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OPEC Cuts Hurt Refiners, Help Canadian Oil Sands in 2Q17

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Wednesday, August 02, 2017, 5.15PM / Fitch Ratings

Reduced OPEC oil exports to the North American market are narrowing an important price spread between light and heavy crude blends, pressuring margins for U.S. refiners on the Gulf Coast with specialized conversion capacity, according to Fitch Ratings. At the same time, Canadian exporters of heavy crude benefit from the tighter spreads in the form of higher realizations for their discounted grades of heavy oil.

OPEC members have begun to target reductions in exports to the U.S. in an effort to cut into ample U.S. crude inventories, which are monitored closely as a barometer of the global oil supply and demand balance. The U.S. inventories are also seen as important in setting global prices insofar as U.S. shale has emerged as the most important source of short-term supply in the oil market.


On July 26, the U.S. Energy Information Administration (EIA) reported that inventories stood at 483 million barrels, down from 532 million barrels in April. This occurred despite U.S. shale production ramping up to 9.4 million barrels per day (mbpd) compared with 8.8 mbpd at YE16.


As supplies of lower priced, heavier crude blends with higher sulfur content exported by OPEC have waned, the key price differential between benchmark light and heavy grade oil in the U.S. has narrowed considerably. This has cut into Gulf Coast refiners' profit margins during 2Q17. Many Gulf Coast refiners, including Valero Energy, CITGO and Phillips 66, have considerable coking capacity to convert heavier crude oil into gasoline and other refined products. Those refiners benefit from a wide spread between higher priced West Texas Intermediate (WTI) and Western Canadian Select (WCS), the heavy crude benchmark in Canada.


That spread has tightened over the past few months from historical averages in the $15 per-barrel range to an average of $9.80 per barrel in 2Q17. On a percentage basis, the WCS discount below WTI has fallen to approximately 20% versus historical averages of 25%. Producers in Canada's Oil Sands region, including Cenovus Energy and MEG, benefited in 2Q17 from contracted light-heavy spreads as realized margins increased due to the reduced WCS discount.


We do not expect very tight light-heavy crude price spreads to persist over the long term given pending increases in heavy Canadian Oil Sands output. The Fort Hills project (194,000 bpd bitumen) is expected online later this year. Increased pipeline capacity from Canada into the U.S. should also contribute to an easing of spreads.


One additional near-term wrinkle in the outlook for heavy crude supply in the North American market is the potential cutoff of Venezuelan oil exports to the U.S. as a result of newly imposed sanctions. According to EIA data, U.S. refiners are major buyers of Venezuela's heavy high sulfur crude oil. Any move by the Trump administration to block imports from Venezuela could lead to a renewed search for heavy crude supply in the Gulf, likely tightening the light-heavy spread even more.


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