend Requirements Comparison EPA Adjusted SOURCE: EPA 8

9 May-28 Sep-28 Jan-29 May-29 Sep-29 Jan-21 May-21 Sep-21 Jan-211 May-211 Sep-211 Jan-212 May-212 Sep-212 Jan-213 May-213 Sep-213 Jan-214 May-214 Sep-214 Jan-215 May-215 Sep-215 Jan-216 May-216 Sep-216 $/Gallon Renewable Identification Number (RIN) Values RIN values have increased 16% since September 215 and are approaching values seen during early to mid SOURCE: OPIS, Baker & O Brien analysis 9

10 Cents per Gallon of Gasoline and Diesel RFS Compliance Cost RFS compliance cost has increased from 5.5 cents per gallon on average in 215 to 8.4 cents per gallon year to date through October RFS Compliance Cost per Gallon of Gasoline and Diesel Produced or Imported D3 - Cellulosic D5 - Sugar Ethanol D4- Biodiesel D6 - Corn Ethanol SOURCE: OPIS, Baker & O Brien analysis 1

11 215 RFS Implications by Company Estimated G+D, B/D 1,8, 1,6, 1,4, 1,2, 1,, 8, 6, 4, 2, Top 2 U.S. Gasoline (G) and Diesel (D) Producers (215) Estimated Net Domestic Supply versus Estimated Branded Retail Placement vs RINs Purchases Gasoline + Diesel Production Subject to RVO Estimated Potential Retail Sales Volume Reported/Estimated RINs Purchases RIN Purchases, $MM Company Notes: PSX: Likely a purchaser relative to obligation XOM: Noted as balanced in 213 has since sold 2 refineries Shell: Large retail network relative to refining production CVX: Noted as long in 213 BP: Noted as long in 213 CITGO: Large retail network relative to refining production FHR: No retail but sizeable marketing and terminal presence Total & Husky: Likely purchases entire RIN obligation due to no retail/rack 11

12 $/Bbl. of Unfinished Gasoline $/Bbl. of Unfinished Gasoline 215 RIN Cost Impact on Refiners RIN Cost Impacts for an Integrated Refiner versus Merchant Refiner Fully Integrated / Large Marketing Presence Degree of Market Integration Determines Profitability from RINs Merchant Refiner / No Marketing Presence 7 Integrated Refiner avoids a RIN cost of $2.33/Bbl. leading to a net margin of $15./Bbl. 7 Merchant Refiner is at a $2.33/Bbl. disadvantage (1) due to purchasing RINs leading to a lower net margin. (2) Cost to Produce Gasoline/Diesel Source: Baker & O Brien PRISM Sales Margin Cost of RINs Net Income Unfinished Fuel Sales Price 4 Cost to Produce Gasoline/Diesel Sales Margin Cost of RINs Net Income Unfinished Fuel Sales Price (1) RIN compliance cost in 215 was $2.33/Bbl. (2) 216 RIN costs through September are $3.48/Bbl. which further disadvantages a Merchant Refiner. 12

13 $/Bbl. of Light Oil Product 215 RIN Cost Impact versus Other Production Costs In 215, RIN costs accounted for approximately 28% of the total operating costs (excluding feedstock cost) to produce a barrel of light oil (gasoline and distillate) $64.75/Bbl Other (1) 4 Maintenance Labor Utilities Purchased RINs Other Feedstock Cost Crude Cost 1 (1) Other costs include environmental, insurance, and Ad Valorem taxes. Source: Baker & O Brien PRISM Typical USGC Refinery 13

14 $/Bbl. of Light Oil Product 215 Operating Cost Comparison In 215, excluding crude oil and feedstock costs, the typical USGC refinery was at a disadvantage in terms of operating costs compared to refiners in Northwest Europe (NWE) and Asia Pacific (AP) Other Maintenance Labor (1) Utilities Purchased RINs Other Feedstock Cost Crude Cost (1) Other costs include environmental, insurance, and Ad Valorem taxes. Source: Baker & O Brien PRISM 4 USGC NWE AP 14

15 Liquid Volume Percent Yield Options to Mitigate RFS Cost: Produce Incremental Jet Fuel Refiners have limited flexibility in shifting products which is highly dependent upon the natural crude oil yield of the specific crude oil slate being processed. 1% 9% 8% 7% 6% 5% 4% Light Ends LSR Naphtha Kerosene Diesel Gasoline Jet Fuel ULSD Product Blending Options: 1. Produce more jet fuel by reducing the volume of kerosene blended into diesel up to the diesel specifications. Alternatively, adjust the diesel cut point temperature to reduce the kerosene being dropped into the diesel cut. 3% 2% 1% % ATB LLS Produce more kerosene by adjusting naphtha cut point temperature. Source: Baker & O Brien 15

