17 December 2016, New York — U.S. refiners such as Valero Energy Corp and Marathon Petroleum Corp are bracing for stricter, smog-busting gasoline regulations set to hit in January, threatening more headwinds for an industry that has just endured its least profitable year since the shale boom started five years ago.
Many refiners are grappling with record costs to meet U.S. biofuel standards and the prospects of rising crude prices in the wake of the decision by OPEC and other oil producers to cut production.
“The new rules are certainly going to increase costs and impact margins. But how much, we’ll have to wait and see,” said Ed Hirs, an energy economist at the University of Houston.
The Obama administration’s so-called Tier 3 standards require all but the smallest refiners to produce gasoline with an average sulphur level of 10 parts per million (ppm), down from the current standard of 30 ppm. Reducing sulphur cuts tailpipe emissions but also strips out octane, which must be replaced at a cost.
President-elect Donald Trump has promised to cut regulations but did not address this issue during his campaign. Any substantive changes would potentially punish refiners who have already invested millions, to comply with the new rules.
The U.S. Environmental Protection Agency awards credits to refiners who produce gasoline with sulphur levels below regulated levels, and they may transfer credits from the existing Tier 2 program into the new one. Refiners can dip into their own pile of credits or buy them from their competitors to offset their production of higher-sulfur gasoline.
The low-sulfur credits cost $25 a few years ago but are now trading at roughly $350 each, a trader said. The number of credits a refiner must buy depends on how much sulphur is in the gasoline. The higher the sulphur level, the more credits necessary.
Many refiners, such as PBF Energy and Phillips 66 signalled plans to rely on the credits to phase in implementation of the program.
The U.S. government said up to 40 of the 108 refineries affected by the new standards will need to purchase additional credits to comply, according to a 2014 peer-reviewed analysis by the EPA.
Dennis Nuss, a spokesman for Phillips 66, said the company has a multi-year compliance plan, but added the company may consider the use of sulphur credits as part of its strategy.
Mark Broadbent, a refinery analyst with Wood Mackenzie, said he believes biofuel costs and rising crude prices are more threatening than the cost of credits. A similar system that requires refiners to blend biofuels like ethanol into the fuel pool or purchase credits has been blamed for industry layoffs and project delays this year.
“If Tier 3 credits turn, that would accelerate the investment process, and that might be a short-term hit to margins. Ultimately, the refiners will need to invest,” Broadbent said.
Barclays analysts said the new Tier-3 standards will actually boost margins in the first half of 2017, as refiners pass along the cost to consumers.
Refiners who plan on cutting sulphur must also contend with a loss of octane. Components like reformate that boost octane will increase in value under the new regulations, experts said.
“The new rules make it more expensive to produce high-octane gasoline at a time we are seeing more cars require premium gasoline,” said Mark Routt, chief economist for the Americas at KBC Advanced Technology in Houston.
One contractor who works with refiners to replace the catalysts within units that reduce sulphur said companies are working hard to determine the effect on octane.
“They are running computer models to see how much octane they are losing and how much it costs to replace it,” said the contractor, who requested anonymity because he was not authorised to speak about client relationships.
*Jarrett Renshaw; Editing: David Gregorio – Reuters