Study 175 Full Report

Study No.
175
July 2018
CANADIAN
AN ECONOMIC ASSESSMENT OF THE INTERNATIONAL
ENERGY
MARITIME ORGANIZATION SULPHUR REGULATIONS
RESEARCH
ON MARKETS FOR CANADIAN CRUDE OIL
INSTITUTE
Canadian Energy Research Institute | Relevant • Independent • Objective

An Economic Assessment of the International Maritime Organization i
Sulphur Regulations on Markets for Canadian Crude Oil
AN ECONOMIC ASSESSMENT OF THE INTERNATIONAL MARITIME ORGANIZATION

SULPHUR REGULATIONS ON MARKETS FOR CANADIAN CRUDE OIL
July 2018
ii Canadian Energy Research Institute
An Economic Assessment of the International Maritime Organization

Authors: Experience Nduagu

Evar Umeozor
Alpha Sow
Dinara Millington
With contributions from: Aashish Gaurav
Hassan Assaad
ISBN 1-927037-60-7
Copyright © Canadian Energy Research Institute, 2018

Sections of this study may be reproduced in magazines and newspapers with acknowledgement to the
Canadian Energy Research Institute
July 2018
Printed in Canada
Front cover photo courtesy of Google images
Acknowledgements:
The authors of this report would like to extend their thanks and sincere gratitude to all CERI staff that provided
insightful comments and essential data inputs required for the completion of this report, as well as those involved
in the production, reviewing and editing of the material, including but not limited to Allan Fogwill and Megan
Murphy. The authors would also like to thank the following individuals and institutions for providing data and helpful
insights for this study. Responsibility for any errors, interpretations, or omissions lies solely with CERI.
• James Storm • Ian Austin

• William R. Edwards • Kavan Motazedi
• Gerard Monaghan • Dr. Joule Bergerson
• Neil Camarta • Argus
• Eric P. Murray • Methanex
ABOUT THE CANADIAN ENERGY RESEARCH INSTITUTE – CANADA’S VOICE ON ENERGY

Founded in 1975, the Canadian Energy Research Institute (CERI) is an independent, registered charitable
organization specializing in the analysis of energy economics and related environmental policy issues in the energy
production, transportation and consumption sectors. Our mission is to provide relevant, independent, and objective
economic research of energy and environmental issues to benefit business, government, academia and the public.
For more information about CERI, visit www.ceri.ca
CANADIAN ENERGY RESEARCH INSTITUTE

150, 3512 – 33 Street NW
Calgary, Alberta T2L 2A6
Email: info@ceri.ca
Phone: 403-282-1231
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An Economic Assessment of the International Maritime Organization iii
Table of Contents
LIST OF FIGURES ............................................................................................................. v
LIST OF TABLES ............................................................................................................... vii
ACRONYMS AND ABBREVIATIONS .................................................................................. ix
EXECUTIVE SUMMARY .................................................................................................... xi
CERI Refinery Optimization Modelling .............................................................................. xi
Non-Compliance Scenarios ................................................................................................ xii
IMO Regulation: Impact on US Refinery Margins ............................................................. xii
Scenario Assumption and Compliance Options ................................................................. xiii
Impacts on Canadian Heavy Oil ......................................................................................... xv
CHAPTER 1 HISTORY OF THE IMO AND REGULATIONS................................................. 1
Historic Levels of Compliance ............................................................................................ 2
Impact of Previous IMO/ECA Regulations on Crude Markets ........................................... 3
CHAPTER 2 GLOBAL CRUDE OIL MARKETS................................................................... 5
Crude Supply and Demand ................................................................................................ 5
Global High Sulphur Residual Oil Market........................................................................... 10
Middle Distillates Oil Markets............................................................................................ 12
CHAPTER 3 IMPACTS ON THE REFINING SECTOR ......................................................... 15
CERI Refinery Model .......................................................................................................... 15
CERI Refinery Modelling Results ........................................................................................ 25
CERI Refinery Linear Programming Results ....................................................................... 27
Potential Crude Displacement ..................................................................................... 27
Realistic Optimal Crude Blends and Margins ..................................................................... 30
CHAPTER 4 SCENARIO ANALYSIS................................................................................. 33
Scenarios for Future Refinery Outlook .............................................................................. 33
Residual Fuel Oil Balance and Potential Markets .............................................................. 33
Non-Compliance Scenarios ................................................................................................ 39
Crude Diet Prices and Refinery Products ........................................................................... 41
IMO Regulation: Impact on US Refinery Margins ............................................................. 43
CHAPTER 5 COMPLIANCE OPTIONS............................................................................. 49
Scenario: Moderate Non-Compliance .............................................................................. 49
Scrubbers ........................................................................................................................... 50
Refinery Additions.............................................................................................................. 52
Slow-Steaming ................................................................................................................... 55
Distillates ............................................................................................................................ 56
Liquefied Natural Gas......................................................................................................... 59
Methanol............................................................................................................................ 60
Arctic Heavy Oil Transport Ban .......................................................................................... 60
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CHAPTER 6 IMPACTS ON CANADIAN HEAVY OIL ......................................................... 63

Price of Canadian Heavy .................................................................................................... 63
WTI-WCS Price Differential ................................................................................................ 68
Canadian Crude Oil Exports to the US ............................................................................... 72
Canadian Export Pipeline Network .................................................................................... 76
Canadian Rail Network....................................................................................................... 77
CHAPTER 7 CONCLUSION............................................................................................ 79
REFERENCES ................................................................................................................... 89
APPENDIX....................................................................................................................... 93
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List of Figures
E.1 Refinery Margin Impacts Due to IMO 2020 Regulation .............................................. xii
E.2 Resid Bunker Fuel Substitution Effects under the Moderate NC Scenario ................. xiii
E.3 WTI and WCS Price Differential ................................................................................... xv
2.1 Global and North American Crude Oil Production ...................................................... 5
2.2 Global Crude Production Volume by Quality in 2016 .................................................. 6
2.3 Quality and Production Volume of Major Crudes in 2016 .......................................... 7
2.4 The America’s Share of Global Crude Oil Types Produced, 2016 ................................ 9
2.5 Canadian Historical and Projected Bitumen Production ............................................. 9
2.6 Residual Fuel Oil Demand ............................................................................................ 10
2.7 Jurisdictional Fuel Oil Consumption ............................................................................ 11
2.8 Bunker Fuel Consumption by Type, 2016 .................................................................... 12
2.9 Global Diesel and Gasoil Consumption ........................................................................ 12
2.10 Global Refined Oil Product Desulphurization Capacities ............................................. 13
3.1 A Typical Hydroskimming Refinery Process ................................................................. 15
3.2 Product Yields for Refineries with Different Complexities .......................................... 16
3.3 Historical Ranges of Crude Oil Flows into US PADDs ................................................... 18
3.4 Historical Percentages of Refined Oil Products ........................................................... 19
3.5 Optimization Model Design and Components ............................................................ 22
3.6 Historical Crude Pricing ................................................................................................ 24
3.7 PADD 1 Calculated versus Actual Refined Product Volumes ....................................... 25
3.12 Potential Crude Displacements.................................................................................... 27
3.13 Composition of Heavy Sour and Heavy Sweet Crudes:
Model versus Optimal Blends ...................................................................................... 28
3.14 Composition of Light Sour and Light Sweet Crudes:
Model versus Optimal Blends ...................................................................................... 29
3.15 Composition of Medium Sour Crudes: Historical versus Optimal Blends .................. 29
3.16 Composition of Crude Blends Limited by Logistics and Operations ............................ 30
3.17 Average 2017 Refinery Margins of Cokers and FCC .................................................... 31
3.18 Improvement of Refinery Margins .............................................................................. 32
4.1 Global Fuel Oil Production, 2015 ................................................................................. 34
4.2 Residual Fuel Oil Consumption by Country ................................................................. 35
4.3 Regional Residual Fuel Oil Consumption ..................................................................... 36
4.4 Residual Fuel Oil Consumption Sectors ....................................................................... 36
4.5 Market Share of International Bunker Fuel Oil............................................................ 37
4.6 Change in Demand for Residual Fuel Oil ..................................................................... 38
4.7 Switchable Demand for HSFO ...................................................................................... 39
4.8 Non-compliance Scenario Assumptions ...................................................................... 40
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4.9 Light Sweet Crude Oil Price Outlook With and Without the IMO Regulation ............. 41
4.10 Historical Refined Product Prices................................................................................. 42
4.11 Price Forecast for Ultra Low Sulphur Diesel ................................................................ 43
4.12 Average 2017 Refinery Margins of Cokers and FCC .................................................... 43
4.13 Medium (FCC) Refinery Margins under Different Compliance Scenarios ................... 44
4.14 Complex (Coker) Refinery Margins under Different Compliance Scenarios ............... 45
5.1 Substitution Options of Resid Bunker Fuel .................................................................. 49
5.2 Estimates of Ships with Scrubbers by Previous Studies .............................................. 51
5.3 Substitution Volumes for Resid Bunker Fuel ............................................................... 52
5.4 Global Crude and Vacuum Distillation Capacities, 2017 ............................................. 54
5.5 Fuel Consumption and Speed Relationship ................................................................. 55
5.6 Prices of MGO, IFO 180 and IFO 380 Bunker Fuels at Houston ................................... 58
5.7 Marine Oils and Blends Prices...................................................................................... 59
6.1 Light-Heavy Differentials ............................................................................................. 63
6.2 Maya-WCS and WTI-WCS Differentials at Cushing ...................................................... 64
6.3 Potential Composition Changes in the Optimal Crude Blend ...................................... 65
6.4 Venezuela and Mexico Crude Outputs are Decreasing ............................................... 66
6.5 Competing International Crudes in the Gulf Coast...................................................... 67
6.6 Changes to WTI and WCS Prices Due to the IMO Regulation ...................................... 69
6.7 In Situ Capital and Operating Production Costs........................................................... 70
6.8 New SAGD Project Viability by 2020 ............................................................................ 71
6.9 Expanded SAGD Project Viability by 2020 ................................................................... 71
6.10 Canadian Supply and Disposition of Crude Oil ............................................................ 72
6.11 Canadian Crude Exports to the US ............................................................................... 74
7.1 Refinery Margin Impacts Due to the IMO Regulation ................................................. 81
7.2 Resid Bunker Fuel Substitution Options ...................................................................... 82
7.3 Resid Bunker Fuel Substitution Volumes ..................................................................... 83
7.4 Prices of Conventional Marine Oils and the Blend Options ........................................ 84
7.5 WCS-WTI Price Differential Impact Due to the IMO Regulation ................................. 85
7.6 New SAGD Project Viability by 2020 ............................................................................ 86
7.7 Expanded SAGD Project Viability by 2020 ................................................................... 86
A.1 Generic Refinery Input-Output Regression Model ...................................................... 93
A.2 LP Optimization Model ................................................................................................ 95
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An Economic Assessment of the International Maritime Organization vii
List of Tables
1.1 SOx Emissions Controls ................................................................................................ 2
2.1 Crude Classifications by API and Sulphur Content ...................................................... 8
2.2 Available Refining Capacity .......................................................................................... 13
3.1 Crude Oil Classifications ............................................................................................... 18
3.2 Configurations of US Refineries ................................................................................... 20
3.3 Canadian and US Refinery Capacity and Configurations ............................................. 21
3.4 Sulphur Specifications of Refinery Products ................................................................ 23
3.5 Fixed and Variable US Refinery Costs .......................................................................... 24
4.1 High Sulphur Bunker Fuel Price ................................................................................... 40
5.1 Operational Risks of Using Marine Gasoil as a Bunker Fuel ........................................ 57
6.1 Maximum Refinery Losses Under Different Scenarios ................................................ 68
6.2 Canadian Crude Exports Status by PADD Region ......................................................... 75
6.3 Existing Rail Terminals and their Capacity from Western Canada .............................. 78
A.1 US Refinery Capacities and Configurations ................................................................. 95
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An Economic Assessment of the International Maritime Organization ix
Acronyms and Abbreviations

DFO Diesel Fuel Oil
ECA Emission Control Areas
FCC Fluid Catalytic Cracking
FMG Finished Motor Gasoline
GDP Gross Domestic Product
HFO Heavy Fuel Oil, same as HSFO and RFO
HSFO Heavy Sulphur Fuel Oil, same as HFO and RFO
HSO Heavy Sour Crude
HSW Heavy Sweet Crude
IBIA International Bunker Industry Association
IFO Intermediate Fuel Oil
IMO International Maritime Organization
KTJF Kerosene-Type Jet Fuel
LNG Liquefied Natural Gas
LP Linear Programming
LS Low Sulphur
LSFO Low Sulphur Fuel Oil
LSO Light Sour Crude
LSW Light Sweet Crude
MED Medium Crude
MGO Marine Gas Oil
NC Non-Compliance
PADD Petroleum Administration for Defence District
RFO Residual Fuel Oil, same as HSFO and HFO
SAGD Steam-Assisted Gravity Drainage
SOR Steam-to-Oil Ratio
TAN Total Acid Number
ULSD Ultra-Low Sulphur Diesel
WCS Western Canadian Select
WTI West Texas Intermediate
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An Economic Assessment of the International Maritime Organization xi
Executive Summary
A recent regulation by the International Maritime Organization (IMO) sets a global limit for
sulphur in fuel oil used to power ships at 0.5% (by mass) from the current 3.5% starting in January
2020. This more stringent regulation restricting emissions from ships plying international waters
could significantly change the crude oil landscape at regional and global levels. For example, the
2020 IMO sulphur regulation would require the removal of up to 12,000-16,000 tonnes per day
of sulphur contained in the 3-4 million barrels/day of high sulphur bunker fuel used for marine
transport. This change will propagate through the value chain; from the marine industry that will
seek replacement fuels to refiners that produce bunker fuel, and to upstream oil producers who
produce crudes that generate high sulphur residues used in bunkering.
Canada is one of the major producers of high sulphur heavy crude oil with production growing
steadily since 2008. Bitumen production is expected to reach 3 million bbl/day by the end of 2018
and continue increasing. Canadian heavy sour crude is refined primarily in Canada and the United
States (US) where there are sufficient capacities of complex refineries to handle this type of crude.
Canadian bitumen contributes very little to bunkering since it is consumed by the complex
refining in Canada and the US. Instead, Canadian crude will have to compete for US refining space
on netback refining value with other crudes that currently contribute to High Sulphur Fuel Oil
(HSFO) supply. The Canadian Energy Research Institute (CERI), therefore, used a refinery
modelling and optimization approach to investigate the impact of the IMO regulation on Canadian
crude production and price.
CERI Refinery Optimization Modelling

CERI developed an optimization model to account for US refinery configurations and their
operating costs, capital investments, crude oil blending, and the associated refinery acquisition
costs of crude blends, product slates and their market values, thus requiring the development of
revenue forecasts from the sales of refinery products. The results show that the optimization of
US refineries at a Petroleum Administration Defense District level (PADD-level) can lead to a
potential displacement of some volumes of certain crudes that have historically been processed
in some PADDs. Also, our results indicate that heavy sour crudes are likely to displace mostly light
sweet and medium crudes in a logistically and operationally unconstrained environment. In
addition, increases in heavy sweet crudes are expected in some PADDs.
With the imposition of more realistic constraints, the magnitude of these displacements is
reduced - mirroring recent crude receipts with optimal refinery margins. These results are driven
by cheaper heavy crudes, yield levels of high-value product slates, and profitability of the process.
The refinery margin improvements obtained from the realistic optimal case range from a 75% to
300% increase in profit, with the most notable improvement coming from PADD 1 (the US Eastern
region) but no improvement recorded for PADD 4.
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Non-Compliance Scenarios
Non-compliance regarding this new regulation is a serious concern for the IMO. CERI developed
scenario and price outlooks for various crude diets and refinery products for 2020, 2025 and 2030.
This facilitated the analysis of future prices for middle distillates, represented by ultra-low sulphur
diesel. Three non-compliance scenarios are assessed:
• Low non-compliance (Low NC) – assumes 80% compliance (20% non-compliance) by 2020
given up to 80% of global trade occurs between regions where ECA is in force and other
regions of the world.
• Moderate non-compliance (Moderate NC) – assumes 75% compliance (25% non-
compliance) by 2020.
• High non-compliance (High NC) – assumes 70% compliance (30% non-compliance) by
2020.
These scenarios consider the fact that non-compliance will differ across geographical regions, for
example in regions known for strict enforcement versus those known for less rigid enforcement.
IMO Regulation: Impact on US Refinery Margins

Changes in resid and distillate prices will reduce refinery margins to a notable degree, particularly
those of simple and medium refineries (Figure E.1).
Figure E.1: Refinery Margin Impacts Due to IMO 2020 Regulation
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An Economic Assessment of the International Maritime Organization xiii
Our analysis indicates a general trend of decreasing refinery netbacks in the years after 2020 in
all the non-compliance scenarios for medium refineries; complex refineries enjoy increased
margins in the Low NC scenario. Under the Low NC and Moderate NC scenarios, which are
considered the plausible scenarios given the low probability of the High NC, the IMO regulation
impacts will bring about a refinery margin loss of $16/bbl to $20/bbl between 2020 and post-
2025 relative to average 2017 margins.
Although some PADDs will have low margin reductions and even an increase in margins for some
by 2020, we expect the highest margin reduction refineries, in this case, the medium refineries in
the US, to set the prices for heavy sour crudes and determine the light-heavy crude price
differentials.
A general trend of declining margins for some years after 2020 results from an expected drop in
prices of middle distillates as the market rebalances and the distillate prices drop to normal levels.
Unfortunately, the price of resid will not recover at a rate that can stabilize the refinery margins,
and thus, cannot cushion the effect of the rebalancing middle distillates prices. This is because
the effect of price movements of the middle distillates outweighs the margin-boosting effect from
slowly increasing resid prices.
Scenario Assumption and Compliance Options

The Moderate NC scenario is chosen to assess how different options can substitute resid bunker
fuel volumes by 2020, 2025 and 2030 (see Figure E.2).
Figure E.2: Resid Bunker Fuel Substitution Effects under the Moderate NC Scenario
100%
14.0% 15.0%
Volume of HSFO captured
80% 11.0%
14.0%
25.0%
60%
60%
40% 61%
57%
20%
5.0% 7.0%
1.9%
5.0% 5.0%
0%
2020 2025 2030
Scrubbers Methanol LNG Low Sulfur Distillates Non Compliance Desulphuration Blended HSFO
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Once the rules take effect, almost 60% of the shipping industry fuel currently using high sulphur
resid will need to switch to either marine gasoil or a blend of high sulphur and ultra-low sulphur
middle distillate marine fuels. Under the Moderate NC scenario, we estimate that scrubbers will
be used for only about 3% of the HSFO volume by 2020. Adoption of scrubbers is likely to increase
moderately and peak by 2025 where about 5% of the resid bunker demand is consumed in
tandem with scrubbers. CERI projects that LNG will replace about 1.9% to 7% of resid bunker fuel
volume during the study period.
Conversion additions, mainly in China and India refineries, between end-2017 and the beginning
of 2020, amount to 1.7 million bbl/day, nearly split between coking, hydrocracking and catalytic
cracking (S&P Global Platts, 2018). The location of the refineries makes it improbable that these
conversion capacities will contribute significantly to low sulphur marine bunker fuels.
About 240,000 bbl/day resid hydrodesulphurization capacity can be assumed to contribute to low
sulphur fuel oil by 2020. This number will increase in the future as the increase in the light-heavy
product differentials is expected to motivate investments in desulphurization. Desulphurization
will capture up to 14% planned additional refinery resid hydrodesulphurization capacity by 2025.
Increasing refinery utilization capacities will be part of the solution to the bunker fuel availability
problem but will equally add to the problem of resid glut. This is because more resid will be
produced as refiner’s process more crude. World refineries can produce about 1.3 million bbl/day
of distillates together with 1.2 million bbl/day heavy fuel oil and related products. A 10% increase
in the global refinery capacities will result in 2.6 million bbl/day of distillates together with 2.3
million bbl/day heavy fuel oil and other products by 2030. In each case, large amounts of
distillates that can bridge the gap of cleaner bunker fuel demand can be produced, thereby
keeping high sulphur fuel oil prices low. Additionally, the world is reaching peak gasoline demand
and would not need the additional naphtha generated by the added crude processing.
The reason refiners are not making costly refining modifications like adding new coking capacities
at faster rates may be because the price volatility that will be created from the IMO rule
implementation is not expected to last long enough to make such investments viable. Markets
are expected to rebalance in a couple of years, and this discourages significant capital investments
in complex refining units, which have payback periods of at least two decades. Also, there seems
to be enough room to process more crudes to meet the expected increases in demand for
distillates for marine fuel use, but this does not address the problem of the residual oil glut arising
from the introduction of the IMO regulation.
Slow-steaming of ships is another approach the shipping industry may likely employ to save fuel
costs by consuming less fuel. Given that shipping fuel consumption has a velocity-squared
relationship, a slight reduction in ship speeds by a few knots (equivalent to 1.85 km/hour) will
lead to a significant reduction in fuel consumption and costs. Our analysis shows that reducing
ship’s speed to achieve a 25-50% reduction in fuel consumption is possible if the compliant fuel
prices skyrocket.
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An Economic Assessment of the International Maritime Organization xv
Impacts on Canadian Heavy Oil

