1. Oil & Gas sector: Christmas cheers – Uncle Sam to Indian refiners

Oil & Gas sector: Christmas cheers – Uncle Sam to Indian refiners

With the closing of WTI-Brent arbitrage, US upstream players including shale will benefit and a resultant shift in global refining competitiveness will favour Asia

By: | Published: December 28, 2015 12:08 AM

The US, last week, lifted its four decade crude export ban after it was pushed through the House and Senate and signed by the President. As highlighted in our thematic report Shale we refine East!, dated July 17, 2015, an imminent fall in US shale production and a regime shift in US crude export policy will narrow the WTI
(West Texas Intermediate’s) discount over Brent, structurally shifting the competitive advantage for refining from US (one-fifth of global production) to Asia. WTI has indeed flipped into premium over Brent and refining margins in the US have converged to Singapore benchmarks. We believe export-oriented Reliance Industries (RIL) and upcoming complex refining capacities by IOCL, BPCL and HPCL are extremely competitive globally and will benefit most from this paradigm shift in refining.

Rationale for lifting export embargo

The ban was first imposed in 1975 as the US was reeling from the 1973-74 Arab oil embargo. Despite it being a net oil importer at ~7mnbbls/d, there was a strong case for lifting of crude export ban, primarily because the increasing barrels of US production over the past five years was led by light-sweet shale oil, which was not suitable to be processed by complex US refiners which are better equipped to handle heavy-sour crude. This mismatch necessitated movement of crude oil over longer distances to deliver it to refineries for which it is suited. With the lifting of the ban, 9.2mnbbls/d of US crude and ~490mn bbls of stockpiles are available for export.

Closing WTI-Brent arbitrage…

Abundance of light-sweet shale oil resulted in US benchmark WTI trading at deep discounts versus Brent, resulting in a comparative advantage for WTI-based US refiners. In our report, we had forecasted a trend reversal in WTI-Brent spread as we had anticipated a fall in US shale production and relaxation of crude export restrictions. WTI discount over Brent has indeed narrowed fairly quickly (from $6.5/bbl in August) to a slight premium over Brent, recently.

Will benefit complex Asian refiners and US upstream players

The closing of WTI-Brent arbitrage will benefit US upstream players including shale and a resultant shift in global refining competitiveness will favour Asia. Since our report, US refining margin has squeezed from ~$25/bbl to $10/bbl, while Reuters Singapore refining margin has increased from $8/bbl to $10/bbl (refer chart).

Indian refiners have competitive edge

We expect RIL to be one of the biggest beneficiaries of this shift in global refining margins given its scale and complexity. The upcoming complex Indian refining capacities (by IOCL, BPCL and HPCL) are amongst the most competitive globally (26% lower fixed cost). Moreover, we expect domestic surplus to ease as robust demand will outstrip announced capacities, which bodes well for downstream oil companies.

Rationale for lifting export embargo

The ban was first imposed in 1975 as the US was reeling from the 1973-74 Arab oil embargo, which dealt a heavy shock to the US economy and sent global prices shooting up. However, because of the recent shale boom, US production has surged significantly, displacing Middle Eastern imports into the US. However, it is a net oil importer with ~7mnbbls/d of crude imports even today.  Also, lack of adequate pipeline infrastructure prevents the transportation of domestic production to refining hubs capable of harnessing light crude. This has led to huge inventory pile ups like hubs like Cushing which have aggravated the sharp correction in WTI prices. With lifting of the ban, 9.2mnbbls/d of US crude and ~490mn bbls of stockpiles will be available for export. This has made a strong case for US exports as access to international markets will enable producers to get higher prices.

Closing WTI-Brent arbitrage…

Since the shale boom compounded by infrastructure constraints and the crude export ban, WTI which is a benchmark for US crude has traded at a significant discount to Brent which is the global benchmark. However, since OPEC refused to prop up global prices and play the role of swing producer, Brent prices have corrected sharply, narrowing the differential between the 2 benchmarks.

In our thematic report, we had forecasted a trend reversal in WTI-Brent spread as we had anticipated a fall in US shale production and relaxation of US crude export restrictions.

Will benefit complex Asian refiners and US upstream players

Closing of WTI-Brent arbitrage will benefit US upstream players including shale, while US refiners who so far enjoyed huge competitive advantages due to low feedstock costs will hurt. This will result in a gradual shift in refining competitiveness in favour of Asia benefitting complex refiners like RIL. Since our report, US refining margins have squeezed from $25/bbl to $10/bbl, while Reuters Singapore refining margins have increased from $8/bbl to $10/bbl.

Indian refiners have competitive edge

We expect RIL to be one of the biggest beneficiaries of this shift in global refining margins given its scale, complexity and dynamic product slate. The upcoming refining capacities in India are amongst the most complex globally and are much more competitive (26% lower fixed cost). Moreover, we expect domestic surplus to ease as robust demand will outstrip announced capacities, which augurs well for domestic refining & marketing companies amidst subdued global outlook.

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