Could the U.S. Become a Net Exporter of Gasoline?

07/25/08

Could the U.S. Become a Net Exporter of Gasoline?

Refiners struggle with demand dislocation between developed and developing world, biofuels, and the emergence of ultra-efficient vehicles.

As the global energy supplies shift to meet changes in demand, the United States could potentially become a net exporter of gasoline by 2010, a new Booz & Company study has found. A confluence of factors, including rising demand for fuel in Asia and the BRIC nations (Brazil, Russia, India and China), mandates for biofuels, alternative technology vehicles, and the introduction of $2,500 automobiles is confounding the refining industry, which counts on 20-year predictions to guide investment decisions made today.

In the first half of 2008, the refiners went from exhilaration to desperation. The industry has never faced so many contradictory trends, both on the demand and supply sides, note the authors of the report, titled “Refining Trends: The Golden Age Or the Eye of The Storm? Part IV: Tough Choices.”

Over the last few years, industry margins have never dropped below their 2002 level of $3 to $5 per barrel. But margins could now be about to fall as the economy worsens. Over the longer term, beyond 2013, the width of margins will be dictated by demand growth in the developing world, where the need for new refining capacity will be greatest. That represents a fundamental shift from dynamics of the recent past, when margin cycles were determined almost solely by the speed at which capacity was added.

The report looks in detail at the dynamics of both the demand and the supply sides of the refining industry. On the demand side, the thirst for transportation fuels has risen fast over the last few years, despite higher prices—but that could be about to change. U.S. consumers are now cutting back on their fuel use, and if the average U.S. income falls, fuel consumption is likely to drop off further. The report predicts that the current price of $4 per gallon could reduce U.S. demand by 3 percent, depending on the state of the nation’s economy.

On the other side of the equation, refining capacity is set to expand markedly as the industry reacts to high margins over the last few years. Based on current plans, distillation capacity will widen by about 6 million barrels per day by 2012. Biofuels, however, could dampen the need for new U.S. capacity if producers meet government targets. Europe also has ambitious biofuel targets, though its plans are less clear given recent political announcements.

As fuel demand shrinks and refinery capacity expands, refiners could find themselves in an oversupply situation. Most strikingly, the U.S. could soon find itself in the position of being a net exporter of gasoline—something that seemed highly unlikely just a few months ago. Asia will be happy to mop up the spare amounts. But the effect of such a shift—given shipping costs and specific refining economics—will be to reduce margins for both European and U.S. refiners.

The long-term picture for refiners is potentially more favorable, though the landscape is tough to forecast. On the one hand, additional economic growth in the BRIC countries (Brazil, Russia, India, and China) of just 1 percent per year would raise transportation fuel demand by 3 million barrels per day by 2025; and new ultracheap cars, such as Tata’s Nano, could spur conventional fuel demand significantly. On the other hand, new technologies, such as plug-in hybrid cars, threaten to end the hydrocarbon era for good. The pace at which consumers shift to electrified transport will depend on the trajectory of car battery development and the incentives offered by governments.

The Booz & Company report predicts two centers of fuel demand going in opposite directions—one in the developed world, where demand will tail off as new technologies become established, and another in Asia, where the impact of GDP growth on fuel consumption will be proportionately larger than it would in developed economies. Overall, given most eventualities, the report foresees continued growth in fuel demand until 2040—the exception being if the world experiences moderate economic growth and a high penetration of alternative vehicles.

On the supply side of the refinery industry, the impact of biofuels is likely to be important. But it is uncertain where biofuels are going; in the current debate, interest groups are voicing concern over biofuels’ impact on the environment and food prices. Weighing these factors, and factoring in moderate economic growth, the report estimates the industry will require 3 million bpd of distillation capacity beyond what is in the pipeline today by 2020. With strong global growth, there could be a need for as much as 16 million bpd of additional capacity.

Much of that capacity will be needed in Asia, where demand for fuels will be greatest. The report recommends that refiners consider canceling or delaying capacity additions in developed economies in favor of building new plants nearer Asia’s expanding markets. In addition, it suggests that refiners improve their ability to switch between gasoline and diesel production, and that they renew their focus on biofuels.

The landscape for refiners is unsettling. But opportunities remain abundant. Refiners should monitor regulatory changes closely, diversify their portfolios, and remain strategically flexible.