The price discount on Western Canada Select (WCS) crude with respect to the West Texas
Intermediate (WTI) price point will expand significantly due to the IMO regulation. Figure E.3
illustrates how the refinery margin loss affects the WCS (heavy sour) pricing relative to WTI (light
sweet). The dotted lines represent the WCS pricing that is historically discounted at $13/bbl plus
the discounts resulting from the IMO regulation for the three scenarios considering a medium
refinery in the US.
Figure E.3: WTI and WCS Price Differential (2017 US$)

90
80
70
Crude prices ($/bbl)
60
50
40
30
20
2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
WTI WCS w/o IMO WCS Low NC WCS Moderate NC
Source: CERI
Under the plausible scenarios, a refinery margin loss of $16/bbl to $20/bbl between 2020 and
post-2025 is expected to be directly transferred to a light-heavy differential. The cumulative
differential which includes the historical WTI-WCS discount of $13/bbl sums up to $31/bbl-
$33/bbl of WTI-WCS differential within the study period.
Our analysis shows that new SAGD projects with SORs of less than 3 m3/m3 are likely to break
even when the IMO regulation is introduced whereas those with SORs greater than 3 m3/m3 will
operate at a loss. A significant volume of SAGD-derived bitumen production could be affected.
Based on SAGD production data, about 574,000 bbl/day of bitumen produced in Alberta has an
SOR of more than 3 m3/m3 (CanOIl, 2017).
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An Economic Assessment of the International Maritime Organization 1
Chapter 1: History of the IMO and

Regulations
The International Maritime Organization (IMO), formerly known as the Inter-Governmental
Maritime Consultative Organization, or IMCO, was established in 1948 in recognition of the
common goals for shipping nations to improve safety at sea. The first success of this organization
was the implementation of the International Convention for the Safety of Life at Sea (SOLAS) in
1960. This is still considered the most important of all treaties dealing with maritime safety. After
adopting SOLAS, the IMO proceeded to deal with matters such as the facilitation of international
maritime traffic, load lines and the carriage of dangerous goods.
Although safety was and remains the IMO's most important responsibility, a new problem began
to emerge – pollution. The growth in the amount of oil being transported by sea and in the size
of oil tankers was of concern and the Torrey Canyon disaster of 1967, in which 120,000 tonnes of
oil was spilled, demonstrated the scale of the problem.
In the late 1970s, the IMO introduced a series of measures designed to prevent tanker accidents
and to minimize their consequences. It also tackled the environmental threat caused by routine
operations such as the cleaning of oil cargo tanks and the disposal of engine room wastes. In
tonnage terms, engine room wastes are a bigger hazard than accidental pollution.
The most important of all these measures was the International Convention for the Prevention of
Pollution from Ships, 1973, as modified by the Protocol of 1978 (MARPOL). It covers not only
accidental and operational oil pollution but also pollution by chemicals, goods in packaged form,
sewage, garbage and air pollution.
MARPOL has been updated by amendments throughout the years to protect human health in
coastal cities from sulphur pollution, a known health hazard, and for protection of international
waters and the broader global environment. In 1997, a Protocol was adopted to amend the
Convention, and a new Annex VI was added which entered into force in May 2005. Annex VI –
Prevention of Air Pollution from Ships – set limits on sulphur oxide (SOx) and nitrogen oxide (NOx)
emissions from ship exhausts, prohibited deliberate emissions of ozone-depleting substances,
such as halons and chlorofluorocarbons (CFC), and designated emission control areas (ECAs) with
more stringent standards for SOx, NOx and particulate matter.
Further changes to MARPOL Annex VI addressed a progressive reduction globally in emissions of

SOx, NOx and particulate matter. The MARPOL Annex VI regulations that came into force in 2005
were revised in 2008; the revision came into force in 2010. For all oceans worldwide, the sulphur
content allowed was capped at 4.5%, and after 2012 this limit was reduced to 3.5%. Also, ECAs
established a further reduced sulphur limit. One ECA is along the North American coast, and
another comprises the Baltic Sea and the North Sea up to the Shetland Islands and the western
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entrance of the English Channel. Within ECAs the sulphur limit was initially set to 1.5%,
subsequently reduced to 1.0% in 2010 and now at its current limit of 0.1% since January 2015.
The ECAs established are:
• Baltic Sea area – as defined in Annex I of MARPOL (SOx only);

• North Sea area – as defined in Annex V of MARPOL (SOx only);
• North American area (entered into effect August 1, 2012) – as defined in Appendix VII of
Annex VI of MARPOL (SOx, NOx and PM); and
• The United States Caribbean Sea area (entered into effect January 1, 2014) – as defined
in Appendix VII of Annex VI of MARPOL (SOx, NOx and PM).
In 2016, the IMO introduced a new global limit on the sulphur content in marine fuels powering
ships with an effective date for the reduction of January 1, 2020. Under the new global cap, ships
will have to use marine fuels with a sulphur content of no more than 0.5%. The Emission Control
Areas will remain at the 2015 standard of 0.1% sulphur content in North America, Europe and
Baltics (Table 1.1).
Table 1.1: SOx Emissions Controls
Outside an ECA Established to Limit SOx Inside an ECA Established to Limit SOx and
and Particulate Matter Emissions Particulate Matter Emissions
4.5% m/m prior to January 1, 2012 1.5% m/m prior to July 1, 2010
3.5% m/m on and after January 1, 2012 1.0% m/m on and after July 1, 2010
0.5% m/m on and after January 1, 2020 0.1% m/m on and after January 1, 2015
Source: IMO
Historic Levels of Compliance

With the regulations in place, the question remains on how to verify the compliance of the ships
efficiently. To date, compliance is checked by inspection authorities who enter ships at berth,
review fuel log books and fuel quality certificates and, if suspicion is raised, take a fuel sample to
be analyzed at certified laboratories. With the results of the analysis, it is possible to verify
compliance and if needed, take legal action. However, these controls can check just a minor
number of ships. It is also not possible to evaluate the performance and compliance of scrubber
technology by predicting the amount of sulphur removed in bunker oil samples. This is a
challenge if this method becomes a more popular and common method to meet compliance in
the future.
In the ECAs, compliance by ships is high. For example, researchers at the Chalmers University of
Technology in Sweden have shown that between 87% and 98% of ships comply with the tougher
regulations for sulphur emissions that were introduced in northern Europe in 2015. The lowest
levels of compliance were observed in the western part of the English Channel and the middle of
the Baltic Sea.
July 2018
While the 1% limit in the ECAs could still be met with sulphur-reduced Heavy Fuel Oil (HFO), the
new regulation forces ships to either use more expensive alternatives such as marine gas oil
(MGO), ultra-low sulphur HFO, or consider reconstruction to enable the use of alternative fuel
such as liquefied natural gas (LNG) or methanol. As an alternative technology, the operation of
exhaust gas cleaning systems (scrubbers) is also permitted, if it provides the same level of
protection against sulphur dioxide emissions as the use of low sulphur fuel. These options have
been deployed to some ships, and the first studies have documented their effectiveness and
economic efficiency (Reynolds, 2011; Jiang et al., 2014), but they are still under development and
are not widespread. For the vast majority of ships, the only option to meet the regulations is to
use desulphurized fuel.
The different compliance methods include:
• Desulphurize refinery fuels and use lower sulphur content fuel.

• Switch entirely or partially to middle distillates for bunker fuel.
• Reduce SOx emissions via on-board scrubbers (also helps reduce particulate matter, PM).
• Undertake custom blending of fuels on board and use segregated bunkers tanks.
• Establish emissions trading, which could allow trading of marine and shore-based credits.
• Switch to alternative fuel sources (e.g., LNG, methanol).
Currently, enforcement rules and penalties are up to the individual member states and flag states.
Although there are no IMO global enforcing mechanisms, there are other approaches countries
might use to manage enforcement including restricting non-compliance ships and firms from
business dealings in the host or flag country. Those firms also face a reputational risk if non-
compliance is alleged or confirmed.
Impact of Previous IMO/ECA Regulations on Crude Markets

Much tougher rules governing emissions from ships plying international waters could significantly
change the crude oil market landscape at regional and global levels. For example, the 2020 IMO
sulphur regulation could require the removal of up to 20,000 tons per day of sulphur contained
in the 3-4 million barrels/day of high sulphur bunker fuel used for marine transport by 2020.
These sudden changes will propagate all along the value chain, from the marine industry that will
seek a replacement fuel, to refiners that produce bunker fuel, and to upstream oil producers who
produce crudes that generate high sulphur residues used in bunkers.
Will global refinery capacity be deployed to serving the marine market in 2020? Will refiners
produce suitable fuels, and what will be the composition of these fuels? How does one ensure
compliance, and how will the IMO tackle transitional issues? To what extent will the uptake of
scrubbers and alternatives impact overall demand?
In the previous regulations, when the ECA’s sulphur content dropped from 1% to 0.1%, the market
saw an introduction of a range of new fuel formations that cost less than expensive marine gas
oil, suggesting that a future with a global cap of 0.5% would not solely rely on an all-in switch to
distillates. There is likely going to be new types of blends emerging to meet the 0.5% limit. In fact,
July 2018
the International Bunker Industry Association (IBIA) expects a more widespread use of vacuum
gas oil and use of very low sulphur HFO where available with a bit of low sulphur blendstock
added. Some refineries are exploring opportunities to produce specific 0.5% marine fuels from
existing product streams, some refineries may desulphurize HFO, and some independent
innovators are looking to get into the marine fuel market by stripping sulphur out of HFO.
As with all predictions, there are uncertainties.
July 2018
Chapter 2: Global Crude Oil Markets

Crude Supply and Demand
Crude oil production and consumption have grown historically, and all indications are that despite
carbon management pledges by governments, production and consumption will continue to grow
(Figure 2.1). This growth responds to global population and gross domestic product (GDP). Global
GDP growth averaged 3.8% from 2001 to 2017 (IMF, 2018) whereas global population growth
averaged 1.2% within the same period (Worldometers, 2018).
Figure 2.1: Global and North American Crude Oil Production

100
90
80
Crude oil production (million bbl/d)
70
60
50
40
30
20
10
0
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
World - ref World - High oil price United States
World - Low oil price Canada
Source: EIA, CERI
According to the EIA’s International Energy Outlook 2017, global petroleum liquids consumption
is expected to have an average annual growth of 0.7% between 2015 and 2050 while global
annual GDP growth will average 2.3% during the period. Petroleum and other liquids production
are projected to have average annual production growth of 1.2% and 0.3% in Canada and the
United States, respectively (EIA, 2017).
Reduction of the sulphur content of bunker fuels from 3.5% to 0.5% in 2020 will ultimately
decrease the demand for high sulphur fuel oil flows, and as a result, impact crude oil flows and
prices globally. In 2016, sour and medium sour crudes, with sulphur content above 0.5 wt.%,
made up 64.5% of the global crude supply which is a significant fraction (Figure 2.2).
July 2018
Figure 2.2: Global Crude Production Volume by Quality in 2016
90,000
Crude oil production ('000 bbl/d)
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
-
2000 2005 2010 2012 2013 2014 2015 2016
Ultra Light Light and Sweet Light & Medium Sour Light & Sour
Medium & Sweet Medium & Medium Sour Medium & Sour Heavy & Sweet
Heavy & Medium Sour Heavy Sour Unassigned production
Source: ENI, CERI.
Global crude oil produced has seen an increase in its sulphur content, thereby becoming
increasingly sour. The fraction of medium sour and sour crude produced increased by 2.4% from
62.1% in 2000 to 64.5% in 2016. This trend seems to continue given depleting global sweet crude
oil resource dispositions and technological advancements that render unconventional resources
technologically and economically viable to extract. An exception to this trend is the fact that
technological innovation has also enabled significant increases in production of light sweet crude
from unconventional shale oil resources in the United States. US light oil production has increased
significantly whereas the Mexican Maya and Venezuelan heavy crudes supply have waned in
recent years and may continue to decline in future.
Figure 2.3 shows global crude oils, their sulphur contents and API gravities. The sulphur content
of residual oil reflects the quality of the crude oil that produces it. Crude quality is influenced
chiefly by its sulphur content and the density measured as API gravity. This means that the higher
the sulphur content of the crude, the higher the sulphur content of the residual oil, and vice versa.
On the other hand, the higher the API gravity, the lower the yield of residual oil produced and
vice versa.
July 2018
Figure 2.3: Quality and Production Volume of Major Crudes in 2016
Source: ENI
Unless significant shale oil fracking is sanctioned and deployed in other regions with shale oil
resources, it is still reasonable to expect that the long-term outlook of crude quality will at least
remain unchanged or become increasingly sour. Crude with a sulphur content greater than 0.5
wt.% are regarded as sour (see Table 2.1), and these types of crudes generate a significant
proportion of high sulphur fuel oil used as bunker fuel.
July 2018
Table 2.1: Crude Classifications by API and Sulphur Content
Crude
API S Wt.% Examples
Classification
Light sweet >=35 <0.5 WTI, LLS, Brent
Arab Light (Saudi Arabia), West Texas Sour,
Light sour >=35 >0.5 Canadian Light Sour, Alaska North Slope, Forties
Blend, Hibernia Blend
Medium sour 27-35 >0.5 Mars, WTS, Arab medium, Basra light, etc.
Heavy sweet <=27 <0.5 Indonesia Duri
Heavy sour <=27 >0.5 Maya, Cold Lake, WCS, Arab Heavy
Source: CERI; classifications are based on EIA (2018) crude imports.
Though marine bunker fuels account for about 4% of global demand, they are an important outlet
and revenue for the refining industry (IEA, 2018a). The marine industry absorbs unwanted
residual fuel oil – a refinery product which has declining demand due to factors including
emissions control regulations that require cleaner-burning fuels onshore and the decrease in
residual fuel oil demand for non-bunker uses.
Figure 2.4 shows that heavy crude oil production from the Americas (Argentina, Brazil, Canada,
Colombia, Ecuador, Mexico, United States and Venezuela) is a large portion of the global medium
sour and sour crudes produced in 2016. A staggering portion (about 82%) of global heavy crude
supply came from the Americas in 2016. Twenty-nine percent of all crudes produced in this region
is medium sour and sour crude types (not shown in Figure 2.4). The Americas produced about
26% of the global crude volume in 2016. The significance of these statistics is that the IMO sulphur
regulation is likely to have the greatest impact on producers in the Americas because countries in
this region are the producers of heavy and sour crudes.
July 2018
Figure 2.4: The America’s Share of Global Crude Oil Types Produced, 2016
Heavy Sour
Heavy & Medium Sour
Heavy & Sweet
Medium & Sour
Medium & Medium Sour
Medium & Sweet
Light & Sour
Light & Medium Sour
Light and Sweet
Ultra Light
Total
0% 10% 20% 30% 40% 50% 60% 70% 80% 90%
Source: Data from ENI, Calculations by CERI
Crude oil production growth in the US will be dominated by light sweet shale oil whereas in
Canada crude oil production growth will be driven by oil sands-derived heavy sour crude.
Canada’s resource disposition is predominantly high sulphur heavy crudes. Canada (specifically,
Alberta) is one of the major producers of high sulphur heavy crude oil with its production growing
steadily since 2008. In CERI’s reference case, shown in Figure 2.5, bitumen production is expected
to reach 3 million bbl/day by the end of 2018 and continue afterwards (Millington, 2018).
Figure 2.5: Canadian Historical and Projected Bitumen Production

6,000
Bitumen production ('000 bbl/day)
5,000
4,000
3,000
2,000
1,000
-
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
Mined Bitumen Extraction Total In-Situ Bitumen Extraction
Source: CERI
July 2018
Canadian heavy sour crude is refined primarily in Canada and the United States. These countries
have sufficient capacities of complex refineries that can handle this type of crude. Refinery
operators want to minimize the residual oil yield unless they are built to process residual oils into
lighter ends, through medium and deep conversions. Therefore, heavy sour crudes are sold at a
discount to the light sweet crudes. The price discount of Canadian heavy crude relative to light
sweet crudes is analyzed in Chapter 4.
Global High Sulphur Residual Oil Market

The global market for high sulphur resid has been under pressure for some time with the
increased availability of LNG primarily for power generation. According to the EIA, the global
residual oil demand stands at about 7.8 million bbl/day. Of this amount, about 3.2 million bbl/day
is used as bunker fuel (see Figure 2.6).
Figure 2.6: Residual Fuel Oil Demand
Source: Shell (2017), S&P Global Platts (2018)
The decline in the demand and supply of residual fuel oil is caused by a perpetual decrease in the
demand of the non-bunker residual market. As can be seen in Figure 2.6, residual fuel oil demand
for purposes other than bunker fuels has declined since the 1990s. This trend is expected to
continue given the increasing use of natural gas and LNG which are cleaner fuel options and are
becoming more economical alternatives to residual fuel oil use for power generation and
industrial use. It remains to be seen whether a decrease in the price of high sulphur fuel oil will
lead to a significant increase in the use of this fuel for power generation and industrial
applications. The global residual oil demand and supply have decreased historically, and this trend
is expected to continue in the future (Figures 2.6 and 2.7).
July 2018
Figure 2.7: Jurisdictional Fuel Oil Consumption

12,000
Fuel Oil Consumption (million bbl/day)
10,000
8,000
6,000
4,000
2,000
0
2000 2002 2004 2006 2008 2010 2012 2014 2016
Asia Middle East Europe & Eurasia S. & Cent. America Africa U.S. Canada
Source: BP (2017), CERI.
The global residual fuel demand has decreased since the 1980s from close to 13 million
barrels/day to about 8 million barrels/day in 2014 (Mayes, 2015). Residual fuel production has
followed the same trend, declining in response to the falling trend of demand.
The period 2005 to 2010 marks a period of remarkably high bunker demand growth which also
matched periods of high growth in GDP, global trade and fleet capacity. During this period, bunker
demand grew by 3.1% annually on average driven by an expansion of global trade of 4% and
overall GDP growth of 3.4% (S&P Global Platts, 2018). The bunker demand growth dropped to an
average growth of 1.3% annually between 2010 and 2015 but is projected by S&P Global to stay
above 2.5% annually between 2020 and 2025. The projected growth is expected to be driven by
an optimistic future of GDP and waterborne growth of 3%.
The projected bunker demand growth will not translate to residual oil demand growth for bunker
fuel. Rather, a dramatic decrease in the residual oil demand for bunker fuel is expected by 2020
due primarily to the MARPOL 2020 Regulation. In 2016, high sulphur residual oil made up about
45.8% of the total fuel oil demand out of 7.2 million bbl/day fuel oil demand and 3.5% of total oil
demand (Fitzgibbon, Martin, & Kloskowska, 2017). Regional bunker fuel demand by type (Figure
2.8) shows that the Asia Pacific and Europe have the highest levels of fuel oil demand.
July 2018
Figure 2.8: Bunker Fuel Consumption by Type, 2016
1.5 1.4
Bunker fuel demand (million bbl/day)
1
0.7
0.5
0.5 0.4
0.3
0.2 0.2 0.2
0.1 0.1 0.1 0.1
0.1
0
North America Latin America Europe Africa Former Soviet Middle East Asia Pacific
Union
Fuel oil Gasoil/Diesel Other
Source: McKinsey (Fitzgibbon et al., 2017), CERI.
Middle Distillates Oil Markets

Historically, global demand for diesel and other distillates has increased and is projected to grow
further. Global consumption of diesel and gasoil is dominated by Asia and Europe, with more than
half of the global demand coming from these regions (Figure 2.9).
Figure 2.9: Global Diesel and Gasoil Consumption

30,000
Diesel/Gasoil Consumption
25,000
20,000
('000 bbl/day)
15,000
10,000
5,000
0
2000 2002 2004 2006 2008 2010 2012 2014 2016
Asia Europe & Eurasia U.S. S. & Cent. America Middle East Africa Canada
Source: BP (2017), CERI.
Global capacity to produce desulphurized gasoil, resid and middle distillates is highest in three
regions: North America, Asia Pacific and Europe (Figure 2.10 and Table 2.2). Fortunately, the major
demand centres for diesel and gasoil such as Asia, Europe and North America have high
desulphurization capacities. However, even if the capacities are ramped up to 90%, they will not
July 2018
sufficiently meet the demand for diesel and gasoil. On the contrary, desulphurization capacities
for vacuum gasoil and fuel oil far exceed the demand for fuel oil in some regions, particularly in
North America and Europe.
Table 2.2: Available Refining Capacity (million bbl/day 2017)