16 Net Refinery and Blender Production, MB/D Options to Mitigate RFS Cost: Produce Incremental Jet Fuel - Continued 216 refinery production data suggests that some refiners have shifted towards increased jet fuel production and decreased diesel production as RFS compliance currently excludes the production of jet fuel. 12, U.S. Refineries and Blenders Net Production 1, 8, 6, 4, Gasoline Jet Fuel Diesel 2, Source: EIA YTD 16

17 Exports, MB/D Jan-21 May-21 Sep-21 Jan-211 May-211 Sep-211 Jan-212 May-212 Sep-212 Jan-213 May-213 Sep-213 Options to Mitigate RFS Cost: Export Gasoline and Diesel Jan-214 May-214 Sep-214 Jan-215 May-215 Sep-215 Jan-216 May-216 Both gasoline and diesel exports have increased in recent years. While some of this increase can be attributed to the shale oil revolution, some of the increased exports are in response to reducing RVO exposure. 1,6 1,4 1,2 1, Gasoline U.S. Gasoline and Diesel Exports Diesel Source: EIA 17

18 Exports to Mexico, MB/D Jan-21 Apr-21 Jul-21 Oct-21 Jan-211 Apr-211 Jul-211 Oct-211 Jan-212 Apr-212 Jul-212 Oct-212 Jan-213 Apr-213 Jul-213 Oct-213 Options to Mitigate RFS Cost: Exports to Mexico Jan-214 Apr-214 Jul-214 Oct-214 Jan-215 Apr-215 Jul-215 Oct-215 Jan-216 Apr-216 Jul-216 Gasoline and diesel exports to Mexico through September of 216 are up over 2% compared with 215 and were up 17% in 215 from Gasoline Diesel U.S. Gasoline and Diesel Exports to Mexico Source: EIA 18

19 Options to Mitigate RFS Cost: Integrate Downstream Those refiners with blending and distribution assets are able to generate RINs which can offset either partially or totally the RIN cost incurred by their refineries. Merchant refiners lacking these assets may consider acquiring or building out a blending and marketing network. Major strategic decision with long-term implications Need to understand overall profitability and not just focus on reducing RIN costs. Should consider the impact from any future revisions to the RFS. 19

20 Refinery Net Cash Margin, $/Bbl. of Input Options to Mitigate RFS Cost: Revise Point of Obligation (Political Solution) Moving the point of obligation away from the refinery to the blender would have increased the refining margin by $2.4/Bbl. in 216 (through 3 rd Quarter). 2 Refinery Net Cash Margin 216 (YTD through 3 rd Quarter) 15 1 Current RFS Regulation Revised Point of Obligation 5 2, 4, 6, 8, 1, 12, 14, 16, 18, -5 Source: Baker & O Brien PRISM Cumulative Crude Charge, MB/D 2

21 Options for a Refiner to Mitigate RFS Cost: Summary Minimize RVO by shifting naphtha and diesel cut points into jet fuel. Pros: Easy to do Cons: Small volumes with limited impact Export gasoline and diesel Pros: Possible Tier 3 sulfur benefit for gasoline Cons: Requires access to waterborne exports Vertically Integrate Build Renewable Blending Facility Pros: Build to meet needs only Cons: Compete with current customers Vertically Integrate Buy Blender Pros: Could be located anywhere in U.S. Cons: Possibly over pay for blending capabilities 21

22 Conclusions Next to crude oil and feedstock costs, RFS compliance through purchasing RINs represents the next highest cost to a domestic refiner. Excluding feedstock costs, purchased RINs can account for over a third of a refinery s operating costs. While there are some options for a refiner to mitigate their purchased RIN cost through product exports and maximizing jet fuel production, these options have to be evaluated relative to their impact on the overall profitability of the refinery. Recent data suggests that some refiners have increased gasoline and diesel exports and have shifted more of their kerosene into jet fuel rather than diesel. Any major investments or integration into renewables blending and marketing should be carefully evaluated as a major strategic decision. Understand the long-term implications should the RFS someday be revised. 22

23 Baker & O Brien Independent Energy Consultants Dallas 121 N. Central Expressway Suite 12 Dallas, TX Phone: Fax: Houston 1333 West Loop South Suite 135 Houston, TX 7727 Phone: Fax: London 146 Fleet Street Suite 2 London EC4A 2BU Phone: