# Presentation: 521178

## Changing World Product Markets and Potential Refining Capacity Increases

***NPRA Annual Meeting***
***March 2006***
**Joanne Shore**
**John Hackworth**
**Energy Information Administration**

**Notes:**
Events of the past few years have brought much more attention to refining, culminating with last fall’s hurricane damage to refineries and pipeline deliverability that brought gasoline prices to over $3.00 per gallon.

While refining capacity in the United States has been increasing since 1995 on average by 177 thousand barrels per day, which is the same as adding one new refinery per year, our need for imported gasoline has increased in recent years.  

But it looks like the tide is turning, and we may see a larger increase in capacity than we have seen for some  time, not only in the United States, but in most other areas of the world as well.

## Changing World Product Markets and Potential Refining Capacity Increases

**World Supply/Demand Cycles & Shifts in Demand**
**Historical Regional Demand & Supply (Why capacity varies regionally)**
**U.S., Europe, Asia**
**Demand growth, product mix, trade**
**Price Signals for Capacity Changes**
**Capacity Change Outlook: Who, What, Where**
**Over- or Under-Capacity Potential**

**Notes:**
This presentation begins by stepping back to look at the long-term picture of changes in world supply and demand in order to see the cycles and product shifts that have occurred.

But world numbers mask the marked difference in regions that make up those total world figures.  So the next section will review the elements of supply and demand in the U.S., Europe and Asia that help to explain the capacity in place in those areas today, and how that capacity may change in the future.  In particular, we will focus on demand and product mix shifts, with some discussion of capacity and trade that has developed to meet that demand.

Next the presentation will visit the changing price incentives we are seeing for capacity investments.  Even here, price incentives vary in different world regions.

And the last two sections will conclude with a summary of capacity expansion activity, noting how much and what type of capacity additions are being planned in different parts of the world, as well as who seems to be adding the capacity.  We can’t leave without some musings on the question of whether we are heading towards an over- or an under-capacity situation.

## World Capacity & Consumption Changes Result in Utilization Increases

**Notes: World Excluding FSU**
**Source: BP World Statistical Review 2005**

**Notes:**
Annual capacity and demand growth changes have moderated since the 1960’s and 1970’s.  The bars on this graph represent changes in capacity and consumption.  The green and red smooth lines are a polynomial fit to help illustrate the cyclical swings as the industry evolved through price increases and recessions following the Arab Oil Embargo and the Iran-Iraq War, up through 2004.

Note the apparent lag in capacity changes from demand shifts, and how that lag has moved the world from one with much excess capacity to today with higher utilizations.  
That lag in capacity since the 1980’s is due mainly to the fact that the world had too much capacity relative to demand for some time.  
Utilization, represented by the grey line, had fallen to 70% in the early 1980’s as demand fell following the large oil price increases stemming from the Iran/Iraq war and subsequent recession.  As demand recovered, utilization increased.  
Eventually new capacity began to emerge, and utilization has been close to 90% since the late 1990’s.

In 2004, most of us were surprised with the strength in world demand growth, driven mainly be a large increase in Asia – China in particular.  Yet in the long-term, this growth was not unusual.  But it did serve to push capacity utilization up again, and alert the market to the need for changes ahead.

## World Distillates Growing More than Gasoline & Fuel Oil Declining

**Notes: World excluding FSU; middle distillate is jet, kerosene, diesel and heating oil (No. 2) Source: BP World Statistical Review 2005**

**Notes:**
Besides the ups and downs of demand and capacity, we also are seeing shifts in product demand mix that have implications for refining.

The chart shows the cumulative changes in demand starting in 1985. 
Gasoline and distillate are the two major growth categories, but distillate has grown faster than other refined products, which has implications for refinery investment.  Where and why that is occurring will be covered in later slides.   
While the strong growth in distillate has been going on for some time, 2005 gave rise to some price signals that may indicate a shift in capacity incentives to accommodate this growth in the future.

Residual fuel oil demand has been diminishing everywhere, which means continued interest in bottom-of-the-barrel investments, and recent economics certainly favor such investments.  

As an aside, it is interesting to note that in the short run, residual fuel markets can vary with weather and natural gas prices.  Recent natural gas price increases in the U.S. resulted in demand increases this past year.  In the longer term:
If crude oil price stays high, we will see significant declines in residual fuel demand;
And environmental concerns will continue to diminish the high-sulfur residual fuel market.

## Historical Regional Demand and Supply

**Overview of regional demand differences**
**U.S and Europe – Atlantic Basin partners**
**Asia Pacific – Mixture, with total driven by large emerging countries**

**Notes: World Excluding FSU**
**Source: BP World Statistical Review 2005**

**Notes:**
The major petroleum products behind petroleum demand growth are gasoline and distillates, as shown in this chart.

While this is true of all regions, individual regions are exhibiting different total growth and different product mix changes – both of which will affect regional refining capacity changes.

The section will initially focus heavily on the Atlantic Basin partners of U.S. and Europe, followed by the Asian market, which, while driven in total by the large emerging economies of India and China, is far from a homogeneous region.  