Russia Other
US and Latin Middle
Africa Europe and China Asia- World
Canada America East
Caspian Pacific
Distillation
Crude oil
20.3 8.0 4.1 17.1 7.1 8.9 13.9 18.0 97.4
(atmospheric)
Vacuum 9.3 3.6 1.0 6.7 2.9 2.5 5.5 5.7 37.2
Upgrading
Coking 2.9 0.8 0.1 0.7 0.4 0.3 1.9 0.9 8.0
Visbreaking 0.2 0.4 0.2 1.6 0.5 0.6 0.2 0.5 4.1
Solvent
0.4 0.1 0.0 0.1 0.0 0.1 0.1 0.1 1.0
Deasphalting
Catalytic cracking 6.0 1.6 0.3 2.4 0.7 0.9 3.1 2.8 17.7
Hydrocracking 2.3 0.2 0.2 2.0 0.4 0.8 1.6 1.5 9.0
Total Upgrading 11.8 3.1 0.8 6.8 2.0 2.7 6.9 5.8 39.8
Source: OPEC WOO 2017
Figure 2.10: Global Refined Oil Product Desulphurization Capacities
World
Other Asia-Pacific
China
Middle East
Russia & Caspian
Europe
Africa
Latin America
US & Canada
0 5 10 15 20 25 30
Capacity (million bbl/day)
Vacuum gasoil/Residual Middle distillates
Source: OPEC (2017)
July 2018
July 2018
Chapter 3: Impacts on the Refining Sector

In this chapter, the impacts of the IMO regulation on the refining sector are assessed.
Refineries are a complex system of various operations and vary from simple (hydroskimming) to
medium and deep conversion configurations. Hydroskimming refineries are simple in
configuration with crude distillation being the major process operation. This type of refinery lacks
upgrading facilities, and thus, cannot further process residuals into high-value products.
However, medium and deep conversion refineries, which are complex refineries, can process
heavier fractions into lighter distillates.
An overall process schematic for a typical refinery operation resulting in distillates and the
residual oil is shown in Figure 3.1. Figure 3.2 shows the percentage yield of refineries with various
complexities.
Figure 3.1: A Typical Hydroskimming Refinery Process
Source: Kaiser (2017)
July 2018
Figure 3.2: Product Yields for Refineries with Different Complexities

60%
50%
40%
Product makeup
30%
20%
10%
0%
Hydroskimming Medium Conversion Deep Conversion
LPG Gasoline Distillate Heavy Fuel oil and other
Source: CERI
An important challenge for refiners will be the disposal of excess high-sulphur residue, which will
no longer find demand as a bunker fuel by 2020. The composition of residuum are as follows:
carbon (83%–87%), hydrogen (10%–14%), nitrogen (0.1%–2%), oxygen (0.1%–1.5%), sulphur
(0.5%–6%), and heavy metals (e.g., Ni and V) under 10 parts per million (Elshout, Bailey, Brown,
& Nick, 2018).
The dramatic decrease in demand is expected to lower the price for high-sulphur resid fuel. Most
analysts agree that this surplus would have to clear into lower price tiers, such as oil-fired power
generation, at prices which could be as low as thermal parity with coal (Grati, 2017). The situation
creates both opportunities and challenges for refiners.
Delayed coking, visbreaking, fluid coking, solvent deasphalting and residual fluid catalytic cracking
(FCC) are some of the widely applied processes to convert resid into lighter products which are
more valuable (Elshout et al., 2018). Refiners with these carbon rejection technologies have
significant advantages over others.
Refiners that could benefit from the IMO regulations (Ruiz-Cabrero, Govindahari, & Moreno,
2017) would have the following characteristics:
• Complex refineries with coking, hydrocracking and residue desulphurization that

maximize LSFO and distillate. For example, most refineries in the US (particularly in PADDs
2 and 3), Asia and the Middle East.
• Refiners that convert residual oil to distillates will benefit because of investments in
delayed coking which produces both gasoline and distillates.
July 2018
• Refiners that use intermediate residue streams, such as hydrotreated vacuum gas oil
(VGO) will benefit by realizing a higher price at a lower cost than refiners that use
distillates (Ruiz-Cabrero et al., 2017).
• Coker refineries, especially in the US Gulf Coast (PADD 3), PADD 2 and Asia.
• Refineries with access to crudes with a very low sulphur content.
Refineries that will suffer from the IMO regulations (Ruiz-Cabrero et al., 2017) include:
• Simple refineries that produce mostly HSFO. Examples are high sulphur hydroskimming
and topping refineries in Russia.
• Refineries with low distillate yields such as pure-play gasoline refineries in northwest
Europe and the US East Coast.
• Pure-play gasoline refiners with FCC units and reformers will be unfavourably affected
during the period of disruption.
• Pure-play gasoline refiners may operate the gasoline-generating FCC units at lower
utilization rates in order to reduce gasoline production.
Refinery location is also important. HSFO prices have been lower in regions such as northwest
Europe, the US Gulf Coast and Singapore.
CERI Refinery Model

CERI uses a generic Input-Output model to capture:
• Inputs and outputs of the US refineries by PADD as illustrated in Figure 3.6.

• The various types of refinery configurations currently operating in the United States.
• Nominal and available refining capacities at individual PADDs.
• Differences in crude blend flows and product slates at each PADD.
• Sulphur handling capacities at refineries within each PADD.
The model predicts product slates using as predictors the crude blends flows at different types of
refineries in each US PADD district. More detail about the modelling approach is presented in
Appendix A. CERI developed its crude oil refinery model using historical EIA data of crude oil
feedstocks into various refineries within individual PADDs in the United States. Crude oil flows are
categorized into five types based on API values and sulphur contents, as shown in Table 3.1.
July 2018
Table 3.1: Crude Oil Classifications
Crude Oil Type Range of Range of Sulphur Representative API o Sulphur

API o Content (wt.%) Crude Content
(wt.%)
Light Sweet (LSW) >35 <0.5 WTI 37.5 0.4
Light Sour (LSO) >35 >0.5 Arab light 38.7 0.8
Medium (MED) 27-35 >0.5 Iraq Basra 30.2 2.9
Heavy Sweet (HSW) <=27 <0.5 Indonesia Duri 20.3 0.2
Heavy Sour (HSO) <=27 >0.5 WCS 21.0 3.5
Source: CERI; classifications are based on EIA (2018) crude imports.
A monthly time series data from January 2009 to December 2017 is explored to understand the
range of quantities of each crude type refined at the PADDs – as shown in Figure 3.3. Analysis of
the time series data is important to understand the patterns of crude flows into various US PADDs.
Figure 3.3: Historical Ranges of Crude Oil Flows into US PADDs

0.9
0.8
0.7
0.6
Quantity in Feedstock (%)
0.5
0.4 min_Pctge
0.3
0.2 max_Pctge
0.1
0
LSO
LSO
LSW
MED
LSO
LSO
LSO
LSW
MED
LSW
MED
LSW
MED
LSW
MED
HSO
HSO
HSW
HSO
HSW
HSW
HSO
HSW
HSO
HSW
PADD1 PADD2 PADD3 PADD4 PADD5
Product data (see Figure 3.4) reveals the products predominantly generated from each PADD. The
product information allows the model to reflect the important products and enhance its
predictive power.
July 2018
Figure 3.4. Historical Percentages of Refined Oil Products
KEY
• HGLs – Hydrocarbon gas liquids, • DFO – Distillate fuel oil
• FMG – Finished motor gasoline • RFO – Residual fuel oil
• OOP – Other oils for petrochemicals
• AG – Aviation gasoline
• SNaphtha – Special naphtha
• KTJF – Kerosene-type jet fuel, • SG – Still gas
• Lub – Lubricants • MPP – Miscellaneous petroleum products
• ARO – Asphalt and road oil
July 2018
As can be observed from Figures 3.3 and 3.4, greater effort is focused mainly on the major
products which include finished motor gasoline (FMG), distillate fuel oil/diesel (DFO), kerosene-
type jet fuel (KTJF), residual fuel oil (RFO) and coke.
Refinery configuration, crude feedstock data from the EIA, refining economics data from the Oil
& Gas Journal (Oil & Gas Journal, 2017) and the recommendations from NETL`s Refinery
Benchmark Study (Cooney et al., 2016) provided relevant information used to develop the
refinery model. The model known as PRELIM (Abella, Motazedi, Guo, & Bergerson, 2016) is used
as a source of crude assay data and model validation. Further, refinery products modelling results
are compared with EIA published products data at the PADD level.
The US and Canadian refinery information, their configurations and throughputs are presented in
Tables 3.2 and 3.3.
Table 3.2: Configurations of US Refineries (bbl/day)

Deep
US Capacity Hydro- Medium Conversion Deep Conversion - Coker Conversion -
Region (bbl/day) skimming Resid HC
FCC GO-HC Both FCC GO-HC Both FCC
PADD1 1,213,800 5.8% 66.8% - - 12.8% - 14.7% -
PADD2 4,004,040 10.7% 17.0% - 1.8% 46.9% - 23.6% -
PADD3 9,621,767 5.1% 7.9% 1.3% 2.7% 45.0% 0.4% 35.0% 2.6%
PADD4 683,245 26.6% 17.6% - - 55.7% - - -
PADD5 2,934,785 7.9% 9.6% 5.6% 8.6% 37.4% 12.1% 18.9% -
US 18,457,637 7.6% 14.6% 1.6% 3.1% 42.4% 2.1% 27.3% 1.3%
Source: NETL (Cooney et al., 2016), Oil and Gas Journal (2017), CERI.
July 2018
Table 3.3: Canadian and US Refinery Capacities and Configurations

Catalytic Catalytic Catalytic
Thermal Processes
Cracking Hydrocracking Hydrotreating
Fresh & Distillate, Gasoil
Coking & Distillate,
US Refining Capacities Crude Vacuum recycled & Resid
visbreaking Gasoil & Resid
feed desulphurization
PADD 1 1,213,800 526,680 73,350 453,150 40,770 409,140
PADD 2 4,004,040 1,723,470 529,020 1,216,620 318,980 1,674,610
PADD 3 9,621,767 4,509,333 1,468,150 2,820,015 1,204,600 3,840,653
PADD 4 683,245 241,005 81,290 203,539 54,720 304,623
PADD 5 2,934,785 1,521,150 548,580 815,580 536,570 1,097,250
Total US Refining
Capacities 18,457,637 8,521,638 2,700,390 5,508,904 2,155,640 7,326,276
Canadian Refineries
Parkland Fuel Corp. -
Burnaby, BC 55,000 11,800 0 17,800 0 16,500
Consumers - Cooperative
Refineries Ltd. - Regina,
Sask. 145,000 40,000 10,000 25,000 0 55,000
Husky Oil Operations Ltd. -
Lloydminster, Alta. 82,000 15,000 7,500 0 0 0
Husky Oil Operations Ltd. -
Prince George, BC 12,000 0 0 3,300 0 0
Imperial Oil - Edmonton,
Alta. 189,000 69,000 0 64,500 0 78,500
Imperial Oil - Dartmouth,
NS 85,000 41,500 0 31,500 0 16,000
Imperial Oil - Nanticoke,
Ont. 113,500 48,000 0 48,500 0 29,500
Imperial Oil - Sarnia, Ont. 119,000 31,500 25,500 30,500 18,500 14,500
Irving Oil Ltd. - St. John,
New Brunswick. 300,000 100,000 20,000 95,000 34,000 0
Nova Chemicals (Canada)
Ltd. - Corunna, Ont.* 80,000 33,000 0 0 0 0
Shell Canada Ltd. -
Scotford, Alta. 92,000 0 0 0 62,000 0
Shell Canada Ltd. - Sarnia,
Ont. 71,000 24,400 5,000 19,000 9,000 0
Silver Range Financial
Partners LLC -, Newf. 115,000 55,000 20,000 0 0 25,000
Suncor Energy Inc. -
Edmonton, Alta. 142,000 47,500 17,100 40,850 0 98,800
Suncor Energy Inc. - Sarnia,
Ont. 85,000 26,730 0 16,668 32,078 43,588
Suncor Energy Inc.-
Montreal, Que. 137,000 54,000 0 32,000 0 33,000
Valero Energy Corp.,
Ultramar Ltd. - Levis, Que. 23,5000 48,500 0 67,500 0 70,800
Total Canadian Refining
Capacities 2,057,500 645,930 105,100 492,118 155,578 481,188
*Uses Marcellus ethane feedstock

Source: Oil and Gas Journal (2017), CERI
July 2018
A linear programming optimization model is developed using the input-output refinery model,
and the parameters obtained based on the above-noted methodology. In developing a refinery
linear programming model, the following economic parameters considered are (see Figure 3.5):
• Refinery configurations and their operating and fixed costs.

• Crude oil blending and the associated refinery acquisition costs of crude blends.
• Revenue generated from the sales of refinery products.
Figure 3.5: Optimization Model Design and Components
The objective of the PADD-level refinery optimization is to determine the makeup of a crude blend
that maximizes refinery margins given certain imposed constraints.
The baseline refinery LP optimization model is developed to determine optimal margins for each
PADD for the refineries operated in December 2017. The results are compared with those
obtained using PADD-level historical information published from December 2016 to December
2017.
Compliance scenarios for 2020, 2025 and 2030 when the IMO sulphur regulations will be in effect
are assessed using the optimized model. Historical minimum and maximum compositions (based
on January 2009 to December 2017 monthly values) of crude feedstocks into the US PADDs are
considered.
By constraining the composition of each crude type flowing into individual PADDs within limits of
the volumes processed in the past (following EIA data, Figure 3.3), CERI maintained realistic crude
input flows into each PADD. We also recognize the different refinery configurations that exist in
each PADD and their requirements on handling high sulphur crude or high TAN (Total Acid
Number) crude. For example, Canadian bitumen is high sulphur, high TAN which only a few
refineries have the required metallurgy to process.
It is important to note the absence of vacuum distillation units in some of the complex coking
refineries in PADD 3. By implication, these refineries cannot operate above the 950 oF residue cut
point when significant quantities of bitumen are in the feed. The furnace tube velocity is too low
July 2018
to increase the required transfer temperature needed for bitumen without excessive feed
cracking and tube coking in the furnace. To achieve a more reasonable 1,020/1,050 cut point,
therefore, requires design modifications to the velocity steam system, furnace tube sizing,
transfer piping diameter, column inlet design and overhead vacuum system for many, if not most,
vacuum column systems in PADD 3 (James, 2018).
However, our PADD-level model only permits the historical levels of different types of crudes that
have been previously processed in each PADD. This means that the refineries in that PADD treated
such crude blends in the past and, thus, it can be assumed that the PADD can process the same
type of crude blends currently or in the future.
This is a conservative approach that restricts the crude blending options to a known historical
observation. We recognize that there might be other crude blend alternatives that exist outside
the historical space being considered. However, the introduction of those alternative blends
brings issues of sulphur and TAN limitations that affect the compatibility of the blends with the
existing refinery infrastructure. It is for this reason that the model is scoped only to include crude
blends that have been processed previously.
Similar to the historical crude blend constraints, the minimum and maximum yields of each
product produced between January 2009 and December 2017 (EIA data, Figure 3.4) are identified
and used to constrain the yields of products from the optimization model. This approach limits
the solution space to only the range of yields that have been reported to correspond to historical
crude mix processed in that PADD during the same period.
The refinery capacity factors published by the EIA are imposed on the optimization model to
specify availability. This is necessary to ensure that the volumes of crudes processed in a PADD
are aligned with the design and operational capacity factor and throughput.
Sulphur contents of the crude blends and products are very important parameters of the model.
The sulphur content of the crude is controlled to ensure that the refinery can handle the feed
whereas the sulphur content of the refinery products must meet set requirements (see Table 3.4).
Table 3.4: Sulphur Specifications of Refinery Products
Refinery Products Notation Sulphur Specs.

(Wt.%)
Finished motor gasoline FMG 0.003
Kerosene-type jet fuel KTJF 0.3
Distillate fuel oil DFO 0.0015-0.05
Heating fuel oil HFO 0.05
Residual fuel oil (Bunker) RFO 0.4-3.5
Coke Coke 1-6
Source: CERI
July 2018
Also, information on total sulphur input into refineries and sulphur production from the PADDs
are used to constrain the model to the historical range of sulphur loads and to ensure that the
material balance of sulphur flows is satisfied.
Table 3.5 shows our assumed fixed and variable costs for refineries. The cost does not include
initial capital investments.
Table 3.5: Fixed and Variable US Refinery Costs
Fixed Variable Total

PADD 1 3.54 0.96 4.5
PADD 2 2.87 0.89 3.76
PADD 3 2.55 1.05 3.6
PADD 4 2.87 0.89 3.76
PADD 5 3.34 1.38 4.72
Source: Oil & Gas Journal (2018)
For the baseline refinery and LP optimization model, the average crude and product prices for
December 2017 are used (see Figure 3.6 and Table 3.6).
Figure 3.6: Historical Crude Pricing

65
60
Crude price ($/bbl)
55
50
45
40
35
30
Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17
Heavy Sour Light Sweet Medium Light Sour Heavy weet
July 2018
CERI Refinery Modelling Results

We present in this section the results of the generic PADD-level refinery model which is for PADDs
1-5. When provided with a crude blend assay that typifies what has historically been fed into
PADDs 1-5, the model calculates the product slate using built-in multivariate correlations (see
Figures 3.7-3.11). The PADD-level refinery model shows a reasonable fidelity level with a
coefficient of determination of between 77% and 87%, indicating the ability of the model to
predict the response variable.
Figure 3.7: PADD 1 Calculated versus Actual Refined Product Volumes
July 2018
July 2018
CERI Refinery Linear Programming Results

Potential Crude Displacement
For the case modelled here, the results show that optimization of refineries at a PADD-level can
lead to a potential displacement of some volumes of certain crudes that have historically been
processed (see Figure 3.12).
Figure 3.12: Potential Crude Displacements
20%
15%
Change in crude types due to PADD-level
10%
5%
0%
optmization
-5%
-10%
-15%
-20%
-25%
HSO HSW LSO LSW MED
July 2018
Results (Figure 3.12) show that the heavy sour crudes are likely to displace mostly light sweet and
medium crudes. In addition to this observation, increases in heavy sweet crudes are expected in
some PADDS. These results are driven by the cheaper priced crudes, yield levels and high-value
products, and profitability of the process.
In the optimized scenarios, PADDs 1, 4 and 5 have their heavy sour crude intakes increased by 17-
20% above what they processed between December 2016 and December 2017 (Figure 3.13). The
optimal crude composition indicates that heavy sweet components of the crude blends will
increase by 6% in PADDs 1, 13% in PADD 2 and 16% in PADD 5.
Figure 3.13: Composition of Heavy Sour and Heavy Sweet Crudes:

Model versus Optimal Blends
On the other hand, the light sour composition in the optimal crude blends for all the PADDs except
PADD 4 increased when compared to the historical data (Figure 3.14). Light sour crude
composition increased by 11% in PADD 1, 3% in PADD 2, 10% in PADD 3 and 27% in PADD 5.
July 2018
Figure 3.14: Composition of Light Sour and Light Sweet Crudes:

Model versus Optimal Blends
Results show a decrease of light sweet compositions in almost all the PADDs. The highest and
most notable drop in the light sweet composition is in PADD 1 which has a 21% reduction. In the
rest of the PADDs, only a decrease of less than 3% is expected. A reason for this general trend is
the high cost of light sweet crude, which is represented using the WTI price benchmark. Another
reason is that the yields are less than those from heavier crudes.
Similarly, medium crude has its composition in the optimal crude slate decreased in all the PADDs
(Figure 3.15) with PADD 5 being the most notable case with a 56% reduction followed by PADD 1
with a 16% reduction.
Figure 3.15: Composition of Medium Sour Crudes: Historical versus Optimal Blends
July 2018
It is important to remember that in the optimal scenario, each PADD is constrained to process
crude blends within the highs and lows of the crude blend compositions treated in the past. These
conditions are imposed upon the refinery regression model that captures the operations of the
US refineries at PADD-levels. In other words, the results push the boundaries of crude types
processed in a PADD-level refinery to an edge. The optimal solution may replicate certain past
operating conditions which may not be the exact current operating strategy.
However, availability and accessibility of the different crude types and logistical issues impose
additional constraints that warrant further consideration.
Realistic Optimal Crude Blends and Margins

If adequate volumes of the crudes are available, the logistics to deliver the crude is in place, and
the refineries are equipped to handle the corresponding levels of sulphur and TAN, then
processing cheaper heavy and sour crudes will improve refinery margins because of high
conversion levels and product yields. However, that is not the case for all the PADDs. Some PADDs
cannot receive and process larger amounts of some crude types. For example, PADD 2 has the
highest concentration of coking refineries among the US PADDs and thereby, processes the
highest amount of heavy sour crudes. PADD 2 currently processes about 1,767,000 bbl/day of
Canadian heavy crude and provides the largest market for Canadian crude exports.
When operational and logistical constraints are applied to the optimal model, CERI determines
crude blends which reflect frequently used crude compositions and optimizes the PADD-level
refinery margins. Examples of such realistic and optimal refinery crude intakes are shown in Figure
3.16.
Figure 3.16: Composition of Crude Blends Limited by Logistics and Operations

HSO HSW LSO LSW MED TOTAL
2,031,648
1,990,786
1,203,250
1,110,230
854,859
709,958
565,716
460,071
373,919
285,649
274,691
249,716
247,921
235,401
226,766
125,409
118,440
102,157
97,810
70,698
30,155
28,530
19,776
10,760
9,402
1,683
-
-
-
-
July 2018
Results of an assessment of the refinery margins of complex refineries (cokers) and medium
refineries (catalytic hydrocrackers, FCCs) using the historical average blend compositions for each
PADD in 2017 are presented in Figure 3.17. It is important to note that the refinery margins for
cokers are significantly higher than those of FCCs. Medium and simpler (hydroskimming) barely
break even. Current margins for global hydro skimming refiners provide little if any room for these
refiners to accept less. An example is the recent bankruptcy of the 335,000 bbl/day Philadelphia
Energy Solutions refinery. On the other hand, however, complex refineries had margins that are
3.5-9 times higher than those of FCCs.
Figure 3.17: Average 2017 Refinery Margins of Cokers and FCC
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
0 5 10 15 20
Refinery Margins ($/bbl)
By optimizing refinery margins in our PADD-level analyses, significant improvements in the

refinery margins are obtained given the wider solution space – relative to that of an individual
refinery. Consequently, the refinery margin improvements obtained from the realistic optimal
case range from 75 to 300 percentage points with the most notable improvement coming from
PADD 1 (Figure 3.18). However, no visible improvement is recorded in the case of PADD 4.
July 2018
Figure 3.18: Improvement of Refinery Margins
40
35
30
25
20
15
10
5
0
Historical Optimal
July 2018
Chapter 4: Scenario Analysis

In this chapter, modelling results and interpretation will be presented. Scenarios will explore non-
compliance levels, crude and refinery product prices and how these affect refinery margins, and
consequently, determine the light-heavy crude price differentials. The baseline for this analysis is
2017, and the analysis covers pre- and post-2020. Detailed modelling and analysis are made up
to 2025.
Scenarios for Future Refinery Outlook

In this section, we explore how US refining margins will respond to the IMO 2020 regulations, and
in particular to an expected drop in the price of high sulphur resid. The IMO regulations, if fully
complied with, should displace more than 3.2 million bbl/day of resid currently used as fuel in
the shipping industry. The resultant effect is a potential demand loss of more than 3.2 million
bbl/day of resid by 2020 and afterwards, and consequently, a product price decrease compared
to 2019 price levels.
The level at which demand and price drop will be influenced by the level of compliance of the
shipping industry to the IMO regulation.
We used our optimized model to assess the refining margins by 2020, 2025 and 2030 at PADD-
levels. This calculation is done by considering compliance scenarios and price outlook of various
crude diets and refinery products. Future prices of middle distillates, represented using ultra-low
sulphur diesel, are also assessed. The price of ultra-low sulphur diesel is expected to increase in
response to the dynamics of the bunker fuel markets.
Residual Fuel Oil Balance and Potential Markets

Asia produces the highest amount of fuel oil from refineries in the world, accounting for 22% of
the 8.6 million of global fuel oil production (Figure 4.1). Asia is also the largest importer of fuel oil
with about 2.18 million bbl/day imported in 2015.
July 2018
Figure 4.1: Global Fuel Oil Production, 2015

5,000
4,000
Fuel oil use ('000 bbl/day)
3,000
2,000
1,000
-1,000
-2,000
Africa Asia Latin N. America Middle East non-EU EU Oceania Other Asia
America Europe
Production from refineries Imports Exports Fuel Oil Used
Source: UN Data (2018), CERI
The second and third largest fuel oil producers are non-EU Europe and the EU, each contributing
about 19% and 15% of the total global fuel oil production. Thus, cumulatively, fuel oil production
in Europe makes up 34% of the global fuel oil production. While being a large producer of fuel oil
does not mean that the region is a large consumer of fuel oil for international bunkers, as is the
case with the EU, the third largest fuel oil producer as well as the second largest user of fuel oil
for international bunkering. The EU is another region to watch because the 2020 sulphur
regulation is likely to impact the region significantly as compliance levels are expected to be high.
Another region that will be hard hit by the IMO 2020 regulation is the Middle East. This region
produces 18% of the global fuel oil from refineries but consumes about 16% of the global fuel oil
used in international bunkers. The extent of the impact that the IMO sulphur regulation will have
on Middle East bunker fuel market will depend on the compliance level in this region. The
compliance level will vary in different jurisdictions. The Middle East is the second highest
consumer of fuel oil in the world after Asia.
Currently, residual fuel oil finds applications across different industries in virtually every
continent. Figure 4.2 shows the relative amounts of the residual fuel oil use by country.
July 2018
Figure 4.2: Residual Fuel Oil Consumption by Country (2015 values)
Sources: CERI (from UN Data, 2018)
Although the global residual oil demand has decreased for decades – a trend that is observed
across many global jurisdictions, some regions have seen gradual growth in residual fuel oil
consumption (Figure 4.3) over the same period. The Middle East, South America and the
Caribbean are regions that continue to experience growth in residual oil consumption whereas
Asia’s consumption seems to have stabilized since 2008.
July 2018
Figure 4.3: Regional Residual Fuel Oil Consumption (million bbl/day)
Source: Data from UN Data (2018)
Figure 4.4: Residual Fuel Oil Consumption Sectors (‘000 bbl/day)

1,400
Fuel oil consumption ('000 bbl/day)
1,200
1,000
800
600
400
200
-
Bunkering
Bunkering
Bunkering
Bunkering
Bunkering
Bunkering
Bunkering
Bunkering
Bunkering
Combustion
Combustion
Combustion
Combustion
Combustion
Combustion
Combustion
Combustion
Combustion
Transformation
Transformation
Transformation
Transformation
Transformation
Transformation
Transformation
Transformation
Transformation
Africa Asia Caribbean Central Europe Middle East North Oceania South
America America America
Generally, Asia uses the highest amount of fuel oil followed by the Middle East, Europe and South
America (Figure 4.4). In Figure 4.4, residual fuel oil use in different sectors are grouped into
Bunkering (40%), Combustion (24%) and Transformation (36%). Transformation refers to residual
fuel oil the is used in refineries as a feedstock to a hydrocracker and a coker after desulphurization
July 2018
and for other production purposes. Significant amounts of residual fuel oil are used as fuel for
industrial heat generation and electricity generation in Asia, the Middle East, Europe and South
America.
Figure 4.5: Market Share of International Bunker Fuel Oil

1% 1%
2%
Africa Asia
19%
Latin America N. America
5% 45%
Middle East non-EU Europe
EU Oceania
16%
Other Asia
4% 7%
Asia equally uses the largest amount of fuel oil for international bunker fuel. Its fuel oil use in
international bunkers makes up 45% of the total global fuel oil for international bunkers in 2015
(Figure 4.5). This implies that almost half of the global fuel oil used for international bunkering
should find a replacement in Asia. The implications of the change will be significant in the region
and expose the Asian bunker market to the highest levels of bunker fuel price fluctuations and
risks if compliance is strictly monitored and enforced.
The discussion of where a large fraction of the current residual bunker demand (3.5 million
bbl/day) will find new markets brings to focus the possibility of a trend increasing cleaner fuel
options such as natural gas and LNG in some regions. Asia, the Middle East, South America and
Africa are likely major destinations for increased use of residual fuel oil, which will become
cheaper as the IMO regulation kicks in. This is because each of these regions used between
120,000-681,500 bbl/day of residual fuel oil in 2015. These regions used the highest residual fuel
oil for heating and electricity in the world. Thus they are jurisdictions where it is possible to re-
purpose the fuel oil surplus for fuel for electricity and industrial heating.
A recent S&P Global news report indicates that fuel oil traders are turning to the power sector to
assess how much demand may remain for their product after the IMO's tighter bunker sulphur
limits leave most ship operators buying cleaner fuels in 2020 (Burns, Pittalis, Sleiman, Jordan, &
Rubin, 2018). However, it is uncertain how much of the surplus residual fuel oil will be cleared for
electricity and industrial heating. On the one hand, the current global push for cleaner fuels and
July 2018
climate change action may deter this option. On the other hand, will the lack of demand and
consequently, the potential low prices of residual fuel oil, make it an attractive fuel option by
2020?
Globally, about 1.86 million bbl/day of residual fuel consumption was used for electricity
generation and industrial heating in 2015. Increases in the amount of residual fuel oil used for
combustion in places like Asia, the Middle East, South America and Africa has the potential to
dramatically address the oversupply of residual oil. The combined amount of residual fuel oil
combusted in these jurisdictions amounts to almost 1.5 million bbl/day. It is unlikely that the use
of residual fuel oil for combustion in these places will double. However, there is a possibility of an
increase of 20-40% which is equivalent to an additional 300,000-600,000 bbl/day of residual fuel
oil uptake in electricity generation and industrial heating (Figure 4.6). It remains to be seen
whether a decrease in the price of high sulphur fuel oil will lead to a significant increase in the
use of this fuel for electricity generation and industrial heating.
Figure 4.6: Change in Demand for Residual Fuel Oil

1,600,000
Residual fuel oil combusted
1,400,000
1,200,000
(bbl/day)
1,000,000
800,000
600,000
400,000
200,000
-
20% 40% 60% 80% 100%
Percentage increase in residual fuel oil combusted
Even if significant amounts of the residual fuel oil supply in 2020 is channelled towards electricity
generation, this can only happen because of cheap residual fuel oil prices. An increase in demand
for residual fuel oil for heat and electricity generation is not likely to rebalance the prices of the
fuel. It is important to determine the levels of price discount of resid bunker fuel where the
demand for the fuel will switch from one sector to another. Assumptions are made on possible
levels of discount in the price of resid bunker fuels as a result of the IMO regulation. Currently,
the price of HSFO is high due to a tight supply of heavy residue streams for non-switchable
residual oil demand, which is used dominantly by shippers for marine fuel use and refineries as a
conversion feedstock (Ruiz-Cabrero et al., 2017).
July 2018
Figure 4.7: Switchable Demand for HSFO
As shown in Figure 4.7, the price setting point between 2017 and 2019 will be set by unswitchable
demand for residual fuel oil demand for conversion feedstock at refineries. However, between
2020 and 2025, a disruption period when the price of HSFO is set to decline due to a glut of about
more than 3 million bbl/day, the HSFO price will be set by demand substitution with switchable
demand options (see Figure 4.7). The switchable demand options include the use of fuel oil to
replace petroleum coke, which is used as a fuel in cement manufacturing and to substitute coal
and natural gas in power plants. This rationale forms the basis on which the compliance scenarios
are assumed.
Non-Compliance Scenarios
Three non-compliance scenarios (see Figure 4.8) are assessed:
• Low non-compliance (Low NC) – assumes 80% compliance (20% non-compliance) by 2020
given up to 80% of global trade occurs between regions where ECA is in force and other
regions of the world.
• Moderate non-compliance (Moderate NC) – assumes 75% compliance (25% non-
compliance) by 2020.
• High non-compliance (High NC) – assumes 70% compliance (30% non-compliance) by
2020.
July 2018
Figure 4.8: Non-compliance Scenario Assumptions
35%
30%
Non-Compliance
25%
20%
15%
10%
5%
0%
2020 2025 2030
High NC Moderate NC Low NC
CERI assumed the following resid price cuts by 2020, 2025 and 2030 (Table 4.1). These vary based
on the level of non-compliance with the IMO regulation.
Table 4.1: High Sulphur Bunker Fuel Price ($/bbl)
2017 2020 2025 2030

Low NC 42 8 9 12
Moderate NC 42 21 22 30
High NC 42 29 31 42
Source: CERI
During the first few months or years of the IMO 2020 regulation’s implementation, some level of
non-compliance may be accommodated. This will be due to fuel availability, and different levels
of enforcement in different regions. Given that about 87-98% of ships comply with the 0.1%-wt
ECA sulphur rule in Europe, we are assuming the Low NC scenario will be slightly less than the
ECA sulphur rule compliance levels in Europe. We consider the fact that non-compliance will differ
across geographical regions, for example in regions known for strict enforcement versus those
known for less rigid enforcement. Thus, our Low NC scenario assumption is a compliance of 80%
and above. At this level of compliance, we assume that the price of resid bunker fuel will be at
parity or fall below prices of coal or petroleum coke. Thus, our assumption of $8/bbl resid bunker
fuel under the Low NC scenario by around 2020 and slight increases in the prices after that is due
to increases in coking and desulphurization capacities.
The Moderate NC case assumes that the resid bunker prices will approach parity with natural gas
prices. On an energy content basis, prices of natural gas at $3.2/bbl is equivalent to the price of
resid bunker fuel at $21/bbl. Similarly, slight increases in the prices of resid bunker fuels after
2020 are expected due to increases in coking and desulphurization capacities. The High NC
scenario is chosen as a 30% drop in price of the resid bunker fuel by 2020 caused by a non-trivial
July 2018
drop in the demand for the fuel in most developed countries. The price at this level corresponds
to the price of natural gas at slightly above $4/GJ. There is almost a consensus that a high level of
compliance is expected. This is because most ships docking and fueling at the major shipping hubs
in Houston, Singapore and Rotterdam will comply with the IMO 2020 regulation. In addition to
that, the shipping industry has formed a network, the Trident Alliance, with members agreeing to
contribute their reputations, resources, access and competence to drive solution strategies that
contribute to the vision of robust enforcement of the sulphur regulation (The Trident Alliance,
2018). This shipping industry group of more than 45 companies is attempting to mitigate
the threat of weak enforcement of the sulphur regulations and serve the best interests of the
environment and human health as well as create a level playing field for business.
Crude Diet Prices and Refinery Products

The goal of this section is to determine the prices of crudes and refinery products that will be
used for determining future refinery margins and the impact of the IMO regulation on refinery
profitability. The EIA projection for WTI is used to represent the price of light sweet crude
between 2017 and 2030 without the IMO regulation. Considering the amount of resid produced
based on light sweet crude assays and deducting the value loss of refinery products from drops
in resid prices under each compliance scenario, new price profiles for light sweet crude are
generated. The EIA price outlook without the IMO regulation and the new price outlook
generated for the light sweet crude under the three IMO regulation compliance scenarios are
presented in Figure 4.9.
Figure 4.9: Light Sweet Crude Oil Price Outlook With and Without the IMO Regulation
90
Light Sweet Crude Price ($/bbl)
80
70
60
50
40
2017 2020 2025 2030
EIA (w/o IMO) Low NC Moderate NC High NC
Source: EIA, CERI
A similar analysis is performed using crude assays and the potential loss of value of refinery
products to project the potential price losses of other types of crudes (light sour, medium, heavy
sour and heavy sweet), which form the crude blends processed in each of the US PADDs. The
prices of the light sour, medium, heavy sour and heavy sweet crudes are projected for a future
without the IMO regulation by accounting for the potential loss in resid value.
July 2018
A slightly different approach is used to estimate the future product prices of gasoline, heating oil,
jet fuel and ultra-low sulphur diesel. Looking at the pattern of historical price peaks and troughs
(Figure 4.10), the average growth rate during the last extended period of price increases (1990-
2008) is used to project future prices of motor gasoline, jet fuel, heating fuel oil and coke.
Figure 4.10: Historical Refined Product Prices

140
120
100
Price ($/bbl)
80
60
40
20
0 2004
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Gasoline Heating oil ULSD Jet Fuel
Source: EIA
The period between 1990 and the recession in 2008 witnessed an annual average price increase
of 0.03%. However, 0.05% is assumed as the future annual average price increase. With these
prices and that of the resid bunker fuel determined, the price of Ultra Low Sulphur Diesel (ULSD)
is calculated at refinery margin breakeven point for each compliance scenario analyzed (Figure
4.11).
July 2018
Figure 4.11: Price Forecast for Ultra Low Sulphur Diesel
Under the non-compliance scenarios analyzed, the middle distillate (represented by ULSD) price
is estimated to rise by ~19-30% in 2020 from 2017 prices. For both the High NC and Moderate NC
scenarios, a ULSD price of up to $93-$96/bbl is anticipated by 2020. This is a 19-23% increase in
the price of diesel from $78/bbl. On the other hand, the Low NC scenario is expected to push
diesel prices higher to slightly above $101/bbl.
IMO Regulation: Impact on US Refinery Margins

Relative to the 2017 refinery margins (Figure 4.12), the changes in resid and middle distillate
prices will reduce refinery margins to a notable degree.
Figure 4.12: Average 2017 Refinery Margins of Cokers and FCC

Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
Medium - FCC
Complex - Cokers
0 2 4 6 8 10 12 14 16 18 20
July 2018
As shown in Figure 4.13 and later in Figure 4.14, the impact is different for the three compliance
scenarios and affect medium and complex refineries disproportionately.
Figure 4.13: Medium (FCC) Refinery Margins under Different Compliance Scenarios
As discussed previously, current margins for the complex refineries are some multiples of those
of the medium refineries. Simple and medium refineries in the US and worldwide seem to have
little or no flexibility to absorb cuts in their netbacks. The results presented in Figure 4.13 confirm
this fact.
Under the Low NC scenario, medium refineries will see their margins reduced by $15/bbl-$19/bbl
(with an average $17/bbl) by 2020 relative to the average 2017 margins. Some slight but negligible
differences in margin impacts are observed between the PADDs, so average margin impact will
be indicative of the general effects. By 2025 and 2030 the margins for these refineries would have
improved slightly due to market re-structuring. The reduction in their margins will average about
$16/bbl and $13/bbl for 2025 and 2030, relative to 2017 values. The market rebalancing improves
margins of a medium refinery as a result of recovering residual oil prices (Figure 4.11) and of a
reduction in crude oil prices as a result of the crash in the prices of residual oil. However, the
distillate prices will start to fall to approach new equilibrium prices after 2020 (see Figure 4.11)
and consequently, will counterbalance the effects of a reduction in crude oil prices. This is the
reason why refinery margin improvements are not expected to be significant after 2025.
For the Moderate NC scenario, medium refineries will have their margins reduced by an average
of $15/bbl by 2020 relative to 2017 margins. Unlike in the Low NC scenario where the margins
improve by 2025, the refinery margins are reduced further under the Moderate NC scenario by
$3/bbl bringing the average margin reduction to $18/bbl by 2025. This is caused by the
rebalancing market where the drop in middle distillate prices far outweigh the cumulative
July 2018
positive effect of increases in residual price and fall in oil prices. The refinery margin outlook for
2030 under the Moderate NC gets better than that of 2025 and approaches the 2020 refinery
margins. This effect is because the market rebalances the prices of middle distillates and the
residual oil prices increase further.
Under the High NC scenario, medium refineries will have margins similar to those of the Low NC
scenario by 2020 and thereafter, even the worst refinery margin outlook is likely. A margin loss of
up to $26/bbl is expected between 2025 and 2030. There are a few reasons why this scenario has
interesting outcomes. One cogent factor is the fact that compliance levels will be reasonably high
even in this scenario. The Low NC scenario represents compliance of up to 70%. Although the
compliance level is non-trivial, there is not as significant an increase in middle distillate prices as
is observed in the other two non-compliance scenarios. Nevertheless, residual oil prices still fall
significantly, though not like in the other scenarios. This scenario presents an interesting case for
the seriousness of the impacts of the IMO regulation no matter how low compliance levels will
be. From the perspective of the refiners with complex refineries, low levels of compliance could
bring significant negative impacts on their margins.
Figure 4.14: Complex (Coker) Refinery Margins under Different Compliance Scenarios
Margins of complex refineries will be better off than they were in 2017 under the Low NC scenario
as a result of the IMO 2020 regulations. These sophisticated refineries that specialize in
processing heavy crudes will enjoy increases in refinery margins. However, under the Moderate
and Low NC scenarios, they will not be unscathed.
July 2018
Under the Low NC scenario, complex refineries will see their margins increased by $2/bbl-$4/bbl
(with an average $3/bbl) by 2020 relative to the average 2017 margins. The margins for all the
PADDs except PADD 4 would still be better than 2017 margins by about $1/bbl-$4/bbl and $5/bbl-
$8/bbl by 2025 and 2030, respectively. The margins of these PADDs improve because of
favourable crude and refinery product prices. However, PADD 1 has a positive margin (~$2/bbl)
by 2020 and barely reaches a breakeven point by 2025, but its margins become -$3/bbl by 2030.
PADD 1 margins are not promising because of the composition of the crude blend feedstock into
the refineries which is chiefly more expensive crudes such as light sweet and medium crudes. The
PADD also produces the least amount of the middle distillate cuts which are expected to increase
in price as a result of the IMO regulations.
Under the Moderate NC scenario, the general trend shows that margins of complex refineries in
all the US PADDs will reduce relative to 2017 margins. Only a slight variance in the impact on the
PADDs for 2020 and 2025 is observed. The reduction in their margins will average about $2/bbl
(with a range of -$1/bbl and -$3/bbl) by 2020 and $7/bbl (with a range of -$5/bbl and -$8/bbl) by
2025 relative to 2017 values. For the reasons explained previously, the impacts on margins are
not improving with time under this scenario. The market dynamics in 2025 which slightly
increases residual oil prices (Figure 4.11) and reduces crude oil prices are outweighed by
rebalancing middle distillate prices. Again, for the reasons above, the IMO regulation has a higher
impact on PADD 1 than in the other PADDs beyond 2025.
For the High NC scenario, margins of complex refineries will suffer as average refinery margin
losses of $8/bbl, $19/bbl and $23/bbl are expected in 2020, 2025 and 2030, respectively. It is no
longer a surprise why the scenario attracts the highest margin penalty. Though it is the least level
of compliance, the extent of compliance is still reasonably high, and as a result, residual oil prices
still fall significantly. But this scenario does not attract the high middle distillate prices seen in the
other scenarios. Again, this scenario shows that the IMO 2020 regulations will have even greater
negative impacts for complex refineries at low compliance levels.
On a PADD-level, although some PADDs will have low margin reductions and even an increase in
margins by 2020, it is reasonable to assume that refinery planners and crude buyers will use the
highest margin reduction to make decisions. Therefore, we expect the highest margin reduction
cases from medium refineries to set the prices for heavy sour crudes and the light-heavy crude
price differential. If FCCs are considered as the price-setting refineries, a $15/bbl to $17/bbl drop
in refinery margins relative to 2017 can be expected in 2020 for all the non-compliance scenarios.
By 2025, refineries are likely to see their margins drop by $16/bbl to $26/bbl relative to 2017
margins in all the non-compliance scenarios assessed.
Salient observations:
• Increased level of non-compliance may not push middle distillate prices as high as one
would expect with increased levels of compliance. The higher the price of middle
distillates, the higher the margins and this effect outweighs the penalty from diminishing
July 2018
resid prices. An exception to this pattern is a case where the refinery does not produce a
reasonable volume of low sulphur middle distillates.
• A general trend of declining margins is expected for some years after 2020 due to an
expected drop in prices of middle distillates post-2020 as the market rebalances and the
distillate prices drop towards its normal levels. Unfortunately, the price of resid will not
recover at a rate that can stabilize the refinery margins, and thus, cannot cushion the
effect of the rebalancing middle distillates prices. This is because the effect of price
movements of ULSD outweighs the margin-boosting effect from slowly increasing resid
prices.
• It can be deduced that the IMO regulations will have serious negative impacts on simple
and medium refinery margins no matter the non-compliance scenarios considered. Also,
complex refineries will not be spared of these impacts if compliance levels are not high
enough to drive up the prices of middle distillates and push down the prices of residual
fuel oil and heavy sour crudes to significant levels.
July 2018
July 2018
Chapter 5: Compliance Options

