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Oil Market Dislocations Reduce US Refiner IMO 2020 Benefit

Dislocations in oil markets are dampening the outlook for light-heavy crude spreads and value US refiners expected from International Maritime Organization (IMO) 2020 emission standards but Canadian exploration and production (E&P) companies are benefiting, says Fitch Ratings. US sanctions on Iran and Venezuela and inadequate Canadian pipeline infrastructure resulting in Alberta’s oil curtailment have been disruptive.

Credit implications of revised IMO 2020 expectations should be limited. For refiners, we anticipate surplus FCF associated with the IMO 2020 tailwind is earmarked for share buybacks which can be quickly dialed back if needed.

At least one US refiner curtailed a project related to IMO 2020 implementation due to the prospect of longer-term tightness in light-heavy spreads. Marathon Petroleum Corporation (BBB/Stable) announced last week it would shelve the Garyville 3 coker expansion project in light of changing economics produced by light-heavy crude spreads. This project would have gone online at YE 2021.

IMO 2020, which lowers the cap on sulphur content in bunker fuel used by ships to 0.5% from 3.2% due to environmental concerns, should benefit US refiners in two ways. Demand for low-sulfur distillate by shipping companies would increase as it allows shippers to comply with tighter fuel specifications without installing scrubbers or alternative fuel systems. Additionally, discounting of heavy crude oil should result in wider light-heavy spreads, benefiting refiners with deep conversion (coking) capacity. However, geopolitical events including sanctions and Alberta’s oil curtailment to the US have unexpectedly tightened the heavy-sour crude supply, diluting the second benefit.

There are still questions about timing and full implementation of IMO 2020. Recent proposals by some ship owners include complying with IMO 2020 based emissions targets through slow steaming which lowers emissions by burning less fuel rather than using low-sulfur fuel and could further reduce IMO 2020’s expected benefits for US refiners.

Conversely, tighter light-heavy spreads stemming from the Alberta curtailment have largely benefited Canadian E&P companies. However, the effects on individual companies are case by case and depend on the level of spot exposure to Western Canadian Select (WCS) versus integration with downstream. Lack of egress for Canadian crude oil is resulting in project deferrals and lower capex among Canadian E&P companies. While this enhances near term FCF, lack of growth may continue to have some negative secondary effects.

Secondary effects include slower asset sales and, to the degree companies with delayed projects decide to greenlight them at the same time new capacity comes online, future project cost inflation. The lack of long-term takeaway capacity is linked to delayed in service dates for the region’s main pipeline expansions including Enbridge’s Line 3 replacement, a +370,000 bpd expansion; TransCanada’s Keystone XL pipeline at +830,000 bpd; and the Trans Mountain Expansion Project at +590,000 bpd.

WCS to West Texas Intermediate (WTI) price differentials tightened since the beginning of 2019 to the $12 per barrel (bbl) to $14/bbl level, versus blow out levels of $40/bbl-$50/bbl in the fall of last year. Similarly, Mexican Maya grade crude, which historically traded at a discount to WTI, is trading at a premium to WTI this year.
Source: Fitch Ratings

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