## U.S., EU-25, and Asia-Pacific Regions Represent 76% World Petroleum Use

**Note: European Union-25 (EU-25): former European Union-15 plus Estonia, Latvia, Lithuania, Czech Republic, Slovakia, Hungary, Poland, Slovenia (beginning in 1992/93), Cyprus, Malta**
**Source: BP Statistical World Review 2005 **

**Notes:**
This section is going to focus on three major world regions: The United States, Europe, and the Asia-Pacific region.  Together, these areas represent over 3⁄4 of world demand.

The U.S. stands out on this chart in that its gasoline demand exceeds middle distillate demand.   

## Regional Consumption Growth Varied 

**Source: BP World Statistical Review 2005**

**Notes:**
This chart highlights growth in refined products over two time periods and for three regions.  

The United States shows higher volume growth in gasoline than in distillates from 1995 through 2004, but the growth rate of distillate was higher, which has yield consequences for refiners.  Residual fuel oil demand stayed relatively flat in recent years, but the United States has very little residual fuel oil demand relative to other regions.  Looking ahead, the U.S. petroleum growth rate is expected to remain at about the 1995-2004 level through 2010.  

Europe stands out both in its lack of total growth (less than 1% in recent years) and in the growth mix.  Middle distillate growth has been increasing, while gasoline demand has declined as a result of Europe’s emphasis on moving its light-duty vehicle fleet from gasoline to diesel.  As we look ahead, Europe’s growth through 2010 will likely be less than the 1995-2004 growth (perhaps half of the historical rate) as a result of policies to reduce CO2 emissions.

Asia stands out for the size of its increase in demand, even with the brief demand collapse following the Asian financial crisis.  Note also the large gasoline growth along with middle distillate growth as emerging nations, China in particular, increase their use of light-duty gasoline vehicles.  Emerging countries in Asia will continue to keep that region’s petroleum growth high.  

Not surprisingly, more and more capacity announcements emerge from Asia and the Middle East.  Since Asia may be a source of product imports for the Western U.S. in the future, and both Asia and the Middle East affect supply for Europe, which is an important source of U.S. imports, Asia and Middle East capacity growth is of interest as well.  

## U.S. Light Product Demand

**Transportation main driver**
**Not likely to see any major shift from gasoline to diesel in next 10 years**
**Hybrids and diesel likely to increase in next decade, but little impact on demand during next decade**
**Uncertain efficiency changes in all new vehicle sales, but slow impact regardless**

**Notes:**
Turning to the U.S., there are several dimensions of demand growth of interest to refinery capacity planners. 

Transportation will remain the major force behind demand increases in the U.S. over the next decade at least.

With the size of the U.S. light duty vehicle fleet (217 million), and total new car sales representing only 7.5%-8% of the fleet, changes in demand stemming from changes in engines or vehicle types will take time – even in situations with policy-driven high penetration rates.  As a result,
We are not likely to see much shift in the gasoline diesel ratio over the next decade.  From 1985 through 2004, the distillate share of gasoline and distillate consumption increased about 2% (from 37% to 39%), and could continue to increase slowly, but the operative word is “slowly.”  
Hybrid and alternative fuel vehicle impacts will also be small over the next 10 years, even if penetration rates grow fairly quickly.  It simply takes time to change the characteristics of the existing fleet.
There is still much uncertainty on efficiency improvements of future light-duty vehicles.  Even if policy changes are made to improve efficiencies, it will take time for the manufacturers to comply, and those new vehicle sales will take time to affect the entire fleet.

## Imports Supplied About Half Gasoline Demand Growth in Recent Years

**Note: Total gasoline is finished product plus blending components.**
**Source: EIA, Form EIA-814**

**Low-Sulfur Years**

**Notes:**
Product Imports have provided an economic source of supply for the United States historically, mainly for  gasoline, and will continue to play an import supply role for some time.

Much of the growth in gasoline imports to the U.S. during the past few years has come from European sources.

An excess of gasoline supply in Europe, which will be discussed next, and  fuel quality are the major factors influencing growth in volumes from Europe.  Europe’s low-sulfur gasoline program is similar to the U.S. program.  Note that since 2003 before the Tier 2 low sulfur gasoline program began in 2004, European gasoline import volumes increased by over 200 thousand barrels per day (almost 80%).  However, imports may be distorted somewhat in 2005 due to the hurricanes.

At the same time, we saw a drop in volumes of 27 thousand barrels per day from Brazil, as this country and other areas have not moved as rapidly to low-sulfur fuels. 

In 2006, we may see further falloff from areas in Latin America and other regions as we enter the final phase of the Tier 2 program, and as the industry moves away from MTBE.  In general, fewer sources of supply will be able to provide U.S.-quality imports.  However, of those remaining, there still appears to be potential for increased volumes to the United States.   