The shipping industry will bear the brunt of the IMO regulation more than other sectors. They
will have to respond to or bear the brunt of a change in their bunker fuel requirements and the
associated market and price dynamics. No industry other than shipping is more directly impacted
– other industries are only indirectly affected. Also, the level of compliance with the IMO rule will
be determined mostly by the shipping industry.
The industry is capital constrained and has very tight margins, and their margins may shrink
further.
There are uncertainties associated with the way this regulation interfaces with many industrial
sectors (transportation, refining, oil production) and the existence of many options to comply.
Therefore, ship owners have not made significant investments or decisions to modify their vessels
before the 2020 deadline, to discontinue exclusive use of HSFO.
Scenario: Moderate Non-Compliance

After examining the three scenarios, we chose the Moderate NC scenario for further analysis.
Figure 5.1 shows how different options are projected to substitute resid bunker fuel volumes by
2020, 2025 and 2030 under this scenario.
Figure 5.1: Substitution Options of Resid Bunker Fuel

100.0%
14.0% 15.0%
80.0% 14.0% 11.0%

25.0%
60.0%
40.0% 61% 60%

57%
20.0%
5.0% 7.0%
1.9% 5.0% 5.0%
0.0%
2020 2025 2030
Compliance is a concern given the fact that levels of compliance in the short- and long-term may
determine if the goals of the regulation will be achieved and how the markets will respond. Also,
it is still uncertain how compliance will be enforced because the IMO cannot enforce the rule. The
July 2018
flag states where the ships are registered, and the port states could be in a better position to
enforce the rule.
The proposed Carriage Ban, which makes it illegal to carry HSFO on ships that have not installed
sulphur scrubbers, increases the likelihood of higher compliance. The Carriage Ban is expected to
come into effect, but not until March 1, 2020. With the Carriage Ban, it is believed by shipping
industry participants that there will be effective enforcement of the IMO regulation. This is
because the Carriage Ban regulatory amendment makes it easier for port state authorities to
detect and sanction ships (IBIA, 2018). Given these developments, an assumption of 75%
compliance may be low.
Previous estimates of how much of the world fleet will continue to use sulphur fuel vary
significantly. For example, S&P Global Platts (2018) allocates 10-15 vol.% of the displaceable high
sulphur fuel oil to exhaust gas scrubbers, LNG bunkers, or waivers/non-compliance in 2020.
However, it is important to note that the first few months or years of the IMO regulation’s
implementation may likely accommodate some level of non-compliance due to a variety of
reasons including fuel availability, and different levels of enforcement in different regions. Some
of these are the reasons why the Carriage Ban is delayed to March 2020. More so, if about 87-
98% of ships comply with the 0.1%-wt ECA sulphur rule in Europe, it would not be surprising to
see lower compliance levels at a global scale for a slightly less-stringent 2020 IMO sulphur rule.
This is the context for CERI’s Moderate NC assumption of 75% compliance.
Below is the list of the major compliance options which are further assessed.
1. Scrubbers – to reduce SOx emissions via on-board scrubbers (also helps reduce
particulate matter, PM).
2. Desulphurize refinery fuels and use lower sulphur content fuel.
3. Switch entirely or partially to middle distillates for bunker fuel.
4. Undertake custom blending of fuels on board and use segregated bunkers tanks.
5. Switch to alternative fuel sources (e.g., LNG and methanol) that reduce sulphur, CO2, and
particulate emissions.
6. Establish emissions trading, which could allow trading of marine and shore-based credits.
Scrubbers
There are uncertainties as to the market uptake of scrubbers. Questions regarding scrubber
uptake levels, how soon and how strict policing of the new rules will be, as well as calls for a
phased introduction to the new cap (rather than a "hard" start for all on January 1, 2020), means
that shippers and refiners have little idea what roles the other options will play in 2020.
Responses to fuel demand with improved refined products will be slow given the investments
needed. Investing in technology to convert fuel oil into distillates is not only expensive ($1 billion+
per refinery), it is also time-consuming to implement (5-7 years). Buyers can expect price spikes
if there is a shortfall (Hampton & Kumar, 2017).
July 2018
Scrubbers, which reduce the sulphur content of onboard fuel ships, are alternatives to buying
more expensive, cleaner fuel. Shippers are making some investments in onboard scrubbers. For
example, Trafigura, a shipping and chartering company, has invested in 36 tankers with scrubbers
(Hampton & Kumar, 2017). Previous studies have estimated different numbers of ships that will
be equipped with scrubbers by 2020 (Figure 5.2.). H
However, there is a unanimous agreement that the rate at which sulphur scrubber investments
are being made across the shipping industry is not fast enough given that 2020 is not far away.
Figure 5.2: Estimates of Ships with Scrubbers by Previous Studies
Ships with scrubbers by 2020 Estimated HSFO demand for ships

equipped with scrubbers - 2020
Data sources: CE Delft, Assessment of Fuel Oil Availability – Final Report, 2016 and EnSys/Navigistics, Supplemental
Marine Fuel Availability Study 2016
Several issues have been identified as factors in determining the preferred options for ships.
These factors include the cost of scrubber installation, trading routes, the age of vessels, parties
responsible for fuel, type of vessel and trade, bunker market conditions and availability and
affordability of fuels. The uncertainties associated with these issues are highlighted below.
For a financially challenged industry with vessel oversupply and low charter rates, what is the best
option among two options: bear the capital costs of scrubbers (average of $4-5 million) and
operation costs and continue to use low-cost bunker fuels, or switch to low sulphur marine fuel?
Installing a scrubber takes about six months which will be a lost revenue period (Ruiz-Cabrero et
al., 2017). About $2-3 million per vessel will be associated with the IMO’s requirement for ballast
water management system and will add to the financial challenges of the shipping industry. Other
considerations include:
• Trade routes,
• Type of trade,
• Age of vessels, and
• Party responsible for the fuel costs.
July 2018
Currently, less than 1% of the worldwide fleet is operating within the future regulatory limits for
sulphur emissions for open ocean areas outside the Emission Control Areas (ECAs). Scrubbers are
installed in less than 1% of ships worldwide, and analysts believe that its future adoption will be
minimal.
Under the Moderate NC scenario, we estimate that scrubbers will capture only about 3% of the
HSFO volume to be displaced by 2020. It is important to note that the costs of HSFO may increase
as a result of costs of maintaining HSFO bunkering logistics and infrastructure such as HSFO
barges, storage, and pipelines (Ship & Bunker, 2020). This is because HSFO will no longer be the
mainstream bunker fuel and this will adversely affect investments in maintaining bunkering
logistics and infrastructure. Different levels of bunkering logistics and infrastructural development
in hubs have already created a wide HFSO price margin between ports; this margin is likely to
increase significantly in the future. As shown in Figure 5.3, scrubber adoption is likely to increase
moderately and peak at a point where about 5% of the resid bunker demand is replaced with
scrubbers.
Figure 5.3: Substitution Volumes for Resid Bunker Fuel

4,000,000
Volume of HSFO captured (bbl/day)
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
-
2020 2025 2030
Scrubbers Methanol LNG Low Sulfur Distillates
Non Compliance Desulphuration Blended HSFO
Refinery Additions
Global refining capacity additions to 2023 are forecast to amount to 7.7 million bbl/day whereas
the rate of growth of refined product demand is slowing to 5 million bbl/day (IEA, 2018b). About
a third of an additional 7.7 million bbl/day of the extra refining capacity expected to come online
by 2023 will be in the Middle East and the rest in Asia (Denning, 2018). Enough low sulphur-
compliant fuels can be created from these additions to meet the demand for cleaner fuels for the
shipping industry by 2023. However, most of the resid to be produced from these expected
additions may be economical feedstock for FCC and not readily available for low sulphur fuel oil
supply (S&P Global Platts, 2018).
July 2018
Conversion additions in mostly China and India between 2017 and the beginning of 2020 amount
to 1.7 million bbl/day, and are expected to be nearly split between coking, hydrocracking and
catalytic cracking (S&P Global Platts, 2018). The location of the units is not linked to non-bunker
suppliers; thus, it is unlikely that these conversion capacities will contribute significantly to low
sulphur marine bunker fuels. However, they may be export destinations that accept and destroy
unwanted high sulphur resids.
Similarly, though heavy oil desulphurization facilities of 1.1 million bbl/day are expected between
2017 and 2020, only 20 percent of this capacity is a location outside Asia. About 580,000 bbl/day
capacity is for resid treatment, out of which about half of that capacity is intended for FCC feed
pre-treatment (S&P Global Platts, 2018). About 240,000 bbl/day resid hydrodesulphurization
capacity can be assumed to contribute to low sulphur fuel oil by 2020. This number will increase
in the future as the increase in the light heavy product differentials is expected to motivate
investments in desulphurization. Desulphurization will capture up to 14% of the 2025 planned
additional refinery resid hydrodesulphurization capacity.
Investment in desulphurization units is an attractive option because of the price premium that
LSFO will attract by 2020. Desulphurization is still expensive despite being cheaper than cokers
and hydrocracking, the cost being $900 million. However, desulphurization offers more flexibility
(Ruiz-Cabrero et al., 2017). When price differentials are wide between refined light and heavy
products, desulphurization can produce more distillates to maximize profits. On the other hand,
when the price differentials narrow, desulphurization units can be used to hydrotreat fuel oil to
produce a compliant fuel (Ruiz-Cabrero et al., 2017).
S&P Global Platts (2018) estimates that after considering the incremental crude runs, and asphalt
demand, the planned new facilities are capable of absorbing 1.6 million bbl/day out of the 3.2
million bbl/day resid volumes that need to be destroyed. This means half of the target still needs
to be met, so it would be necessary to examine how modifications of the current refinery
operations could absorb the remaining resid supply.
Currently, the global crude distillation capacity is 97.4 million bbl/day whereas that of vacuum
distillation is 37.2 million bbl/day. North America, Asia Pacific and Europe are the three major
refining hubs with North America having the highest vacuum distillation capacity (Figure 5.4).
Capacity factors have averaged around 78%.
July 2018
Figure 5.4: Global Crude and Vacuum Distillation Capacities, 2017
World
Other Asia-Pacific
China
Middle East
Russia & Caspian
Europe
Africa
Latin America
US & Canada
0 20 40 60 80 100 120
Capacity (million bbl/day)
Vacuum Crude oil (atmospheric)
Source: OPEC 2017
Refiners can process additional millions of barrels per day of crude to make more distillate.
Hampton & Kumar (2017) put this number at 2.5 million bbl/day of crude. This estimate seems
to underrate possible capacity factor increases because it suggests an increase of only 0.3%
capacity factor. While the global average is 78%, some regions such as North America, Europe,
the Middle East and Asia already operate at capacity factors that are close to 90%.
A 5-10% increase in capacity factors across all regions will result in an additional 4.9-9.7 million
bbl/day capacity of crude refining. Thus, room exists to increase the utilization capacity of
refineries at a global level. Even in regions with already high capacity factors, there are
opportunities beyond the 0.3% forecast noted above.
One example of this is increasing capacity factors of refineries in the US PADDs by 3%, 5% and 8%
which will result in productions of about 38,000 to 100,000 bbl/day additional volume of
distillates. A high-level estimation of the limits of global refining capacity increases to meet
distillate demand by 2020 can be made using conversion capacity and product yield
approximations.
If we assume world refineries are, on average, medium refineries, about 1.3 million bbl/day of
distillates together with 1.2 million bbl/day heavy fuel oil and other bottoms will be produced
from a 5% increase in the global refinery capacities. On the other hand, a 10 percent increase in
the global refinery capacities will result in 2.6 million bbl/day of distillates together with 2.3
million bbl/day heavy fuel oil and other bottoms. In each case, large amounts of distillates that
can bridge the gap of cleaner bunker fuel demand can be produced. Equally large amounts of
heavy fuel oil are produced alongside the production of distillates. This will likely keep high
sulphur fuel oil prices low. Additionally, the world is reaching peak gasoline demand and would
July 2018
not need the additional naphtha generated by the added crude processing. So, increasing
capacity may be part of the solution to the bunker fuel availability problem but adds to the
problem of resid glut because more resid will be produced as refiner’s process more crude
volumes.
The reason why refiners are not making costly refining modifications like adding new coking
capacities at faster rates may be because the price volatility that will be created from the IMO
rule implementation is not expected to last long enough to make such investments viable and
there exists some spare capacity to meet demand in the short term. The markets are expected to
rebalance in a couple of years, and this discourages serious capital investments in complex
refining units, which has a payback period of at least two decades.
Slow-Steaming
Slow-steaming, which is a term used for reducing ship speeds, will be one of the options the
shipping industry will use to reduce fuel costs. When marine fuels are cheap, ships travel faster
than usual, and because of that, they consume more fuel. However, when marine fuel prices
skyrocket as is expected by 2020, ships are likely to slow down their speeds in order to conserve
fuel and save costs. Therefore, the rate at which slow steaming will be used will be contingent on
how expensive compliant fuels become during the onset of the IMO regulation.
Figure 5.5: Fuel Consumption and Speed Relationship
Source: Bialystocki and Konovessis, CERI
The slow-steaming approach can be an effective way to cut costs that the shipping industry
cannot pass on to their customers. Given that shipping fuel consumption has a velocity-squared
relationship, as shown in Figure 5.5, a slight reduction in ship speeds by a few knots (equivalent
to 1.85 km/hour) will lead to a significant reduction in fuel consumption and costs. For example,
slowing down by 2 knots (3.7 km/hour), from 19 knots to 17 knots, results in a fuel savings of
about 15 tonnes/day, from 60 tonnes/day to 45 tonnes/day (Figure 5.5) – about a 25% reduction
July 2018
in fuel costs. With this illustration, it is evident that reducing ship’s speed to achieve a 25-50%
reduction in fuel consumption is possible if the compliant fuel prices skyrocket.
Considering the potential of fuel savings from slow-steaming of ships, it will not be surprising to
see this option deployed at significant levels to address fuel shortages and buffer high prices of
compliance fuels by 2020. CERI envisages a dynamic balancing act between complaint distillate
fuel demand and prices and the rates of slow-steaming. It is important to note that most of the
slow-steaming ships will use compliant fuels, most of which will be distillates. Slow-steaming will
be used to reduce the costs of running the compliant fuel which will be expensive at the onset of
the rule.
However, slow-steaming will increase voyage time, delay deliveries and cause more ships to be
deployed on the oceans. Longer voyage times will cause more ships to be used to meet global
trade balance. But on the other hand, the world currently has an oversupply of ships, a situation
that will benefit from increasing the number of ships required for global shipping demand.
Slow-steaming does not help in the destruction of excess High Sulphur Fuel Oil but precludes the
treatment of additional crudes in order to produce more distillates in response to compliant fuel
scarcity. Slow steaming does nothing to address the amount of HSFO that is in excess of market
requirements in 2020 and beyond. Unfortunately, this latter point is of uttermost importance for
Alberta.
Distillates
Switching to marine gas oil1 (MGO) is seen as the easiest route to compliance, and it is expected
that MGO will be the preferred option for ship owners by 2020 (ExxonMobil, 2018). There is one
outstanding benefit to the option: the use of MGO requires no upfront investment. However, it
also faces a major setback, which is associated with high fuel costs. For example, Ship & Bunker
data indicates that over the last five years, the average premium for MGO over HFO in Rotterdam
was $255/MT (ExxonMobil, 2018). By 2020 the price of MGO will significantly increase whereas
that of HFO will decrease dramatically. This is because of demand-price dynamics of the products
which will result from the IMO sulphur limit regulation.
Distillates refer to fractions separated from the crude oil in fractional distillation. Distillates are
colloquially known as marine gasoil (MGO). Marine gasoil is like diesel fuel but has a higher
density. Unlike HFO, marine gasoil does not have to be heated during storage. Marine gasoil is
used in smaller medium- to high-speed auxiliary units or auxiliary motors and ship’s engines. It is
produced with varying degrees of sulphur content, though the maximum permissible sulphur
content is 1.5% (ISO 8217 DMA quality label).
To achieve various specifications and quality levels, HFO is blended with distillates, e.g., marine
gasoil or marine diesel oil. The resulting blends are also referred to as intermediate fuel oils (IFO)
or marine diesel oil. They are classified and named according to their viscosity. The most
1
This is 100% distillate oil.
July 2018
commonly used types are IFO 180 and IFO 380, with viscosities of 180 mm²/s and 380 mm²/s,
respectively.
In choosing marine fuel blends, for shippers, fuel oil is preferred over gasoil. Many marine engines
are optimized to operate on heavy fuel oil (HFO). Because of its low viscosity, lubricity, acidity and
flash point, marine gas oil often leads to several adverse effects on fuel and engine systems. Thus,
switching to MGO in traditional marine engines carries significant operational risks which are
listed in Table 5.1.
Table 5.1: Operational Risks of Using Marine Gasoil as a Bunker Fuel

Characteristics Operational Drawbacks
Low Viscosity Fuel oil pump: Internal leakage, breakdown of the hydrodynamic
film leading to seizures
Fuel oil pump: Insufficient fuel index margin, limiting acceleration
Fuel injection nozzle: Increase inflow, leading to non-uniform
combustion and decreased fuel efficiency
Low Lubricity Fuel injection pump: abnormal wear of plunger/barrel
Low Sulphur/ Boilers: Increased turndown ratio and minimum boiler load, leading
Low Acidity to deterioration of ignitability
Engines: Ignition delay and defective combustion
With the reduction in acidity (sulphuric acid formed), deposits may
be formed using high alkali base number cylinder oil and abnormal
cylinder liner may occur
Flashpoint Higher fire hazard
Fuel oil is a fraction obtained from distilling crude oil during the refining process. It could be a
distillate or a residue and is the least volatile and heaviest of the commercially-used fuels. Some
10% of fuel oil produced is used to power large ships. A further 15% is used for heating, and
refineries use the remainder as feedstock for further upgrading.
Bunker fuel prices vary according to fuel type, quality, and bunkering locations. Figure 5.6 shows
the prices of MGO, IFO 1802 and IFO 3803 at the Houston hub.
2
IFO 180 is an Intermediate Fuel Oil blend of 88% residual oil and 12% distillate oil
3
IFO 380 is an Intermediate Fuel Oil blend of 98% residual oil and 2% distillate oil.
July 2018
Figure 5.6: Prices of MGO, IFO 180 and IFO 380 Bunker Fuels at Houston
800
700
Bunker Prices ($/tonne)
600
500
400
300
200
Jun-17 Jul-17 Aug-17 Sep-17 Oct-17 Nov-17 Dec-17 Jan-18 Feb-18 Mar-18 Apr-18 May-18
MGO IFO 180 IFO 380
Source: Ship & Bunker (2018), CERI
Significant price differentials exist between the bunker fuels and across the hubs. At the Houston
hub, for example, the prices for MGO were higher than that of IFO 380 prices by as much as
$175/tonne to $250/tonne between June 2017 and March 2018. Also, the price differentials vary
across regions, for example, the MGO - IFO 380 price differential at the Singapore hub varied
between $150/tonne and $247/tonne within the same period.
On the other hand, and as expected, the price differentials between MGO and IFO 180 are
significantly less than those of MGO and IFO 380 between June 2017 and March 2018. Note that
both MGO and IFO 180 are cleaner fuels than the IFO 380. At the Houston hub, the prices for
MGO were higher than that of IFO 380 prices by $41.5 to $90/tonne in that period.
Blending is another option that can achieve compliance with the IMO regulation. We first
considered mixing ULSD and heavy bunker fuel (Blend I). Achieving a sulphur content under 0.5%
would require about 14% of heavy bunker fuel. The cost of the blend is high (43 cents per
kilogram). Nevertheless, using a fuel mix of ULSD and heavy bunker fuel is still better than running
100% ULSD due to a potential savings of $30/tonne.
Alternatively, a blend of LS-MGO and heavy bunker fuel (Blend II) contains 12% heavy bunker fuel
and 88% LS-MGO with a blended cost of $440/tonne. This blend also achieves the 0.5% sulphur
content. The cost of this blend is $20/tonne cheaper than using LS-MGO.
When the two blending options are compared (Figure 5.7), it is assumed that Blend II is likely to
be preferred because it is cheaper and has better fuel properties than Blend I.
July 2018
Figure 5.7: Marine Oils and Blends Prices

120
100
Marine Fuel Price ($/bbl)
80
60
40
20
0
2017 2020 2025 2030
MGO ULSD Heavy Bunker Blend I Blend II
There is no current incentive to blend fuels. However, by 2020 the prices of LS-MGO and ULSD
are expected to increase significantly. This will create a greater price spread between low and
high sulphur bunker fuels. Consequently, the price movements by 2020 may motivate more use
of blending, especially for Blend II.
Results show that the spread between the low sulphur distillates (ULSG and LS-MGO) and the
blended fuel is likely to be highest at the onset of the IMO rule but will dramatically narrow in the
long run. A high differential of about $30/bbl can be expected by 2020 whereas by 2025 the value
may decrease to $3-5/bbl. Unless inhibited by logistics, blending and storage infrastructure, we
expect that a significant portion of distillates that will be introduced into the marine fuel market
will be blended with HSFO by 2020.
Liquefied Natural Gas

A small but growing number of vessels will use liquefied natural gas (LNG) and other compliant
alternate bunkers (ExxonMobil, 2018). LNG is expected to be applied to newly built vessels,
particularly those that operate on fixed, predictable routes, or within a geographic area,
particularly ECAs (Grati, 2017). Retrofits have been rare so far; a recent example is the WES
Amelie, a container ship operating almost exclusively in the Baltic and the North Sea ECA (Grati,
2017). The current infrastructure for LNG bunkering is limited and will need to rapidly expand if
LNG bunkers are to become more common for the largest consumers (Grati, 2017).
IHS Maritime counts 218 ships fitted for LNG fuel in service or under construction, and another
123 deemed "LNG ready." Although the switch to LNG requires a higher up-front investment,
lower LNG prices could enable a more cost-effective approach than low sulphur oils. LNG also has
lower carbon emissions which provide additional environmental benefits beyond the decrease in
sulphur emissions (Grati, 2017). LNG bunker consumption is expected to grow, yet by 2020, LNG
bunkers will form only a very small percentage of total bunker consumption.
July 2018
The CE Delf report projected LNG consumption on board LNG carriers based on the projected
number of LNG carriers operating in 2020. The report projected the number of LNG carriers to
increase by 20-35% from that of 2012. It further evaluated the use of LNG as a fuel by 2020. They
concluded that LNG would power a total of 170 ships in 2020. The study also found that given the
low market penetration of other alternative fuels such as methanol and other biofuels, their share
in the marine fuel market will be negligible.
Our analysis aligns with the EnSys 2016 and CE Delf reports’ conclusion of negligible market
penetration of alternative fuels in the maritime industry by 2020. The previous reports identified
ship retrofitting and LNG bunkering as the two main obstacles to LNG development as a maritime
fuel. Our projection of 1.9% to 7% of resid bunker fuel displacement volume fuel consumption
falls within the range of IMO 3rd GHG study’s projection of 2-10% of the total marine fuel share.
Methanol
Methanol is a fuel that could be used significantly in the marine industry in the future. Currently,
there are seven ocean-going chemical tankers operating and four more under construction which
ship methanol and are powered by two-stroke dual-fuel engines capable of running on methanol,
fuel oil, marine diesel oil or gas oil (DNV.GL, 2016). Methanol consumption has lower GHG
emissions compared to conventional shipping fuels and meets IMO sulphur restrictions, while
also significantly reducing NOx emissions. The sustainable development of the fuel requires that
overall lifecycle emissions do not exceed those of conventional shipping fuels. For this reason, the
source and method of production are considered important.
Some previous studies have confirmed the availability of technologies for extensive methanol-as-
fuel supply chain development. According to DNV GL (2018), the operational costs for methanol
systems are expected to be comparable with those for oil-fueled vessels without scrubber
technology. The additional costs of installing methanol systems on board a vessel (e.g., internal
combustion engine, fuel tanks, piping) is roughly one third that of the additional costs associated
with LNG systems. This is because there is no need for special materials able to handle cryogenic
temperatures or for pressurized fuel tanks. In addition, capital costs are reducing dramatically, as
learnings from experiences are yielding benefits.
A majority of the existing methanol supply infrastructure is tailored to channel it as feedstock to

the chemical industry. As the supply chain extends further into the transportation fuel market,
including shipping, more low-carbon methanol may be needed to improve the environmental
performance. Low-carbon methanol can be produced from both natural gas or alternative
feedstocks such as biomass. These considerations lead us to conclude that methanol’s use as a
substitute for resid bunker fuel is limited, at least in the short run, but it can grow substantially
depending on future oil price scenarios.
Arctic Heavy Oil Transport Ban

Another issue worth considering is the “ban versus no ban” debate of high sulphur heavy crude
oil in the Arctic. The US and Greenland support the ban whereas Russia and Canada and other
countries oppose it. If there is a ban, that means higher transport costs for transporting high
July 2018
sulphur heavy oil that could be cheaply transported to destinations with sufficient coker
capacities. The imposition of a ban on heavy sour oil in the Arctic, if implemented, will put more
downward price pressure on Canadian heavy crude markets.
July 2018
July 2018
Chapter 6: Impacts on Canadian Heavy

Oil
The contribution of Canadian oil to the global HSFO bunker fuel supply is not significant. This is
because Canadian bitumen is consumed by the bottom of the barrel complex refining in the US
and Canadian refineries. Nevertheless, it is envisaged that Canadian bitumen will have to
compete for US refining space on netback refining value with other crudes that currently
contribute to HSFO. Therefore, there is a need to understand what constitutes the marginal
barrel, what drives the quality discount and crude cost structure and the impacts on Canada’s
heavy oil production.
Price of Canadian Heavy

Figure 6.1 illustrates the historical benchmark price series and the WTI-WCS differential
(Millington, 2018). The WTI-WCS differential is a discount on the Canadian crude price
benchmark, Western Canadian Select (WCS) against the West Texas Intermediate (WTI) crude
benchmark. The reality is that the WTI-WCS differential fluctuates over time based on market
conditions. Historically, a low of US$6/bbl in April 2009 and a high of US$42/bbl in December
2007 have been recorded. Even recently, the differential was US$27.20/bbl in March 2018.
Figure 6.1: Light-Heavy Differentials (US$/bbl)
$130.00
$120.00
$110.00
$100.00
$90.00
$80.00
$70.00
$60.00
$50.00
$40.00
$30.00
$20.00
$10.00
$-
Jul-2005
Jul-2008
Jul-2009
Jul-2010
Jul-2011
Jul-2012
Jul-2013
Jul-2014
Jul-2017
Jul-2006
Jul-2007
Jul-2015
Jul-2016
Jan-2005
Jan-2006
Jan-2007
Jan-2008
Jan-2009
Jan-2010
Jan-2011
Jan-2012
Jan-2013
Jan-2014
Jan-2015
Jan-2016
Jan-2017
Jan-2018
Apr-2005
Apr-2006
Apr-2007
Apr-2008
Apr-2009
Apr-2010
Apr-2011
Apr-2012
Apr-2013
Apr-2014
Apr-2015
Apr-2016
Apr-2017
Oct-2005
Oct-2006
Oct-2007
Oct-2008
Oct-2009
Oct-2010
Oct-2011
Oct-2012
Oct-2013
Oct-2014
Oct-2015
Oct-2016
Oct-2017
WTI - WCS Differential ($/b) Europe Brent Spot Price FOB ($/b) West Texas Intermediate (WTI) @ Cushing ($/b) Western Canadian Select (WCS) @ Hardisty ($/b)
$30.00 Annual WTI-WCS Differential (US$/bbl)

$25.00
$20.00
$15.00
$10.00
$5.00
$-
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018E
Source: EIA, Baytex Energy, CERI
July 2018
The price of crudes used in CERI’s models varies according to the quality and access to demand
centres. Light sweet crudes are easier to process, yield more high-value refinery products, and
thus, are priced higher than heavy and sour crudes. Proximity to the coast or unrestrained access
to markets is an equally important contributor to how much crude is discounted relative to others.
Figure 6.2: Maya-WCS and WTI-WCS Differentials at Cushing (US$/bbl)

100
90
80
70
60
50
40
30
20
10
0
2012 2013 2014 2015 2016 2017
WCS Cushing Maya Maya-WCS Differencial
WTI Cushing WTI-WCS Differential
Source: Argus, CERI
For example, WCS trades at a discount to the Mexican Maya although they are of similar quality.
Historically, Maya has traded at a premium to WCS (Figure 6.2). This is because Maya is a
waterborne crude, which is readily available to US Gulf Coast refiners. However, the price of Maya
represents the potential price WCS producers could realize (Millington, 2018). The majority of
Canadian heavy crude (WCS) must be transported via pipeline or rail from Alberta (Edmonton and
Hardisty) to the US Midwest where the benchmark is WTI.
Increase in demand for light sweet crude, which will arise due to the IMO 2020 rule, is expected
to widen light sweet crude’s premium over heavier, sour crudes. On the positive side, the
widening of the price differential could boost the advantage some Canadian and US refiners have
gained by configuring their plants to further process heavy, sour crude over the past 20 years.
These refineries can increase their margin by buying heavy sour crude feedstock at significant
discounts. It seems reasonable to discount heavy sour crude due to the decrease in resid
demands and prices.
The refinery optimization model is used to assess the optimal relationships between crude
quality, refinery configuration and margins at PADD levels. Based on the refinery optimization
model for each class of refinery configuration (hydroskimming, medium and deep conversion
refineries), certain crude blends maximize the refinery margins. The optimal crude feedstock
blends will be preferred unless in market situations where the prices of other crudes which are
July 2018
not part of the optimal crude blend become so cheap that a change in crude feedstock makes
economic sense.
Light sour and heavy sour crudes are likely to compete in the Gulf Coast (PADD 3) and US Midwest
(PADD 2) if there are no notable logistical constraints. The competition will be simply about price
and maximization of refinery margins. In this respect, the results from our optimal refinery model
do not show any increase in the heavy sour crudes in PADDs 1 and 2 (Figure 6.3). It even suggests
that a slight decrease (about 3%) of heavy sour, a 7% decrease in medium crudes and an increase
in heavy sweet and light sour crudes to be treated in the US Midwest will result in higher margins.
However, it seems almost certain that logistics and refinery make-up will guarantee the continued
receipts of Canadian heavy sour in this region.
Figure 6.3: Potential Composition Changes in the Optimal Crude Blend
20%
15%
Change in crude types due to PADD-level
10%
5%
0%
optmization
-5%
-10%
-15%
-20%
-25%
HSO HSW LSO LSW MED
No change in the heavy crude composition of the Gulf Coast crude diet is indicated. On the other
hand, the results show that increasing heavy sweet crude by 8% and decreasing heavy sweet and
medium crudes in PADD 3 will lead to better margins. The increased production of light tight oil
in the US has recently led to higher intakes of this oil in refineries on the East and Gulf Coast, but
the results show that these regions may have had enough of this crude. A reduction of the light
sweet intakes in these regions is indicated for higher margins. For the East Coast (PADD 1),
logistical constraints will limit additional intakes of Canadian heavy crude.
July 2018
Figure 6.4: Venezuela and Mexico Crude Outputs are Decreasing

Venezuela oil output Mexico oil output
Source: Argus
Although the model does not indicate additional heavy sour intakes in the Gulf Coast, the inability
of Mexico and Venezuela to continue to supply competing heavy sour crudes to the Gulf Coast
refineries presents additional opportunities for Canadian heavy oil. Figure 6.4 shows that
Venezuelan and Mexican crude outputs have decreased dramatically over the past 2 years. If the
declining trends of supply of Mexican Maya and Venezuelan heavy sour crudes persist, with the
exception of logistical issues of pipeline access to the Gulf Coast, PADD 3 has suitable refinery
equipment to handle heavy sour crudes. This should make for an easy replacement of the
shrinking Maya and Venezuelan heavy volumes with Western Canadian Select crude. However,
until new pipeline capacity is available, replacing supplies from Venezuela and Mexico will provide
only limited opportunities (CAPP, 2018).
Our optimal model suggests that a 17% growth in the heavy sour composition in the crude diet
of PADDs 4 and 5 will yield better margins. This is accompanied by a significant reduction in the
medium crude component of the optimal crude blend for both PADDs. A reduction in heavy sweet
crude for PADD 4 and an increase in the same crude type for PADD 5 are indicated. Currently,
Canadian crudes make up 100 percent of the imports into PADD 4, most of it heavy crudes.
Increasing heavy sour composition of the PADD 4 crude diet could result in operational
bottlenecks given that the PADD processes predominantly light crudes. However, at least a stable
outlook for Canadian crude is plausible given adequate pipeline accessibility.
Barring no logistical and operational limitations, PADD5 is likely to see significant increases (about
27%) in light sour crudes to maximize margins. Heavy oil conversion and asphalt capacities in the
Washington area have the pipeline logistics and capacity to accept and process Canadian heavy
crude. Given that higher quantities of heavy sour are indicated to improve refinery margins, it is
likely that the competition to meet this potential demand will come from countries that supply
this crude type to the region – and these are Canada, Colombia and Ecuador.
Currently, the price of HSFO is high due to a tight supply of heavy residue streams for non-
switchable residual oil demand. Being a conversion feedstock, it sets the price for HSFO (Ruiz-
Cabrero et al., 2017). On the other hand, by 2020 when the price of HSFO is set to decline due to
July 2018
a resid glut, the HSFO price will be set by switchable demand and competition with other fuel
options.
Loss of volumes of Canadian heavy sour crude is possible because of the likelihood of foreign
crude suppliers competing in North America, especially in the US Gulf Coast The glut of resid, and
consequently, its price crash of heavier crudes, will spur low-cost producers of heavy crudes in
the other parts of the world to compete in the Gulf Coast. As shown in Figure 6.5, these countries
already hold significant market shares in the Gulf Coast and will be looking to expand their market
shares when the IMO regulations kick-off.
Figure 6.5: Competing International Crudes in the Gulf Coast
Venezuela
Iraq Venezuela
Saudi Arabia
Saudi Mexico
Colombia
Arabia Canada
Colombia
Canada
Iraq
Mexico
Source: EIA, Argus
The margin losses will be transferred to the heavy crude that yields relatively high amounts of
resid, with an accompanying reduction in the global price of all high sulphur crudes. This reduced
netback for the Eastern Hemisphere supply of high sulphur crudes will increase the competition
faced by Canadian suppliers and could potentially reduce the volume of Canadian crude
processed in the US, especially in the Gulf Coast where several international crudes from Canada,
Venezuela, Saudi Arabia, Mexico, Iraq and Colombia are competing (Figure 6.5).
The expected discount will be added to the existing Western Canadian Select price discount due
to crude quality and market access limitations. Market access limitation and logistics is a factor
that has also impacted the crudes from the US Midland. The first quarter of 2018 benefited simple
refineries which had access to the light sweet West Texas Crude. Full pipeline linkages in West
Texas, where light US oil originates from, have depressed prices for Midland Texas crude to more
than three-year lows (Kumar, 2018).
On the other hand, OPEC production cuts, supply issues and political instability among big
producers of heavy crude like Venezuela and Mexico have raised the cost of heavy, sour oil
July 2018
(Kumar, 2018). As a result, complex refineries that can process high sulphur crude but are heavily
dependent on Venezuelan and Mexico crudes had reduced margins. This is the case for refineries
in the Gulf Coast which do not have access to Canadian heavy crude due to lack of or sufficient
connecting pipelines. This has indirectly strengthened the price of the Canadian high sulphur
heavy crude.
WTI-WCS Price Differential

It is important to assess the light-heavy price differential and the volumes of Canadian heavy oil
that may be at risk (supply costs constrained) due to the potential widening of the light-heavy
differential arising from the 2020 IMO sulphur regulation. Our methodology for assessing this risk
is based on a project supply cost model which ranks projects according to economic viability
concerning a range of light-heavy differentials.
Table 6.1: Maximum Refinery Losses ($/bbl) Under Different Scenarios

2020 2025 2030
Medium Refineries
Low NC -18.6 -16.9 -18
Moderate NC -16.2 -19.1 -20.3
High NC -17.8 -27 -28.2
Complex Refineries
Low NC 1.6 -0.2 -2.5
Moderate NC -2.8 -8.1 -12.6
High NC -8.7 -20.2 -25.7
As shown in Table 6.1, for the medium refineries, refinery margin losses of $16/bbl to $28/bbl are
possible under the scenarios assessed. These losses may be directly transferred to a light-heavy
differential given the assumption that medium refineries with the highest margin losses will set
the price. Figure 6.6 illustrates how the refinery margin loss affects the WCS (heavy sour) pricing
relative to WTI (light sweet) for each of the scenarios. The dashed lines represent the WCS pricing
that is historically discounted at $13/bbl plus the refinery margin losses from our analysis of the
discount resulting from the IMO regulation.
July 2018
Figure 6.6: Changes to WTI and WCS Prices Due to the IMO Regulation (2017 US$)
90
80
Crude prices ($/bbl) 70
60
50
40
30
20
2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
WTI WCS w/o IMO WCS Low NC
WCS Moderate NC WCS High NC
Source: CERI
The cumulative discount on WCS with respect to WTI expands dramatically. Between 2020 and
2025, the cumulative WTI-WCS price differential averages $30/bbl. This is an unsustainably high
differential though it is close to the WTI-WCS price differential seen recently. In March 2018, the
differential was US$27.20/bbl due to transportation and logistical bottlenecks. If the differential
remains steady at this point without a continued increase in oil price, some oil sands producers
may be forced to shut down production. This was the situation recently when Cenovus Energy
shut down production due to high price differentials. However, continued upward movement of
the WCS pricing in the case shown in Figure 6.6 could cushion some of the effects of the higher-
than-usual light-heavy differential. If there is Low NC, the WTI-WCS will widen further, with a
possibility to extend the cumulative WTI-WCS price differential to $40/bbl. This level of
differential could present a challenge to the Canadian oil sands industry because the high supply
costs of oil sands could render some bitumen production uneconomical. However, based on many
indications, the Low NC is an unlikely scenario.
Given that the supply costs are made up of the capital and operating costs (Figure 6.7), it is
important to assess how they contribute to the total supply costs of in situ bitumen production
in Canada. Some of the projects are yet to recover their capital investments. By implication, these
projects must generate sufficient income to cover the capital and operating costs in order to break
even.
On the other hand, it can be assumed that projects over 20 years have their capital investments
fully recovered which means that only the operating costs and sustaining capital costs are to be
covered by the income projects generate to break even. The operating expense fraction of the
supply costs have varied over time as a function of operational performance, efficiencies and
energy (mainly natural gas) costs. However, after the oil price slump in 2014, several cost-cutting
July 2018
strategies have been deployed, and as a result, operating costs across the industry and the cost
of new capital investments are declining (Figure 6.7).
Figure 6.7: In Situ Capital and Operating Production Costs
50
45
Bitumen Supply Costs (C$/bbl)
40
35
30
25
20
15
10
5
0
2004 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
CAPEX OPEX
Source: CERI
One factor that has reduced operating costs is that natural gas prices have been relatively low in
recent times due to the shale gas boom. The declining operating costs have also been attributed
to efficiency improvement efforts of the sector. The efficiency improvement efforts that have led
to lower operating costs can also be related to a reduction in steam-to-oil ratios (SOR) of the
projects.
The SOR is the volume of steam in cold-value equivalents used to extract a unit volume of
bitumen. The lower the volume of steam used to extract a barrel of bitumen, the more efficient
the process which consequently lowers the energy-related costs. The SORs of the current in situ
projects vary considerably though about half of the production volume has a SOR between 2 and
4 m3/m3.
Change in the SOR of a project can significantly influence the supply costs or the viability of the
project. A 25% increase in the SOR of a new and expanding SAGD project from a SOR of 3 m 3/m3
will increase the supply costs by 7-9%. However, a 25% reduction in the SOR of the project will
reduce the supply costs by almost 4-7%. The results are similar when the same sensitivity results
applied to non-energy operating costs.
Figure 6.8 shows the profitability of a new SAGD project (2017 US$ values) for different WCS
pricing cases: 1) Without the IMO regulation, 2) Low NC scenario with the IMO regulation, and 3)
Moderate NC scenario with the IMO regulation. The results show that only new SAGD projects
with SORs of less than 3 m3/m3 may break even when the IMO regulation is enforced under the
most likely scenarios presented in Figure 6.8.
July 2018
Figure 6.8: New SAGD Project Viability by 2020
25
20
Profit or loss (US$/bbl)
15
10
5
0
1 2 3 4
-5
-10 SOR (m3/m3)
w/o IMO Low NC Moderate NC
Source: CERI
Similarly, Figure 6.9 shows the profitability by 2020 of a SAGD expansion project (2017 US$ values)
for the different WCS pricing cases mentioned above. It appears that for expanded SAGD projects,
a wider range of SORs would not be affected by the IMO regulation under the most probable
scenarios.
Figure 6.9: Expanded SAGD Project Viability by 2020
40
35
30
25
20
15
10
5
0
1 2 3 4
SOR (m3/m3)
WCS w/o IMO WCS Low NC WCS Moderate NC
Source: CERI
Given these results, the volume of SAGD bitumen production at risk can be deduced. Expanded
projects may not be affected significantly, but standalone projects with a SOR greater than 3
m3/m3 are at risk. The significant volume of SAGD-derived bitumen production could be affected.
Based on SAGD production data, about 574,000 bbl/day of bitumen produced in Alberta has a
SOR of more 3 m3/m3 (CanOIl, 2017).
July 2018
Canadian Crude Oil Exports to the US

