By John Auers
The city of Chicago is known for a lot of things, both good and bad – pizza/good, crime/bad, Cubs/used to be bad/now good; Bears/used to be good/now bad, etc. From a refiner’s standpoint, Chicago has also been a bit of a mixed bag; although by and large, the good has dominated the bad. While operating costs are high (mostly due to relatively expensive unionized labor) supply/demand factors have generally been pretty favorable. On the feedstock side, the boom in U.S. shale crude and Canadian production resulted in things getting really good for a while, with regional refiners enjoying double-digit crude discounts (vs. the U.S. Gulf Coast) for several years. Even though those discounts have shrunk over the last couple of years, an advantage over the Gulf Coast remains and should continue for the foreseeable future. Chicago refiners have also historically been advantaged on the product side of the equation, with regional demand (extending away from the city to neighboring states) greater than the capabilities of regional refiners. The shortfall has been made up by products supplied by USGC plants through the Explorer and TEPPCO pipelines and has resulted in Chicago prices generally exceeding USGC prices to incentivize those movements; however, things are changing, in part due also to the impacts of the crude boom, but also as a result of sluggish product demand. Gasoline has been particularly impacted, with USGC movements into the region falling to near zero. This has Chicago area refiners channeling the Marshall Tucker Band in feeling the, “Windy City Blues” as they scramble to find new outlets for their production. We will explore the market developments and potential responses in today’s blog.
Profile of Chicago Market
Figure 1 graphically portrays the wider Chicago products market, which is likely best characterized by the four states of Illinois, Indiana, Wisconsin and Michigan. The three refineries located in the Chicago area (BP Whiting, Citgo Lemont, and ExxonMobil Joliet) have a total capacity of 875 MBPD and make up over 50% of the total refining capacity in those four states. Considering that more than half of the capacity in the rest of the region is located next to and supplies significant product to bordering states (COP/Wood River, Calumet/Superior, and Marathon/Detroit), the Chicago plants provide an even greater percentage of regional demand.
Figure 1
Chicago Product Pipelines & Regional Refineries
As shown in Figure 1, production from the Chicago plants supplies not only metro area demand, but also moves to Wisconsin through the West Shore pipeline system and to Michigan and Indiana by way of the Wolverine pipeline system, with truck, rail and marine movements also taking place to selected markets. As mentioned earlier, the Chicago and other local refineries have historically been unable to fully meet regional demand, and supplemental product has been brought in from USGC refineries, using primarily the Explorer and TEPPCO pipeline systems.
Changing Supply and Demand Environment
As always, markets evolve, and this has certainly been the case in the Chicago product market. On the supply side, regional refining capacity has been expanding, with increases of over 140 MBPD since 2005, as shown in Figure 2 below. Essentially, all of this growth has taken place since 2010 and has largely come as a result of changes in regional crude markets. With strong growth in both heavy crude from Western Canada and light crude from North Dakota and pipeline accessible Permian crude, several refineries have invested in projects to run these barrels in larger volumes. Net increases in capacity include 35 MBPD at the Phillips refinery in Wood River in 2011, 40 MBPD at BP Whiting in 2013, 15 MBPD at Marathon’s Detroit refinery in 2013 and 30 MBPD at Marathon’s Robinson refinery in 2016. It should be noted that actual throughput (and resulting production of transportation fuels) has increased even more than capacity in the four-state region. Incentivized by large crude discounts, regional refineries increased utilization rates above 90% and crude throughput has grown by about 200 MBPD since 2010.
The changing crude supply environment has not only resulted in greater regional crude runs, but also in the type of crude these plants are processing. Bakken, which tends to make a lot of gasoline, has displaced WTI and Canadian Syncrude, both of which produce more distillate. Heavy Canadian crudes have also become a greater part of the mix, and since they consist primarily of dilbit, which include a large amount of light diluent, they tend to make more gasoline than conventional heavy crude. Overall, the changing crude slates have resulted in greater gasoline yields at regional refineries, which have gone up by about 1 liquid volume % over the past five years according to data reported to the Energy Information Administration (EIA).
All this growth in regional production has taken place in an environment where product demand has generally been decreasing, although recent low prices have temporarily reversed this decline (see Figure 3 below). Between 2004 and 2012, gasoline demand in the four-state region declined by over 100 MBPD, due both to long-term demographic factors and mandated increases in automotive efficiencies (CAFÉ standards). As pump prices have dropped over the last few years (in reaction to the drop in crude prices), consumers have responded by driving more and overcoming the underlying negative demand factors. While this has caused gasoline demand to recover much of the ground it lost since 2004, it is likely that this dynamic is temporary, and that regional gasoline demand will resume a longer term decline pattern over the next couple of years.
All of the above factors (increasing regional supply from both greater crude runs and increasing gasoline yields and generally decreasing regional demand) have led to a significant shift in the regional gasoline supply/demand balances. While we can’t get a specific picture of this shift for the four-state region we have focused on due to the fact that the EIA does not report sub-PADD product movements, we can get an indication of the trend by looking at the broader PADD level data. Until about 10 years ago, PADD 2 brought in a net of 700-800 MBPD of gasoline to supplement internal gasoline production and supply market demand. The supply and demand factors discussed above has caused the PADD 2 net inbound movements to decline to around 400 MBPD, with almost all of this shift coming from reduced movements from the USGC, as shown in Figure 4 below. The decline has flattened in recent years, due to the low price induced increase in demand discussed earlier, but we can expect it will resume when regional demand returns to its expected long-term decline trend.
What to Do?
Based on the actual and expected gasoline supply and demand trends, the wider Chicago market appears to be headed away from a deficit situation to an oversupplied environment. This bodes potential challenges for Chicago area refiners, and ultimately the best solution is to find and access other markets. They can perhaps be guided by what has been happening on the eastern side of PADD 2, where Michigan and Ohio refineries have been facing a similar situation. The recent expansion of Buckeye’s Michigan/Ohio pipeline system into Western Pennsylvania is allowing them to more economically expand their market reach. A further expansion of the system to central Pennsylvania has recently been announced, which will provide even more market access for Michigan/Ohio plants and further improve their economics. In both cases, the use of existing pipe and the presence of under-supply or difficult-to-supply markets played a key role in the attractiveness of those projects.
The markets to which Chicago refiners might look are likely to the south (Kentucky/Tennessee) or possibly to the West (Iowa/Missouri), where demand is relatively strong and logistics from current suppliers are difficult in some areas. We have not yet researched available options or economics for any such projects, only observe the potential exists in those regions to absorb Chicago produced gasoline.
The supply/demand environment for refined products markets are constantly changing, not only in the U.S., but also around the world. These changes are as a result of a variety of factors, including the discovery and development of new crude resources, the construction or expansion of refineries, the construction of new midstream assets, breakthroughs with alternative fuels, demographic changes, new regulations, or any of a variety of other developments. These market changes can have dramatics impacts on the economics of all segments of the petroleum industry and specific company’s and facilities. TM&C closely follows and analyzes developments and much of this is discussed in our Crude and Refined Products Outlook, which we publish biannually. The Outlook contains a forecast of both crude and refined product prices, supply and demand. We also do focused studies for individual clients on the impacts of changing supply and demand trends. If you are interested in learning more about our Outlook, or any of our other products or services, please go to our website, send us an email, or give us a call.