## Europe’s Light Product Demand

**General policy to reduce energy use and CO2 emissions; **
**Petroleum demand growth has been small (annual 0.7% since 1995);**
**Policies led to increased shift to diesel engines;**
**Diesel demand is increasing while gasoline demand is declining;**
**EU is major driver behind world shift to distillate versus gasoline**

**Notes:**
Turning to Europe, this region has had a policy to reduce demand, driven in recent years by its interest in reducing CO2 emissions.  This policy has been effective, with annual average demand growth since 1995 being only 0.7%.  

One of the primary means of curtailing demand was to encourage the use of diesel-engine light-duty vehicles over the less-efficient, gasoline-fuel engines.  Diesel-fueled vehicles now represent about 50 percent of Europe’s light-duty vehicle sales.

This policy resulted in a significant shift in product mix.  Diesel demand is increasing, while gasoline demand is declining.

And as the next slide shows, this change in Europe is the main driver behind the world shift to distillate away from gasoline.

## Europe Is Unique In Degree of Shift to Middle Distillate

**Source: BP Statistical World Review 2005 **

**Notes:**
This chart illustrates the dramatic product mix change that has taken place in Europe relative to the rest of the world by graphing distillate demand’s share of total demand for gasoline and distillate.  

Middle distillate in this graph includes diesel, heating oil and jet fuel, but the change in distillate demand share captured in the chart is driven mainly by changes in diesel fuel demand.

While not shown on the chart, the U.S. share of distillate has shifted slightly higher (2% change since 1985), and the rest of the world has actually shifted a bit towards more gasoline.  

Europe’s strong shift away from gasoline to distillate has created some supply challenges for itself that have affected the U.S. gasoline and distillate markets, as will be discussed.  

The demand shift in Europe was economically met mainly through trade rather than through refinery investment, as the next chart illustrates.

## E.U. Hydrocracking Growing, But Not as Fast as Diesel Demand Shift

**Note: FCC -  Fluid Catalytic Cracking Source: EIA, Oil and Gas Journal**

**Notes:**
The major process in which European refiners are investing to significantly increase distillate yields is hydrocracking.  Fluid catalytic cracking units (FCC), which many refiners in both Europe and the U.S. have, take heavier materials from distillation units and produce mostly gasoline.  The hydrocracking units use heavy feedstocks, and can generate more distillate.  

As this slide shows, European refiners historically have been increasing hydrocracking capacity to increase production of diesel compared to gasoline.  Since 1990, hydrocracking as a percent of distillation capacity has increased from 2% to almost 7%, while FCC capacity as a percent of distillation has leveled at about 16%. 

Despite the growth in hydrodcracking capacity, the deficit in diesel production compared to demand, and the excess in gasoline production has continued to grow.  Additional planned hydrocracking investments would increase average European refinery distillate yields and decrease residual fuel production.  However, the increased volumes resulting from the increase in distillate yield likely will not keep up with the diesel demand growth.

This implies that Western Europe may be able to provide the United States with higher gasoline imports in the next few years.  

## Europe’s Growing Product Imbalance

**Source: IEA**

**Notes:**
This chart quantifies the gasoline and distillate imbalances in Europe.  Distillate products (diesel, heating oil, and jet fuel) are imported in increasing quantities, and excess gasoline is exported in increasing quantities, despite recent hydrocracking investments.

In 2004, the Former Soviet Union countries supplied about 3⁄4 of Europe’s diesel and gas oil imports.

The U.S. East Coast has been the principal market for Europe’s gasoline exports, taking 3⁄4 of Europe’s export volumes.  In 2006, the elimination of MTBE from RFG on the East Coast adds a challenge for Europe’s gasoline exporters to the U.S.

Looking to the future, Europe’s distillate imports are likely to be more difficult to locate as European sulfur specifications are lowered, providing increased incentives for distillate production investments or for distillate desulfurization investments, using imported high-sulfur distillate as input.  

## Summary of European and U.S. Balances

**Source: EIA, IEA**

**United States**

**European Union 15**

**Notes:**
This chart summarizes the supply changes that occurred since 1995 to meet changing demand for both gasoline and distillate in the U.S. and Europe, illustrating their complementary gasoline relationship.  

Demand changes are met by changes in net imports and changes in refinery production. Refinery production changes are broken down into the volumes affected by changes in yield, and those resulting from changes in crude runs.  The yield changes stem from combinations of changing refinery unit operations, changing types of crude oils, and installation of new processing units.  

On the left, the chart shows that the U.S increased gasoline demand has been met mainly by increasing refinery input and imports, with yield changes making a very small contribution. By comparison, increased refinery production from yield improvements played a large role in helping to meet distillate demand.  U.S. refinery distillate yield improvement ranked a little below increased refinery inputs and well above imports as a supply contributor.

In EU-15 countries, refinery production’s contribution to European gasoline demand remained almost unchanged, as gasoline production from increased refinery inputs were counter balanced by declines in production from declines in yield.  Excess product was exported.  For distillate, increased refinery production from both increased throughputs and yields provided about half the added product need, and the other half came from imports.  

## Asia-Pacific

**Growth resumed after financial collapse**
**Much variation – China & India large growth drivers, OECD Asia small growth**
**Product mix future?**
**Non-highway use of petroleum in emerging Asian countries large**
**Distillate use will continue to grow rapidly, but...**
**Light duty vehicle use will also grow, and China’s light-duty fleet is gasoline**

**Notes:**
The Asia-Pacific region is a mixture of developed and emerging countries.  The two large emerging economies of China and India have a large impact not only on this region, but on the world.  On the other hand, OECD Asia (Japan, South Korea, Australia, New Zealand) is growing very little.

As developing countries grow, their non-highway sectors can have large impacts on total energy use, affecting distillate fuels more than gasoline.

But as their transportation sector evolves, gasoline demand may pick up significantly. 

## Asia-Pacific’s  Distillate-Gasoline Shares

**Source: BP Statistical World Review 2005**

**Notes:**
Even with the recent growth spurt in China, the distillate share of the gasoline and distillate markets has not increased across the region.  While the decline appears to be slowing, car-buying in China could cause this trend to turn down again.

This trend towards more gasoline use over distillate contrasts with the U.S and Europe as previously discussed.

## Price Signals for Capacity Change

**“****Margins” and “differentials” drive refinery investment decisions – not price**
**Since the turn of the century, margins and differentials point to need for more investment**
**But views of the future vary**
**Interesting distillate price signal in 2005**

**Source: Bloomberg spot prices**

**Notes:**
As everyone knows, price for petroleum products have increase substantially since the 1990’s, but most of that increase has been driven by the price of crude oil.  Refiners margins must be made from the difference between that crude oil feedstock cost and product price, which has also increased in recent years.  

While refinery margins in the 1990’s were small, they have increased since 2000, albeit not smoothly.  Still, generally higher margins are providing increased incentives to invest.  

Investment incentives derive not only from total margins, but in the case of downstream units, from various other price differentials as well.

The next few slides will explore some of these other price differentials, in particular, light-heavy crude oil and product price differentials, since they are critical for success in bottoms-upgrading investments, and gasoline versus distillate prices, which increase the incentive for more hydrocracking.

## Light-Heavy Product Price Differential & Crude Oil Price Move Together

**Source: Bloomberg spot prices – GC - Gulf Coast, NWE-Northwest Europe ARA Barge, WTI – West Texas Intermediate Cushing**

**Notes:**
One key differential for refinery investment is the light-heavy product price difference.  As the price of high-valued products like gasoline or distillate rise above the price of residual fuel oil, the incentive increases for investing in upgrading to produce less residual fuel and more light products.

This chart depicts the light-heavy product price spread represented by the difference between distillate and residual fuel oil prices.  It highlights the correlation with crude oil prices, and illustrates that increased light-heavy product price movements in 2004 and 2005 were consistent with historical patterns in relationship to crude oil price changes.  
Residual fuel oil competes with other fuels such as coal and natural gas.  As a result, residual fuel oil price does not rise as quickly as crude oil price.  
However, gasoline and distillate rise as much as or more than crude oil prices, depending on the tightness of the market. 
 The result is that the light-heavy product price difference moves with crude oil prices..

The slide also shows both U.S. light-heavy product spreads and Northwest European product spreads to illustrate that this product behavior is very similar in both regions.

## Light-Heavy Crude Price Differential & Crude Oil Price Move Together

**Source: Bloomberg spot price**

**Notes:**
Another related investment incentive is the relative value of low quality heavy crude oils and light crude oils.  When the price of heavy crude oil is “cheap enough” relative to light crude oil, refiners will invest to use that heavier crude.  

Since the relative value of crude oil depends on the value of the barrel of products that are refined from the crude, it follows that the light-heavy crude oil price differential also has some relationship to crude oil price. 

While the crude oil price differential in this slide uses Maya crude oil, which is a far less attractive crude oil than WTI due to its low gravity and high bottoms content, the general relationship holds for other light-heavy crude oil spreads as well. 

## Light-Heavy Price Differentials Move Together

**Source: Bloomberg spot price**

**Notes:**
Now we put the light-heavy product price differential on the same graph as the light-heavy crude price differential.

Note that even though these differentials generally move together, since 2000, the product differential frequently moves ahead of the crude price differential, which illustrates the important feedback of product values to crude price differentials.  

With both crude and product light-heavy price difference increasing with crude oil prices, and with crude oil prices  expected to remain high for some time, incentives have increased for investing in high-conversion heavy crude oil refining units.

## Unusual Atlantic Basin 2005 Distillate Prices 

**Source: Bloomberg Gulf Coast Conventional Gasoline, No. 2 Heating Oil; NW Europe 0.2% Heating Oil and Premium Gasoline **

**Notes:**
And incentives may also be changing for more hydrocracking – particularly in Europe.

While distillate demand growth in the world has been outpacing gasoline demand growth, price incentives to significantly change refining configurations to focus more on distillate have not occurred until recently.

Heating oil prices on both sides of the Atlantic exceeded gasoline prices for much of 2005.  Only the hurricanes in the U.S. brought gasoline prices back above heating oil for a brief period.  The provocative question is whether the unusual gasoline/distillate price situation in 2005 stems from a temporary situation or is the beginning of a more fundamental shift in the relative pricing of these primary light refined products.  