Canada has been the top foreign supplier of crude oil to the US since 2004, and it is likely to
remain as such for the foreseeable future. According to the latest data from the US Energy
Information Administration (EIA), Canada’s total exports to the US increased by 185,000 bpd in
2017; a 6 percent increase from 2016 despite no significant growth in total US crude oil imports
(US EIA, 2018). Statistics Canada data shows that Canada produced 4.2 MMbpd of crude oil
equivalent in 2017 and exported 3.33 MMbpd, with most of these volumes (3.3 MMbpd) being
exported to the US.4 The remaining exports were destined to other countries (Figure 6.10).
Figure 6.10: Canadian Supply and Disposition of Crude Oil

4,750
4,500
4,250
4,000
3,750
3,500
3,250
3,000
2,750
(Mbpd)
2,500
2,250
2,000
1,750
1,500
1,250
1,000
750
500
250
-
2016 2017 Q118
Total Production Imports Domestic Demand Export - US Export - Other countries
Source: (Statistics Canada, 2018).
Nearly all of Canada’s crude oil exports to the US come from the western provinces of Alberta
and Saskatchewan, primarily heavy crude oil producers. Newfoundland and Labrador light crude
is destined for other markets. The clear majority of Canada’s crude oil reserves reside in the oil
sands, so it is natural for these bituminous resources to be the primary driver of Canadian
production. Conventional oil reservoirs are also dominated by resources in the Western Canadian
Sedimentary Basin (WCSB) within the provinces of British Columbia, Alberta, and Saskatchewan
(production out of the Northwest Territories is minimal) and offshore production in
Newfoundland and Labrador. In 2017, central and eastern Canada accounted for only 0.22
MMbpd of total Canadian crude production, while western Canadian production made up 95
percent of the total, with two-thirds coming from oil sands production and the remainder from
conventional production, including pentanes plus and condensate.
4
According to the NEB 2015 Canadian crude oil exports, in 2015, less than 1% of total Canadian exports end up in
markets other than the US.
July 2018
Canadian refineries received almost 1.8 MMbpd in 2017 from domestic sources topped with
imports of 0.8 MMbpd. Even though Canadian crude oil production can accommodate the
demand from domestic refineries, Canada still imports foreign-sourced crude. In the West,
Canadian oil sands producers receive imports of condensate from the US as domestically-
produced pentanes; condensates are not enough to meet the diluent demand for bitumen
transportation. In central and eastern Canada, refineries can receive crude oil by rail and pipeline.
In addition, Atlantic Canada has tidewater access and imports crude from several different
countries.
The rise in US domestic production, driven by the horizontal hydraulic fracturing of tight oil plays
in Texas and the Dakota’s has displaced some oil imports. In 2014, US production of crude oil
exceeded the level of US imports for the first time in 20 years and continued to rise. This light
tight oil has flooded refineries on the East and Gulf Coast. However, since the projected growth
of western Canadian crude oil supplies is predominately heavy crude oil, the US Gulf Coast and
Midwest refineries – with their substantial heavy oil processing capacities – remain a key target
market. Demand for Canadian heavy oil is expected to increase in the US Gulf Coast refining
complex to replace shrinking volumes that come from Mexico and Venezuela. Canada represents
a reliable source of crude for the US, transported straight to the refinery gate.
The US Midwest is still the largest importer of Canadian crude. In 2017, 68% of total Canadian
exports to the US went to the US Midwest (PADD 25). Whereas the US Gulf Coast (PADD 3)
represents a smaller but a growing market, importing almost 0.4 MMbpd of crude oil from Canada
in 2017, which translates to 11 percent of Canada’s total imports, an increase of 5 percent from
2016 (US EIA, 2018). Although the Gulf Coast refineries are best suited to handle Western
Canadian heavy crudes, the existing pipeline infrastructure is not sufficient to effectively access
the market. TransCanada’s Keystone XL pipeline, if successfully implemented, will address the
access issue, adding another 830,000 bpd, but the project has been in development for nearly a
decade. With recently secured 20-year commitments from shippers in the amount of 500,000
bpd (Vamburkar & Orland, 2018), TransCanada might move forward. It has not officially green-
lighted the project and is still working toward a final investment decision (FID).
Overall, heavy sweet and sour crude exports account for 72 percent of total Canadian exports
(2.5 MMbpd) (US EIA, 2018). Medium crudes make up almost 20 percent, and the remainder is
split between light sweet and sour volumes. Figure 6.11 illustrates Canadian heavy crude oil
exports by type and destination in 2017, as reported by the US EIA.6
5
The Petroleum Administration for Defense District (PADD) are geographic aggregations of the 50 States used as
their official delineation to describe their oil market regions. There are five different PADDS: East Coast (1), Midwest
(2), Gulf Coast (3), Rocky Mountain (4) and West Coast (5).
6
National Energy Board estimated Canadian crude oil exports by type and destination, 2014-2015.
July 2018
Figure 6.11: Canadian Crude Exports to the US

2,500
2,000
2016-2017 %Change for Heavy Sour Imports
PADD5 14%
1,500
PADD4 14%
(Mb/d)
PADD3 10%
PADD2 13%
1,000
PADD1 140%
0% 50% 100% 150%

500
0
Light Sweet Light Sour Medium Heavy Sweet Heavy Sour
Source: US EIA
Table 6.2 summarizes the status of Canadian crude exports in all five US PADD regions and
identifies future opportunities to expand Canadian market shares at various locations.
July 2018
Table 6.2: Canadian Crude Exports Status by PADD Region

Canadian Crude Oil Pipeline Opportunities Other Movement Opportunities
Processed
PADD 1 199.3 Mbpd Limited movement due to Rail is the key transportation mode
TransCanada cancelling Energy for future Canadian supplies. Since
33.6 Mbpd of heavy East pipeline project rail is more expensive than
crude pipeline/tanker for other supply
sources, ability to compete for
market share is limited.
PADD 2 2,335 Mbpd The largest market for Canadian No need for another mode of
1,769 Mbpd of heavy crude exports. Expected transport due to extensive pipeline
crude increased reliance on heavy network available from Western
crude from Canada is Canada.
anticipated if refinery upgrades
proceed. Extensive pipeline
network is available from
western Canada.
PADD 3 383.6 Mbpd Demand for over 2 MMbpd of Canadian crude oil can be
381.5 Mbpd of heavy heavy crude oil imports remains. transported through Cushing into
crude Opportunity for Canada to the southern refineries of
increase market share based on Louisiana and Texas, however,
declining Venezuelan supplies. currently limited due to capacity
Limited pipeline capacity leaving limitations in pipelines delivering
western Canada and connecting western Canadian oil to Cushing.
to Cushing, Oklahoma will limit
how much Canadian heavy Opportunity to rely on rail,
crude oil can replace however, will limit competition
Venezuelan market share. due to higher incurred costs.
PADD 4 273 Mbpd Stable outlook for western No need for another mode of
227 Mbpd of heavy Canadian oil to continue transport.
crude supplying import needs through
Enbridge’s Express pipeline
PADD 5 226 Mbpd Some volumes can be provided Rely on marine shipments for half
58.3 Mbpd of heavy by the Trans Mountain pipeline of the required refinery feedstock.
crude to Washington market. Washington and California
primarily represent the future
need for western Canadian crude
oil.
Rail can provide access to the
North Dakota market.
Trans Mountain pipeline can also
provide access for western
Canadian crude oil to the West
Coast of California through marine
tankers from Westridge Marine
Terminal in BC.
Source: US EIA; CAPP
July 2018
Canadian Export Pipeline Network

Western Canada production centers are connected to domestic and US refining and export
centers mainly through pipelines. In 2017, the majority of western Canadian crude oil supplies
were transported to markets by pipeline, but the volumes in excess of available pipeline capacity
relied on rail. Members of the Canadian Energy Pipeline Association (CEPA) reportedly
transported 3.7 MMbpd of crude oil and other liquids over approximately 41,000 km of pipeline
in 2017 (CEPA, 2017). Although pipelines are the preferred method of transportation, an
increasing volume of crude is now transported by rail because of infrastructure constraints.
The existing export pipeline system out of western Canada is currently operating at overcapacity
and producers are relying more on rail to move incremental volumes. Both the Enbridge Mainline
system and Trans Mountain continue to apportion crude supply by reducing shippers’ nominated
volumes to derive an aggregate amount which can be safely transported by the pipeline in
accordance with its available capacity.
Some excess capacity is crucial to be able to manage pipeline maintenance times and to provide
flexibility for new market development and spot shippers. In addition, constraints in pipeline
capacity and the lack of access to existing and new demand centers have deepened the discount
between WTI and Western Canadian crudes and hence have had an impact on the netbacks
realized by Canadian producers.
The combined nominal takeaway capacity of the major pipelines originating from Western
Canada is just over 4 MMbpd. However, in 2017, about 660,000 bpd of this capacity was
unavailable for transporting western Canadian crude oil due to a combination of factors including
equipment being offline, constraints on downstream pipelines, and capacity being allocated for
transporting refined petroleum products for US Bakken crude oil production.
Pipeline capacity is a bottleneck for the Western Canadian crude oil production growth forecast.
Three major pipeline projects remain under active development following the cancellation of
TransCanada’s Energy East pipeline project in October 2017. The combined capacity from
Enbridge’s Line 3 Replacement project (370,000 bpd), Kinder Morgan’s Trans Mountain Expansion
(590,000 bpd), and TransCanada’s Keystone XL (830,000 bpd) would equal 1.8 MMbpd. All this
capacity would be needed to transport the anticipated supply growth from western Canada.
Additionally, Enbridge has invested in the Southern Access pipeline, which started operating in
2016 and transports 300,000 bpd from Flanagan to Patoka, Illinois (Enbridge Inc., 2018). This line
is a link in the transport of western Canadian crude to the US Gulf Coast.
TransCanada completed another pipeline project, within the US, known as the Gulf Coast
Extension pipeline in 2014. This pipeline transports 591,000 bpd of crude from Cushing,
Oklahoma to Texas refineries. It has been key in solving some of the infrastructure constraints
that led to an oversupply of oil at the Cushing storage hub.
July 2018
Western Canadian production has had limited access to the US Gulf Coast market, especially
because of the lack of infrastructure connecting Cushing, Oklahoma (the primary US hub for
Western Canadian crude oil) to refineries in Texas. Besides TransCanada’s efforts, Enbridge
decided to reverse the direction of flow of their Seaway Pipeline (jointly owned with Enterprise
Product Partners L.P.). Since 2012, Seaway has delivered Western Canadian crude oil from the
Mainline system at Cushing, Oklahoma to Freeport, Texas. The original capacity of the reversed
pipeline was only 150,000 bpd but was increased to 400,000 bpd through pump station
modifications and additions in 2013. In 2014, capacity was expanded to 450,000 bpd.
To support Western Canadian market access to the Gulf Coast through Seaway, Enbridge also built
a new line between Pontiac, Illinois and Cushing, Oklahoma (called Flanagan South) with 585,000
bpd of capacity. Enbridge shippers that contract capacity on Flanagan South can nominate
Western Canadian crude volumes for delivery to the US Gulf Coast through this pipeline, which
connects to the downstream Seaway line. In total, more than 1.2 MMbpd of pipeline capacity has
been installed in the US to support market access for Western Canadian crude oil to the Gulf Coast
refining hub.
Canadian Rail Network

Rapid growth in Western Canadian crude oil production (especially from oil sands operations) has
outpaced pipeline capacity and pipeline companies’ expansion efforts. In recent years, rail
transport of crude oil has surged as an alternative mode of transport to accommodate new supply
volumes that exceed pipeline capacity.
Rail provides flexibility to move to different markets in response to demand, which is valuable in
the current economic climate. Rail also provides flexibility in amounts of product shipped and
type of product. The coil and insulated (C&I) rail cars can transport bitumen with little or zero
need for diluent. In comparison, diluted bitumen or dilbit via rail would use the same amount of
diluent as dilbit in pipelines, or around 30%. Railbit will require about 17% diluent and cleanbit
would require no diluent at all.
As current pipeline constraints persist, widening the differential between WCS and WTI, rail can
increase its crude-by-rail rates, but both Canadian railway companies, CN and CP, demand long-
term take-or-pay contracts to backstop investments in additional locomotives and train crews.
The business risk for the rail companies is that these transport volumes would evaporate once
new export pipelines come on stream (Healing, 2018).
Rail transport is expected to continue to increase due to the lack of pipeline capacity. The National
Energy Board states crude-by-rail exports from Canada grew to a record 193,500 bpd in April
2018, a 13% increase from the previous month, as full pipelines forced more producers to use
trains to get their products to market. The oil shipping tally beat the previous record of nearly
179,000 bpd in September 2014 and was well ahead of the 150,000-bpd moved in April 2017.
July 2018
CAPP estimates current rail loading capacity is originating in western Canada at 858,400 bpd.
However, not all this capacity is used and in fact, is shared with other commodities. Table 6.3
displays the existing rail terminals with their capacity from Western Canada.
Table 6.3: Existing Rail Terminals and their Capacity from Western Canada
Source: (CAPP, 2018b)
The lack of access to locomotives, personnel and rail track is limiting shippers’ ability to move
crude by rail. To increase shipped volumes, rail companies will have to make significant
investments, which they are reluctant to do without long-term arrangements with crude
suppliers.
July 2018
Chapter 7: Conclusion
This study assesses the impact of the IMO 2020 sulphur regulation on Canadian oil production.
Though the focus of analysis is the regulation’s impact on heavy oil production in Canada, the
assessment is structured to draw insight from in-depth background and analysis covering global
crude oil markets, PADD-level refinery modelling and linear programming of US refineries, IMO
regulation non-compliance scenarios and compliance options.
In 2016, the IMO introduced a new global limit on the sulphur content in marine fuels powering
ships with an effective date for the reduction of January 1, 2020. Under the new global cap, ships
will have to use marine fuels with a sulphur content of no more than 0.5% (m/m) against the
current limit of 3.5% to reduce emissions. However, Emission Control Areas (ECAs) will remain at
the 2015 standard of 0.1% sulphur content in North America, Europe and Baltics.
The new rule is not as stringent as that of ECAs but is tougher than the current limit and applies
more broadly to ships sailing international waters. The regulation could significantly change the
crude oil market landscape at regional and global levels as it requires the removal of up to 20,000
tons per day of sulphur contained in the 3-4 million barrels/day of high sulphur bunker fuel used
for marine transport. The sudden changes will propagate all along the value chain, from the
marine industry that will seek a replacement fuel, to refiners that produce bunker fuel, and to
upstream oil producers who produce crudes that generate high sulphur residues used in bunkers,
particularly heavy oil producers like Canada, Venezuela, and Mexico.
Marine bunker fuels account for about 4% of the global crude oil demand, but they are an
important outlet and revenue for the refining industry (IEA, 2018a). The marine industry absorbs
unwanted residual fuel oil – a refinery product which has declining demand due to emissions
control regulations (requiring cleaner-burning fuels onshore) and a decrease in residual fuel oil
demand for non-bunker uses.
Sour and medium sour crudes, with sulphur content above 0.5 wt.% constitute about 64.5% of
the global crude supply – a significant fraction of the total crude production. Moreover, heavy
crude oil production from the America’s (Argentina, Brazil, Canada, Colombia, Ecuador, Mexico,
United States and Venezuela) is a large portion of the global medium sour and sour crudes
produced in 2016.
Canada (specifically, Alberta) is one of the major producers of high sulphur heavy crude oil with
its production growing steadily since 2008. Bitumen production is expected to reach 3 million
bbl/day by the end of 2018 and continue afterwards. Canadian heavy sour crude is refined
primarily in Canada and United States which has sufficient capacities of complex refineries to
handle this type of crude. Canadian bitumen contributes hardly anything to bunkers since it is
consumed by the bottom of the barrel complex refining in Canada and the US. Instead, Canadian
crude will have to compete for US refining space on netback refining value with other crudes that
July 2018
currently do contribute to HSFO supply. Therefore, a refinery optimization model is used to

