Lighter, sweeter, cruder, stronger

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Oil refiners might want to prepare for lighter and sweeter times ahead.

The US started importing a larger share of light crude oil — and smaller shares of heavy- and medium-grade oil — in 2021. Now JPMorgan is out with a note arguing that change is here to stay:

The light-oil dominance was initially caused by OPEC production cuts and sanctions on Russia, Venezuela and Iran, according to JPMorgan. As the IEA wrote in 2018, before all that stuff happened, “OPEC producers and Russia account[ed] for three quarters of the world’s medium-grade barrels.”

Heavier grades of crude oil are considered dirtier fuels, meaning they generally produce more pollution, both during extraction and when/if they’re refined into fuel.

That means it’s difficult to find much to dislike about this trend, unless you’re bullish on the Canadian oil sands. JPMorgan takes a stab at it anyway. The bank argues that the shift towards lighter oils could hurt refiners’ efficiency. From their note, with our emphasis:

2. Crude [supply] stream is getting lighter, reducing refinery yields by more than 2% — temporary to structural.

Production cuts from the OPEC+ alliance, coupled with sanctions on Iran, Venezuela and Russia have shifted global crude supply stream lighter. We estimate that OPEC+ voluntary supply cuts this year have resulted in over 2 million barrels per day of medium to heavy grade crude oil being taken out of the global market, led mainly by Saudi Arabia and Russia. These output cuts have inherently reduced the amount of medium and heavy crude in the market, as the share of light crude grades has grown. While refiners are capable of accepting a variety of crude feedstocks, they are calibrated for an optimal input in order to achieve a maximum output. Minor deviations from these optimal inputs are able to be mitigated week by week through blending and additives, however significant shortfalls or surpluses in specific grades can structurally impact refinery yields as refiners are forced to run on suboptimal feedstocks.

The strategists argue that East Coast refineries, which rely more on oil imports than other US refineries, have already seen their yields decline as a result of the “suboptimal feedstocks” of lighter oil:

A note on the rather confusing “PADD 1” heading in the chart above: Refineries in the US are grouped into five “Petroleum Administration for Defense District” regions, originally created as part of a WWII-era rationing system. The entire East Coast is included in PADD 1. (The US’s EIA has an interesting little summary of the history here.)

What’s most interesting here is JPMorgan’s argument that the dominance of light crude oil will be a persistent, or even permanent, change. The strategists say that “the dominance of biofuels and natural gas liquids in the future oil supply can structurally restrict medium and heavier grades of crude from the market.”

If refineries don’t change their technology to adapt to the higher share of light crude oil, their yields could decline by 1 to 2 per cent, JPMorgan says.

In other words, it may not just be higher crude-oil prices that’s pushing up costs at the gas pump this summer. The price gaps between crude oil and refined petroleum products — crack spreads — have also widened since late spring, as JPMorgan shows:

Of course, heavier oils are used for purposes other than fuel. They’re used for asphalt, plastics, industrial products, etc. So it is tougher draw a direct line between heavy-oil imports and gasoline prices.

Temporary supply-chain issues are pushing up crack spreads and gasoline prices too.

The US’s commercial gasoline inventories are at their lowest level for any month of July since 2015, says JPMorgan. (The bank is comparing to previous years’ July inventories, because the summer season almost invariably brings greater demand.)

And refineries have also been “plagued by unplanned outages and maintenance” needs this year, the bank writes.

So don’t get too wistful about the Canadian oil sands — a handful of refinery shutdowns probably have more to do with the increase in gas prices this summer.