We have all been watching the growth in diesel demand, and have known that at some point, price for diesel would have to rise relative to gasoline to produce the incentives needed to shift refinery investment towards more distillate production.  Is this the beginning of that situation?  

The underlying question about the fundamental nature of that imbalance occurring for high European diesel growth and declining gasoline demand is still unresolved, but this year has provided an example of what to watch as we move ahead.

## If WTI Drops from $60 to $40, Will Differential Drop by 33% ($15-$10)?

**Notes:**
We know what incentives are today, but investments must earn a return for many years in the future.  If petroleum markets loosen, and crude oil prices fall back, what could happen to margins and price differentials?

This scatter plot illustrates the relatively strong relationship between crude oil prices and a light-heavy crude oil price difference.  If crude oil prices fall back to $40 per barrel, the light-heavy crude price differential will fall back.  But the scatter around the line indicates that the dynamics behind this relationship may keep the movements from being a simple linear relationship – even though we show a linear fit for discussion purposes.

That differential is affected by residual fuel price.  Both demand and supply of residual fuel oil are changing with changing prices, but demand and supply don’t necessarily move together.  
On the demand side, rising prices make residual fuel oil less attractive than alternatives, and demand for residual fuel falls.  Price for residual fuel then does not rise as much as for light products.  Thus, the value of heavier crude oil drops relative to light crude oils.
The increasing light-heavy crude oil and product price differences increase incentives to add bottoms upgrading capacity, such as coking units, and destroy residual fuel oil supply.  
This balance between heavy product supply and demand will vary, and when crude oil prices return to $40, the light-heavy differentials could be higher or  lower than occurred when prices were rising, depending on the strength of the demand or supply response to the price increase.    

## If WTI Drops from $60 to $40, Margin Relationship Less Certain

**Note: Three hurricane months excluded (Aug-Oct 2006)                 Source Bloomberg Gulf Coast product spot prices and WTI Cushing.**

**Notes:**
The relationship between margin and crude oil price is even less certain.  While margins and crude oil prices have some relationship, there are other factors affecting margins as well, which is why the simple relationship shown in the scatter plot is not very good.

But do not assume the missing explanatory variable is utilization.  There has been no correlation between margin and utilization.  

In general, when crude oil prices rise, markets are tightening, and margins rise.  For prices to fall, markets have to loosen, and margins shrink.  

In the region above $40 per barrel, this scatter plot represents a time when prices are mainly rising.  We don’t have  the margin vs. price relationship as prices fall back from today’s levels to say $40 per barrel.  We could see lower margins on average on the way down  than on the way up depending on what is behind the loosening market.

Still if prices stay higher  than we saw in the 1990’s, it means the market is tighter and  margins and differentials should be higher.

## Looking Ahead to Refinery Capacity Growth

**Where: U.S., Europe, Asia, Middle East**
**What type **
**Who are the companies investing, and what is driving their decisions?**

**“****When one admits that nothing is certain one must, I think, also admit that some things are much more nearly certain than others.” Bertrand Russell, 1947**

**Notes:**
Regions vary significantly in total petroleum demand growth, gasoline versus diesel growth, and clean fuel requirements.  Even product price differentials vary between the  Atlantic and Pacific regions.  

As a result, we might expect refiners in different regions to invest in different types of refinery process facilities.

It also appears that different types of companies have different perspectives about the need for and profit potential of refinery investment – both within and across regions.

## Current Regional Downstream Capacity Reflects Different Needs

**Note: Asia-6: China, India, Indonesia, Japan, Singapore, South Korea; EU-6:France, Germany Italym, Netherlands, Spain, and U.K., Middle East: Bahrain, Kuwait, Saudi Arabia, and UAE.****                    ****Source: Oil and Gas Journal **

**Notes:**
This slide illustrates some regional differences in downstream capacity.  Downstream capacity reflects the product markets served by the refineries of a particular region, and provides clues as to how this capacity may evolve.

U.S. refineries produce the highest gasoline yields of any other region, which is reflected in its high percentage of FCC capacity relative  to distillation capacity.  The U.S. also produces the lowest residual fuel oil yield, while running high volumes of heavy crude oil, which is accomplished with its coking capacity.  The U.S. has half the world’s coking capacity.

Europe and the U.S. are ahead of the rest of the world in producing low sulfur fuels, which is reflected in their high hydro-treating capability.  

This picture will be shifting as product demand mix shifts, clean fuel requirements increase in various regions, and crude and product price differentials change.  The next slides summarize how we think capacities may change around the world. 

## Regional Distillation Capacity Changes 2005-2010

**Sources: Oil and Gas Journal, FACTS, Company Presentations**

**Notes:**
Distillation capacity plans indicate large increases in all regions shown except for Europe.  These estimates are based on compiling those distillation capacity expansion plans reported in construction surveys, company press releases, and company reports to financial analysts.  The U.S. estimate also includes a creep and closure estimate.

. The U.S. capacity additions shown here are higher than many longer-term forecasts, including EIA’s long-term outlook.  Long-term forecasts do not capture cycles, and they are frequently based on historical trends.  In today’s world, historical trends may not be a good indicator of what will likely occur in the next 5 years, but the uncertainty level is high as we will discuss further.  In general, the quality of data and information varies considerably across world regions, affecting the quality of any estimates.

Not surprisingly, we are expecting the largest capacity additions to occur in the Asia-Pacific area.  The Middle East exporting capacity is the next highest.  This region serves the high-growth Asia Pacific area as well as Europe. 

The next few slides will look at the regional plans in more detail.

## U.S. Capacity Changes 2005-2010 (KB/D)

|  | CDU | Coking | FCC/RCC | HDC |
| --- | --- | --- | --- | --- |
|  AZ Clean Fuels  |  150  |  ?  |  ?  |  -    |
|  BP |  | 100 |  |  |
|  Coffeyville  |  15  |  |  |  |
|  ConocoPhillips  |  230  |  105  |  -    |  -    |
|  Frontier  |  10  |  -    |  -    |  -    |
|  Marathon  |  193  |  70 |  40 |  60 |
|  Motiva  |  325  |  90   |  -    |  60  |
|  Sunoco  |  100  |  -    |  ?  |  -    |
|  Valero  |  406  |  30 |  19  | 107  |
|  Others  | 70 |  152 |  31 |  85 |
|  Creep-Closings  |  250  |  -    |  -    |  -    |
|  TOTAL  |  1,749 |  557 |  90  |  312  |

**Note: “?” denotes plans that mention a type of unit, but no capacity volumes.  CDU: Crude distillation unit; FCC: Fluid catalytic cracking; RCC: Residual catalytic cracking; HDC: Hydrocracking. Sources: Oil & Gas Journal, company presentations, Industrial Information Resources**

**Notes:**
Three factors have been influencing plans to increase capacity:  (1) increased refining profitability, (2) high light-heavy price differentials, and (3) increased cash and personnel availability as companies’ finish their low sulfur fuel investments.

These numbers reflect plans, and as such, not everything shown will occur.  On the other hand, past history has shown actual projects within previous 5-year periods to be greater than the publicly discussed plans.  More enthusiasm currently exists for expansion than has occurred in decades.  The total level of expansion shown above has a high probability of occurring, even if the exact mix shown does not occur.

The detail on coking and other downstream units is lagging behind statements about distillation capacity expansions, but we expect most expansion to be in the higher complexity range, with much of it geared to heavier crude oils and accompanying bottoms upgrading, as demonstrated by the coking unit plans shown.  Even less detail is available for FCC units than for coking or hydrocracking.  This is not unusual, and means that the total FCC capacity shown on the slide is below what is likely to occur.  

## Europe’s Capacity Changes 2005-2010 (KB/D)

|  | CDU | VDU | Coking | FCC/
RCC | HDC |
| --- | --- | --- | --- | --- | --- |
|  Croatia  |  -    |  -    |  -    |  -    |  42  |
|  Finland  |  -    |  -    |  -    |  -    |  47  |
|  France  |  -    |  -    |  -    |  2  |  48  |
|  Greece  |  -    |  -    |  50  |  -    |  37  |
|  Italy  |  -    |  -    |  -    |  -    |  25  |
|  Lithuania  |  -    |  -    |  -    |  -    |  -    |
|  Romania  |  -    |  -    |  -    |  -    |  25  |
|  Spain  |  30  |  -    |  20  |  -    |  50  |
|  TOTAL  |  30  |  -    |  70  |  2  |  274  |

**Note: “?” denotes plans that mention a type of unit, but no capacity volumes.       CDU: Crude distillation unit; VDU: Vacuum distillation unit; FCC: Fluid catalytic cracking; RCC: Residual catalytic cracking; HDC: Hydrocracking.**                                                                                    **Sources: Oil and Gas Journal, company presentations.**

**Notes:**
Turning to Europe, note the small level of distillation capacity expansion.  Europe’s problem is product mix more than product growth.
It appears that European refiners share a common view that there is no need for additional distillation capacity.  
But some of Europe’s refiners in some European countries see refinery investment opportunities to address the rapidly growing demand for diesel and the decreasing demand and price for residual fuel oil.
While demand for gasoline is also falling, the apparent view of many European refiners is that the growing need for gasoline imports on the U.S. East Coast represents a reasonable market for their growing gasoline surplus.    

Estimated distillation capacity increases by only 30 KB/D, but hydrocracking may increase 275 KB/D (23%) as a means of producing more distillate.

Based on analysis of several expansion plans, yield changes would mostly raise distillate yield and reduce residual fuel oil production.  Gasoline yield likely would change very little.  The net result would produce more distillate to help meet distillate demand, while volumes of surplus gasoline would grow as European gasoline demand declines. These plans imply that economics are better for reducing residual fuel oil volumes than reducing surplus gasoline.  