understand the impact of the IMO regulation.
CERI developed a linear programming model using the input-output refinery model to account
for US refinery configurations and their operating costs and capital investments. This provided
an analysis of crude oil blending and the associated refinery acquisition costs of crude blends and
revenue generated from the sales of refinery products. The results show that optimization of
refineries at a PADD-level can lead to a potential displacement of some volumes of certain crudes
that have historically been processed there. Also, results show that heavy sour crudes are likely
to displace mostly light sweet and medium crudes in a logistically and operationally
unconstrained environment. In addition to this observation, increases in heavy sweet crudes are
expected in some PADDS.
With the imposition of more realistic constraints, the magnitude of these displacements is
reduced to resemble recent past crude diet receipts with optimal refinery margins. These results
are driven by lower-priced crudes, yield levels of high-value products, and profitability of the
process.
Our analysis overlaid the crude blends being selected by refineries with three different non-
compliance scenarios of the IMO regulation. When assessed together the margin requirements
of refineries and the non-compliance possibilities lead to a price outlook for different oil types
and the WCS-WTI price differential.
The changes in resid and distillate prices will reduce refinery margins to a notable degree. Our
analysis indicates that this is the general trend in the years after 2020 in all the non-compliance
scenarios. We found that a $16/bbl to $19/bbl drop in margins for a medium refinery in the US
relative to 2017 values can be expected in 2020 for all the non-compliance scenarios (Figure 7.1).
By 2025-2030, medium refineries in the US are likely to see their margins drop by $17/bbl to
$28/bbl relative to 2017 margins in all the non-compliance scenarios assessed. However, for the
scenarios we consider plausible, the Low NC and Moderate NC scenarios, the margins of medium
refineries in the US drop by $16/bbl in 2020 and $20/bbl by 2025 and beyond.
July 2018
Figure 7.1: Refinery Margin Impacts Due to the IMO 2020 Regulation
Complex refineries are not considered to set the prices for heavy crude because they would not
be impacted as significantly as the simpler refineries will, at least not in the short term. As shown
in Figure 7.1, margins of complex refineries will be better off than they were in 2017 under the
Low NC scenario because of the IMO 2020 regulation. This is because the complex refineries that
specialize in processing heavy crudes will enjoy increases in refinery margins from low heavy
crude prices and higher than normal middle distillate prices. However, under the Moderate and
High NC scenarios, the margins of complex refineries will not be spared, because compliance
levels may not be high enough to drive up the prices of middle distillates and push down the
prices of residual fuel oil and heavy sour crudes to significant levels.
Different levels of profitability are expected from the PADDs. PADD 4 appears to bear the greatest
brunt of the IMO regulation among all the PADDs. Although some PADDs will have low margin
reductions and even an increase in margins for some by 2020, we expect the highest margin
reduction case from medium refineries to set the prices for heavy sour crudes and determine the
light-heavy crude price differential.
Increased level of non-compliance may not push middle distillate prices as high as one would
expect with an increased level of compliance. The higher the price of middle distillates, the higher
the margins and this effect outweighs the penalty from diminishing resid prices. An exception to
this pattern is a case where the refinery does not produce a reasonable volume of low sulphur
middle distillates.
July 2018
A general trend of declining margins is expected for some years after 2020 due to a drop in the
price of middle distillates post-2020 as the market rebalances and the distillate prices drop to
normal levels. However, the price of resid will not recover at a rate that can stabilize the refinery
margins, and thus, cannot cushion the effect of the rebalancing middle distillates prices. This is
because the effect of price movements of the middle distillates outweighs the margin-boosting
effect from slowly increasing resid prices.
CERI assessed how the market share of different substitution options for high sulphur bunker fuel
would evolve over time (see Figure 7.2). We note that the most likely substitution would be by
low sulphur fuel oil options followed by desulphurization. The installation of scrubbers was found
to be the least preferred option.
Figure 7.2: Resid Bunker Fuel Substitution Options (Moderate NC scenario)
100.0%
14.0% 15.0%
80.0% 11.0%
14.0%
25.0%
60.0%
60%
40.0% 61%
57%
20.0%
5.0% 7.0%
1.9%
5.0% 5.0%
0.0%
2020 2025 2030
Currently, less than 1% of the worldwide fleet is operating within the future regulatory limits for
sulphur emissions for open ocean areas outside the Emission Control Areas (ECAs). Scrubbers are
installed in less than 1% of ships worldwide, and analysts believe that its future adoption will be
minimal. Under the Moderate NC scenario, we estimate that scrubbers will capture only about
3% of the HSFO volume to be displaced by 2020.
Ship retrofitting and LNG bunkering are the two main obstacles to LNG development as a
maritime fuel. Our projection of 1.9% to 7% of resid bunker fuel displacement volume fuel
July 2018
consumption falls within the range of the IMO 3rd GHG study’s projection of 2-10% of the total
marine fuel share.
The majority of the existing methanol supply infrastructure is as feedstock to the chemical
industry. As the supply chain extends further into the shipping fuel market, more methanol might
need to come from sources other than natural gas to improve environmental performance. These
considerations lead us to conclude that methanol’s use as a substitute for resid bunker fuel is
limited, at least in the short run.
Market share percentages are translated into volume demand in Figure 7.3.
Figure 7.3: Resid Bunker Fuel Substitution Volumes (Moderate NC Scenario)
4,000,000
Volume of HSFO captured (bbl/day)
3,500,000
3,000,000
2,500,000
2,000,000
1,500,000
1,000,000
500,000
-
2020 2025 2030
Scrubbers Methanol LNG Low Sulfur Distillates
Non Compliance Desulphuration Blended HSFO
Increasing refinery utilization capacities is part of the solution to the bunker fuel availability
problem but adds to the problem of resid glut because more resid will be produced as refiner’s
process more crude. World refineries can produce about 1.3 million bbl/day of distillates together
with 1.2 million bbl/day heavy fuel oil and other bottoms through a 5 percent increase in
capacities if we assume that global refineries are predominantly medium conversion. On the
other hand, a 10 percent increase in the global refinery capacities will result in 2.6 million bbl/day
of distillates together with 2.3 million bbl/day heavy fuel oil and other bottoms. In each case,
large amounts of distillates that can bridge the gap of cleaner bunker fuel demand can be
produced. Equally large amounts of heavy fuel oil are produced alongside the production of
distillates. This will likely keep high sulphur fuel oil prices low. Additionally, the world is reaching
July 2018
peak gasoline demand and would not need the additional naphtha generated by the added crude
processing.
The reason why refiners are not making costly refining modifications now may be because the
price volatility that will be created from the IMO rule implementation is not expected to last long
enough to make such investments viable. The markets are expected to rebalance in a couple of
years, and this discourages significant capital investments in complex refining units, which has a
payback period of at least two decades. Also, there seems to be enough room to process more
crudes to meet the expected increases in demand for distillates for marine fuel use.
Once the rules take effect, the shipping industry will need to switch to either marine gasoil,
marine diesel, low sulphur residual fuel oil or a blend of high sulphur and ultra-low sulphur fuel.
We assessed two blending options and identified that blending of HSFO and LS-MGO (Blend II) is
likely to be preferred because it is cheaper and has better fuel properties than the Blend II option
which blends HSFO with ULSD (Figure 7.4).
Figure 7.4: Prices of Conventional Marine Oils and the Blend Options
120
100
Marine Fuel Price ($/bbl)
80
60
40
20
0
2017 2020 2025 2030
MGO ULSD Heavy Bunker Blend I Blend II
By 2020 the prices of LS-MGO and ULSD are expected to skyrocket and consequently create a
greater spread between low and high sulphur bunker fuels. Therefore, the price movements by
2020 may motivate more use of blending, especially for the Blend II option.
It is important to note that in choosing marine fuel blends, for shippers, fuel oil is preferred over
gasoil. Many marine engines are optimized to operate on HSFO. The use of marine gas oil or any
of the blends presented in Figure 7.4 often leads to several adverse effects on fuel and engine
systems. Switching to these fuels in traditional marine engines carries significant operational risks
of low viscosity, lubricity, acidity and flash point. Some analysts believe that some of these issues
can be resolved by adapting the engines to burn these fuels, the cost of which is not significant.
July 2018
A key finding of this analysis is how the IMO regulation will affect the Canadian oil sector. Western
Canadian oil is priced at a discount to WTI. That discount has a significant impact on the viability
of oil sector investments in western Canada. The cumulative discount on WCS with respect to
WTI will expand dramatically due to the IMO regulation.
Figure 7.5 illustrates how the refinery margin loss affects the WCS (heavy sour) pricing relative to
WTI (light sweet). The dotted lines represent the WCS pricing that is historically discounted at
$13/bbl plus the discounts resulting from the IMO regulation for the three scenarios considering
a medium refinery in the US.
Figure 7.5: WCS-WTI Price Differential Impact Due to the IMO Regulation (2017 US$)
90
80
70
Crude prices ($/bbl)
60
50
40
30
20
2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028 2029 2030
WTI WCS w/o IMO WCS Low NC WCS Moderate NC WCS High NC
Source: CERI
Given the low possibility of the High NC scenario, its effects on WCS are not emphasized. The
plausible cases are the Moderate and Low NC scenarios where the effects fall within a reasonable
band. Under the plausible scenarios, a refinery margin loss of $16/bbl to $20/bbl between 2020
and post-2025 may be directly transferred to a light-heavy differential. The cumulative discount
sums up to $31/bbl-$33/bbl. This expanded discount could portend high risks of shutting down
production for some oil sands producers; however, it could be offset by continued upward price
movements of WCS and WTI pricing. On the other hand, if global oil prices remain static or
decline, such a higher-than-usual WTI-WCS price differential shall pose a business challenge to
western Canada’s oil sector. The viability of different SAGD projects could be challenged (Figure
7.6) for a new project with steam-to-oil ratios of more than 3 m3/m3 and for an expansion project
with steam-to-oil ratios of more than 4 m3/m3 (Figure 7.7).
July 2018
Figure 7.6: New SAGD Project Viability by 2020
25
20
15
10
5
0
1 2 3 4
-5
-10 SOR (m3/m3)
w/o IMO Low NC Moderate NC
It can be deduced that new SAGD projects with SORs of less than 3 m3/m3 are likely to break when
the IMO regulation is introduced. New projects with SORs greater than 3 m3/m3 will operate in
losses. A significant volume of SAGD-derived bitumen production could be affected. Based on
SAGD production data, about 574,000 bbl/day of bitumen produced in Alberta has a SOR of more
3 m3/m3 (CanOIl, 2017).
The expanded SAGD projects will perform profitably for a wider range of SORs (Figure 7.7).
Figure 7.7: Expanded SAGD Project Viability by 2020
40
35
30
25
20
15
10
5
0
1 2 3 4
SOR (m3/m3)
WCS w/o IMO WCS Low NC WCS Moderate NC
Based on the supply costs and profitability analysis, under the most probable scenarios, bitumen
volumes produced from expanded projects may not be affected significantly, but bitumen
volumes produced from new standalone projects with a SOR greater than 3 m3/m3 are at risk.
If no foreign crude suppliers compete in North America, there may be no significant loss of current
volumes of Canadian heavy sour crude exported to refineries in the US. However, the glut of resid,
July 2018
and consequently, its price decrease is a major challenge that will lead to the refinery margin
losses and the light-heavy differentials that we observe. The refinery margin losses will likely
translate into the market prices of those heavy crudes that yield relatively high amounts of resid,
with an accompanying reduction in the global price of all high sulphur crudes. This reduced
netback for the Eastern Hemisphere supply of high sulphur crudes will increase the competition
faced by Canadian suppliers and could potentially reduce the volume of Canadian crude
processed in the US.
July 2018
July 2018
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Appendix
CERI Input-Output Refinery Model
A generic Input-Output model which uses a linear multivariate regression method is developed
to capture:
• Inputs and output of the US refineries by PADD as illustrated in Figure A.1

• The various types of refinery configurations currently operating in the United States
• Nominal and available refining capacities within each PADD
• Differences in crude blend flows and product slates at each PADD
• PADD-level sulphur handling capacities
Figure A.1: Generic Refinery Input-Output Regression Model
The model is developed and implemented in the R programming language. The model predicts
product slates using as the predictors the crude blend flows at different types of refineries in each
US PADD district. The modelling equation can be summarized mathematically as:
𝑦11 , 𝑦12 , ⋯ 𝑦1𝑛 𝛽11 , 𝛽21 , ⋯ 1

𝛽𝑚 𝑥11 , 𝑥12 , ⋯ 𝑥1𝑛
[ ⋮ ⋱ ⋮ ]=[ ⋮ ⋱ ⋮ ][ ⋮ ⋱ ⋮ ] (Eqn. 1)
𝛽1𝑝 , 𝛽2𝑝 ⋯
1 2 𝑝
𝑦𝑝 , 𝑦𝑝 ⋯ 𝑦𝑝𝑛 𝛽𝑚 1
𝑥𝑚 2
, 𝑥𝑚 ⋯ 𝑛
𝑥𝑚
From the above expression, the parameters m and p are the numbers of predictors and response
variables, respectively. Parameter n defines the size of the dataset used, whereas y and x are the
refinery products and crude oil blends, respectively. The modelling parameters, 𝛽, are obtained
by performing the multivariate regression in R programming platform.
July 2018
LP Model Equations
𝐹𝑜𝑟 𝑐𝑟𝑢𝑑𝑒 𝑜𝑖𝑙 𝑏𝑙𝑒𝑛𝑑 (𝑖), 𝑟𝑒𝑓𝑖𝑛𝑒𝑑 𝑝𝑟𝑜𝑑𝑢𝑐𝑡 𝑡𝑦𝑝𝑒 (𝑗)𝑎𝑛𝑑 𝑟𝑒𝑓𝑖𝑛𝑒𝑟𝑦 𝑐𝑜𝑛𝑓𝑖𝑔𝑢𝑟𝑎𝑡𝑖𝑜𝑛 (𝑘);
𝑜𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡𝑖𝑚𝑒 (𝑡):
𝑚𝑎𝑥𝑖𝑚𝑖𝑧𝑒 𝑅𝑒𝑓𝑖𝑛𝑒𝑟𝑦𝑀𝑎𝑟𝑔𝑖𝑛 = ∑𝑡 ∑𝑗 ∑𝑘 𝑝𝑝𝑡,𝑗 × 𝑃𝑟𝑜𝑑_𝑉𝑜𝑙𝑡,𝑗,𝑘 − ∑𝑡 ∑𝑖 ∑𝑘 𝑝𝑐𝑡,𝑖 ×

𝐹𝑒𝑒𝑑_𝑉𝑜𝑙𝑡,𝑖,𝑘 − ∑𝑡 ∑𝑖 ∑𝑘 𝑝𝑟𝑜𝑐𝑒𝑠𝑛𝑔_𝑐𝑜𝑠𝑡𝑘 × 𝐹𝑒𝑒𝑑_𝑉𝑜𝑙𝑡,𝑖,𝑘
𝑠𝑢𝑏𝑗𝑒𝑐𝑡 𝑡𝑜:
𝑅𝑒𝑓𝑖𝑛𝑒𝑟𝑦 𝑀𝑜𝑑𝑒𝑙 𝐸𝑞𝑢𝑎𝑡𝑖𝑜𝑛𝑠: [𝐏𝐫𝐨𝐝_𝐕𝐨𝐥𝑚𝑎𝑡𝑟𝑖𝑥 ] = [𝐂𝐨𝐞𝐟𝐟𝐢𝐜𝐢𝐞𝐧𝐭𝐬𝑚𝑎𝑡𝑟𝑖𝑥 ][𝐅𝐞𝐞𝐝_𝐕𝐨𝐥𝑚𝑎𝑡𝑟𝑖𝑥 ]
∑ 𝐹𝑒𝑒𝑑_𝑉𝑜𝑙𝑡,𝑖,𝑘 ≤ 𝑐𝑓𝑘 × 𝑅𝑒𝑓𝑖𝑛𝑒𝑟𝑦𝐶𝑎𝑝𝐿𝑖𝑚𝑖𝑡𝑘 ∀𝑘, 𝑡

𝑖
∑ 𝐹𝑒𝑒𝑑_𝑉𝑜𝑙𝑡,𝑖,𝑘 ≤ 𝑚𝑎𝑥𝐹𝑒𝑒𝑑𝑖 × ∑ 𝑐𝑓𝑘 × 𝑅𝑒𝑓𝑖𝑛𝑒𝑟𝑦𝐶𝑎𝑝𝐿𝑖𝑚𝑖𝑡𝑘 ∀𝑖, 𝑡
𝑘 𝑘
∑ 𝐹𝑒𝑒𝑑𝑉𝑜𝑙 𝑡,𝑖,𝑘 ≥ 𝑚𝑖𝑛𝐹𝑒𝑒𝑑𝑖 × ∑ 𝑐𝑓𝑘 × 𝑅𝑒𝑓𝑖𝑛𝑒𝑟𝑦𝐶𝑎𝑝𝐿𝑖𝑚𝑖𝑡𝑘 ∀𝑖, 𝑡
𝑘 𝑘
∑ 𝑃𝑟𝑜𝑑_𝑉𝑜𝑙𝑡,𝑗,𝑘 ≤ 𝑚𝑎𝑥𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑗 × ∑ 𝑃𝑟𝑜𝑑𝑐𝑢𝑡𝐿𝑖𝑚𝑖𝑡𝑘,𝑗 ∀𝑗, 𝑡

𝑘 𝑘
∑ 𝑃𝑟𝑜𝑑_𝑉𝑜𝑙𝑡,𝑗,𝑘 ≥ 𝑚𝑖𝑛𝑃𝑟𝑜𝑑𝑢𝑐𝑡𝑗 × ∑ 𝑃𝑟𝑜𝑑𝑐𝑢𝑡𝐿𝑖𝑚𝑖𝑡𝑘,𝑗 ∀𝑗, 𝑡

𝑘 𝑘
∑ 𝑆𝑢𝑙𝑓𝑢𝑟𝑖,𝑘,𝑡 = ∑ 𝑆𝑢𝑙𝑓𝑢𝑟𝑗,𝑘,𝑡 + 𝑆𝑢𝑙𝑓𝑢𝑟_𝐿𝑜𝑎𝑑𝑘,𝑡 ∀𝑘, 𝑡

𝑖 𝑗
∑ 𝑆𝑢𝑙𝑓𝑢𝑟_𝐿𝑜𝑎𝑑𝑘,𝑡 ≤ 𝑆𝑢𝑙𝑓𝑢𝑟𝐵𝑎𝑙𝑎𝑛𝑐𝑒𝑡 ∀𝑡
𝑘
July 2018
Refinery Optimization Model
Figure A.2: LP Optimization Model
Table A:1: US Refinery Capacities and Configurations

Catalytic
Catalytic Hydrocrackin Catalytic
Thermal Processes Cracking g Hydrotreating
Distillate,
Distillate, Gasoil & resid
US Coking and Fresh & Gasoil & desulphurizati
Region Crude Vacuum visbreaking recycled feed resid on
PADD1 1,213,800 526,680 73,350 453,150 40,770 409,140
PADD2 4,004,040 1,723,470 529,020 1,216,620 318,980 1,674,610
PADD3 9,621,767 4,509,333 1,468,150 2,820,015 1,204,600 3,840,653
PADD4 683,245 241,005 81,290 203,539 54,720 304,623
PADD5 2,934,785 1,521,150 548,580 815,580 536,570 1,097,250
Source: Oil and Gas Journal (2017), CERI
Objectives:
The analysis below will be conducted at PADD levels and for each refinery configuration
1. Find the makeup of a crude blend that minimizes the sulphur content in the Liquid Heavy
Ends (Bunker) and Fuel Oil (Heating oil) but maximizes refinery margins
2. Find the makeup of a crude blend that minimizes the produced volumes of Liquid Heavy
Ends (Bunker) and Fuel Oil (Heating oil) but maximizes refinery margins
3. For types of refineries offer superior economics
4. Estimate the economic impacts of increasing capacity factors of the refineries to maximize
ULSD yields
July 2018

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Study No.

Canadian Energy Research Institute | Relevant • Independent • Objective

AN ECONOMIC ASSESSMENT OF THE INTERNATIONAL MARITIME ORGANIZATION

An Economic Assessment of the International Maritime Organization

Authors: Experience Nduagu

Copyright © Canadian Energy Research Institute, 2018

Front cover photo courtesy of Google images

• James Storm • Ian Austin

ABOUT THE CANADIAN ENERGY RESEARCH INSTITUTE – CANADA’S VOICE ON ENERGY

For more information about CERI, visit www.ceri.ca

CANADIAN ENERGY RESEARCH INSTITUTE

CHAPTER 6 IMPACTS ON CANADIAN HEAVY OIL ......................................................... 63

Acronyms and Abbreviations

CERI Refinery Optimization Modelling

IMO Regulation: Impact on US Refinery Margins

Figure E.1: Refinery Margin Impacts Due to IMO 2020 Regulation

Scenario Assumption and Compliance Options

Impacts on Canadian Heavy Oil

Figure E.3: WTI and WCS Price Differential (2017 US$)

Chapter 1: History of the IMO and

Further changes to MARPOL Annex VI addressed a progressive reduction globally in emissions of

The ECAs established are:

• Baltic Sea area – as defined in Annex I of MARPOL (SOx only);

Table 1.1: SOx Emissions Controls

Historic Levels of Compliance

The different compliance methods include:

• Desulphurize refinery fuels and use lower sulphur content fuel.

Impact of Previous IMO/ECA Regulations on Crude Markets

As with all predictions, there are uncertainties.

Chapter 2: Global Crude Oil Markets

Figure 2.1: Global and North American Crude Oil Production

Source: EIA, CERI

Figure 2.2: Global Crude Production Volume by Quality in 2016

Heavy & Medium Sour Heavy Sour Unassigned production

Source: ENI, CERI.

Figure 2.3: Quality and Production Volume of Major Crudes in 2016

Table 2.1: Crude Classifications by API and Sulphur Content

Heavy & Medium Sour

Heavy & Sweet

Medium & Sour

Medium & Medium Sour

Medium & Sweet

Light & Sour

Light & Medium Sour

Light and Sweet

0% 10% 20% 30% 40% 50% 60% 70% 80% 90%

Source: Data from ENI, Calculations by CERI

Figure 2.5: Canadian Historical and Projected Bitumen Production

Mined Bitumen Extraction Total In-Situ Bitumen Extraction

Global High Sulphur Residual Oil Market

Figure 2.6: Residual Fuel Oil Demand

Source: Shell (2017), S&P Global Platts (2018)

Figure 2.7: Jurisdictional Fuel Oil Consumption

Source: BP (2017), CERI.

Figure 2.8: Bunker Fuel Consumption by Type, 2016

Fuel oil Gasoil/Diesel Other

Source: McKinsey (Fitzgibbon et al., 2017), CERI.

Middle Distillates Oil Markets

Figure 2.9: Global Diesel and Gasoil Consumption

Source: BP (2017), CERI.

Table 2.2: Available Refining Capacity (million bbl/day 2017)

Source: OPEC WOO 2017

Figure 2.10: Global Refined Oil Product Desulphurization Capacities

Russia & Caspian