The review of announced projects indicated interest in bottoms projects is picking up:   
Coking: 1 sure, 2 planned, 1 possible
ROSE (residual oil supercritical extraction) plus gasification: 2 projects 

## Asian Capacity Changes 2005-2010 (KB/D)

|  | CDU | VDU | Coking | FCC/
RCC | HDC |
| --- | --- | --- | --- | --- | --- |
|  China  |  1,966  |  680  |  135  |  142  |  242  |
|  India  |  1,015  |  275  |  50  |  198  |  228  |
|  Indonesia  |  250  |  -    |  -    |  -    |  -    |
|  Pakistan  |  150  |  60  |  -    |  -    |  50  |
|  Other  |  233  |  -    |  33  |  184  |  40  |
|  TOTAL  |  3,614  |  1,015  |  218  |  524  |  560  |

**Note: “?” denotes plans that mention a type of unit, but no capacity volumes.   CDU: Crude distillation unit; VDU: Vacuum distillation unit; FCC: Fluid catalytic cracking; RCC: Residual catalytic cracking; HDC: Hydrocracking                   Sources: Oil and Gas Journal, FACTS, industry media reports.**

**Notes:**
Fast growing Asian demand is accompanied with plans for large capacity expansions, particularly in China and India.  India is planning on enough capacity expansion to provide some increased product export capability.  

There is little product demand growth in the OECD Asian countries (Japan, South Korea, Australia and New Zealand), and little planned capacity expansion.

With growing light product demand and clean fuel needs, we are seeing new downstream unit capacity announcements as well as distillation capacity announcements.

## Middle East Capacity Changes 2005-2010 (KB/D)

|  | CDU | Coking | FCC/ RCC | HDC |
| --- | --- | --- | --- | --- |
|  Bahrain  |  -    |  -    |  -    |  60  |
|  Iran  |  896  |  -    |  171  |  2  |
|  Iraq  |  370  |  -    |  90  |  35  |
|  Kuwait  | 410  |  ?  |  ?  |  ?  |
|  Oman  |  131  |  -    |  75  |  -    |
|  Qatar  |  145  |  ?  |  ?  |  ?  |
|  Saudi Arabia  |  400  |  80  |  100  |  200  |
|  UAE  |  -    |  -    |  -    |  -    |
|  Yemen  |  185  |  -    |  -    |  20  |
|  TOTAL  |  2,537  |  -    |  -    |  -    |

**Note: “?” denotes plans that mention a type of unit, but no capacity volumes.     CDU: Crude distillation unit; VDU: Vacuum distillation unit; FCC: Fluid catalytic cracking; RCC: Residual catalytic cracking; HDC: Hydrocracking**                    **Sources: Oil and Gas Journal, FACTS, industry media reports.**

**Notes:**
In the 1980’s, refineries were built in the Middle East to produce products for export.  Since that period, capacity growth has slowed and been more focused on meeting regional demand growth, handling growth in condensate volumes, and reducing product sulfur content.  But we are seeing a revival of interest in expanding export refinery capacity.  
Most notably, Saudi Arabia is developing a 400 KB/D refinery at Yanbu (2010) and possibly another 400 KB/D facility at Jubail.  Kuwait is adding a 600 KB/D refinery at Al-Zour. But Kuwait is also shutting down a 190 KB/D facility, which means a net increase of over 400 KB/D.
Also, conversion capacity is being added at existing refineries to reduce residual fuel oil  production and increase  light product volumes.  
Capacity expansion between 2005-2010 is estimated to be over 2 million barrels per day.  
One source, FACTS, estimates that net exports of gasoline, jet, and diesel fuel will increase by about 1 million barrels per day, while residual fuel oil exports will decline 0.2 million barrels per day.  
This upsurge in export capacity indicates that Middle East exporters believe refinery capacity growth in regions such as Asia, Europe, and the U.S. will lag demand growth, creating an extra need for Middle East product supply.  
Some countries, Kuwait and Saudi Arabia in particular, see the need to invest in high conversion capacity that can process their heavy crude oils.  
Outside the Middle East, Saudi Arabia is also participating in expansion of Motiva’s U.S. refineries and in a possible $3.5 million refinery project in South Korea.
Expansion in the Middle East includes incentives beyond margins.  Middle East refiners also see investment in production facilities as benefiting the people of their countries by creating skilled job opportunities.  

## Who Will Expand: Outlooks/Plans Vary

| Group | Regions | Future Market Expectations | Refinery Investment Strategy |
| --- | --- | --- | --- |
| Super Majors | All | Margins revert to historic | Maintain top-quartile performance , little expansion need |
| Majors with Large Downstream | U.S. & Europe | Improved margins with cycles | Heavy crude projects & cautious expansion |
| Independent Refiners | U.S. | "Golden Age of Refining" | Expand distillation & conversion |
| Export Refiners | Middle East  | Tight capacity & high light-heavy | Expand for export,  add bottoms upgrading |
| State & Private | India & China | High demand growth, better margins | Rapid expansion existing & grassroots |

**Sources: Trade press articles, company presentations and press releases.**

**Notes:**
Planned refinery expansion not only varies across regions, but also by type of company.

In the U.S. and Europe, the super majors, like BP and ExxonMobil, seem to be the least committed to refinery expansion.  They will invest to maintain their refineries as “top quartile” performers, and may participate in projects in high growth Asian areas.  The view publicly expressed by companies in this group is that the downstream markets are cyclical and profitability likely will return to lower levels.  

Other integrated companies (e.g., Chevron, ConocoPhillips, and Marathon in the U.S. and Total and ENI in Europe) mostly show a greater interest in investing in the refining side of their business than the super majors.  

The companies that are exclusively in the refinery business have grown their portfolio of refinery assets and expanded capacity at those refineries by the largest percent.  Consistent with these actions, this group expresses more optimism about a sustained improvement in refining margins.

In Asia and the Middle East, state-owned companies hold the majority of refining assets.  These companies have expressed a strong need for new capacity and a belief that the current tight capacity situation will ensure higher margins.  The Middle East refiners also see they can improve the value they receive from their heavy crude oil by refining it themselves.  

## Over or Under Capacity Potential

**Putting demand and capacity together regionally**
**Postulating potential for over- or under-capacity **

**Gross Inputs**

**Capacity**

**Source: EIA **

**Notes:**
Before wrapping up, the question of how well this capacity growth matches demand must be addressed. 

Will we have under- or over-capacity?

## Capacity and Consumption Changes2005-2010

**Sources: Capacity see previous slides; Demand: EIA, BP World Statistical World Review 2005, FACTS, IEA**

**Notes:**
This slide illustrates the potential balances between distillation capacity expansion and petroleum demand growth in the major regions. 

The U.S. could actually see capacity expansion stop product import growth, although it is not expected to eliminate product imports. 

Europe will continue to need distillate imports and have extra gasoline to export. It could even see a net increase in its need for product imports.

The Middle East is likely to increase its ability to export product, while Asia, like the U.S., will likely see capacity and demand growth stay fairly close.

## Potential for Over/Under Expansion?

**The potential for under-capacity is probably greatest in the next year or two, before all new expansion plans come online. **
**If the world does not experience any major demand shocks, over-expansion potential is small.**
**The most likely areas where overexpansion has and may again occur are Asia and the Middle East.**

**Notes:**
With such projections, could we see an over-capacity situation develop?  

It does not look like an over-capacity situation is evolving.  Clearly if any unexpected events such as another Asian financial crisis occurs to severely affect demand, we could see a temporary over-supply situation.

The most likely area where an over supply could evolve are Asia and the Middle East, where the large capacity expansions being planned could outpace demand growth.

But the larger concern is the potential undersupply in the short-run.  Capacity is expected to remain fairly tight over the next few years, and demand growth is very difficult to predict. 

## Product Market & Price Outlook Summary

**Demand growth keeps capacity tight to 2010;**
**Light-heavy price differentials and higher margins will result in increased bottoms upgrading capacity;**
**Mixed views on margin outlook will prevent significant overbuilding – with Middle East and Asia being most likely areas for overbuild;**
**Gasoline-diesel price differential will stay close and possibly invert more often as in 2005.**

**Notes:**
To wrap up, growth in the refined product markets should keep refinery utilization relatively high during the next 5 years.

Continued price incentives will encourage bottoms processing capacity additions.

But there are mixed views on future price incentives, which should reduce the potential for overbuilding.  The regions perhaps most exposed to overbuilding are Asia and the Middle East.   

In the Atlantic Basin, the 2005 inversion of the gasoline-distillate price differential may occur more often in the future.  In general, distillate prices relative to gasoline are likely to be stronger than seen previous to 2005.  Europe will be a key area to watch in this regard.  Its demand for distillate imports will continue to put upward pressure on distillate prices, while its increasing volume of gasoline exports will decrease pressure on gasoline prices.

## Summary of Capacity Outlook

**Capacity expansion announcements growing with continued price strength;**
**U.S. capacity could even keep up with demand growth;**
**Europe’s gasoline surplus will continue, but new hydrocracking capacity may slow growth in Europe’s diesel imports;**
**Middle East gearing up to meet growing Asian and European needs;**
**Asia’s growth driven largely by China and India;**
**Continue to watch distillate mix – Particularly in Europe, our Atlantic Basin partner.**

**Notes:**
As price incentives have continued to improve for capacity investments, announcements have been increasing.
U.S. capacity growth in the next 5 years might keep up or even exceed demand growth.  Bottoms upgrading project expansion activity appears to be strong.
Europe’s gasoline surplus is expected to continue, but additional hydrocracking capacity may slow the growth in diesel imports.
The Middle East is positioning itself for another round of export refinery investments to help meet Asian and European demand growth.
Asia is showing the largest growth in demand and in capacity plans, driven mainly by China and India.
The gasoline/distillate mix will need to be watched:
In Asia, China’s rapid growth in light-duty gasoline vehicles may push gasoline growth to overtake the distillate growth
But Europe is still the key from the U.S. point of view.  It’s continued need for diesel imports and growing volumes of gasoline exports will tend to move diesel and gasoline prices closer together, even pushing distillate prices above gasoline.