California refiners feeling the squeeze from regulatory and market pressures
California refiners face unique and compounding pressures, making continued operations a challenge. These range from overall gasoline and diesel demand destruction to declining California crude oil production, to the California Air Resources Board (CARB) expanded “At-Berth” regulation, and a new state law establishing a maximum gross gasoline margin.
Petroleum Product Demand Destruction: One of the key factors contributing to petroleum product demand destruction in California is the success of the low carbon fuel standard (LCFS) to incentivize the transition of the petroleum diesel pool to renewable diesel (RD) and biodiesel (BD). The most recent CARB data for the LCFS program shows RD and BD together made up 75% of the California diesel pool in the second quarter of 2024. This has contributed to length in the California petroleum diesel market, requiring excess production to be exported.
While gasoline has been difficult to replace with lower carbon alternatives, other factors including enhanced fuel efficiency for internal combustion engine vehicles (ICEVs), the adoption of zero emission vehicles (ZEVs), and remote work have led to a 10% drop in California gasoline demand since 2015.
California Crude Oil Production Decline: California crude oil production has been declining at an average rate of 2% per year since the 1980s. Starting in 2019, California restricted in-state crude oil production, leading to a 24% decline in volume between 2019 and 2023. The production decline appears to be accelerating this year, as the first six months of 2024 showed production 12% lower than the first six months of 2023. The state’s efforts to curb crude oil production have continued into 2024. Governor Newsom directed regulators to end the issuance of new permits for fracking by January 2024. The governor has also requested CARB analyze pathways to phase out oil extraction across the state by no later than 2045.
As local crude production delivered by pipeline has decreased, refiners have had to increase imports of waterborne alternatives to maintain fuel production. In 2023 the largest contributors of foreign sources of crude oil to the state included Iraq, Saudi Arabia, and Brazil. Most California refineries were engineered originally to process California crude oil. While refineries have adjusted to run alternate crudes, the quality does not match that of local production and results in decreased refinery utilization and efficiency. Bottom line: Importing waterborne crudes increases supply risk, lowers fuel production, and increases costs.
At-Berth Regulation: CARB’s At-Berth regulation, authorized by the U.S. Environmental Protection Agency (EPA), requires that each vessel visiting a regulated California port or marine terminal must use a CARB Approved Emission Control Strategy (CAECS) to control emissions for the duration of each visit, unless the visit qualifies for an exception. Starting in 2023, the At-Berth regulation applied to container, reefer, and cruise vessels for visits to all regulated terminals. The regulation expands starting in 2025 to include roll-on-roll-off vessel visits to all regulated terminals and tanker vessels for visits to terminals at the Ports of Los Angeles and Long Beach. In 2027, the regulation will apply to tanker vessel visits to all regulated terminals. Stakeholders, including refiners, are concerned about the barriers to compliance which include significant infrastructure upgrades like shore power installations and retrofitting existing vessels to be shore power compatible. This creates challenges for foreign flag vessels that do not invest in retrofitting to meet the new regulation and decreases the supply of vessels that are available to charter. A smaller fleet of At-Berth compliant vessels available to charter will impact refiners’ ability to export petroleum diesel and import crude oil and refined products, adding cost.
Maximum Gross Gasoline Refining Margin Regulation: In March 2023, the state legislature adopted SBx 1-2, the California Gas Price Gouging and Transparency Law, which authorizes the establishment of a maximum gross gasoline refining margin and the imposition of a financial penalty for refiner profits above the maximum margin. The regulation expands the reporting obligations related to maintenance and business of California refineries to the California Energy Commission (CEC). The law created the Division of Petroleum Market Oversight (DPMO) within the CEC to analyze the data provided by all participants in the state’s petroleum industry. It authorizes the CEC to regulate the timing of refinery turnarounds and other maintenance activities in certain instances to mitigate supply shortages and price spikes.
In the case of Phillips 66, their West Coast Realized Margins are already tight and shrinking. According to their most recent quarterly report, West Coast Realized margins[1] for the first three quarters of 2024 was $9.34 per barrel. This is a significant loss as compared to the first three quarters of 2023 at $21.40 per barrel. While these margins sound like a lot, in fact P66’s 3Q2024 net income was negative (showing a loss of $6.64 per barrel) because of high expenses.
What is the impact on product supply and demand?
To understand California product supply and demand balances, it’s helpful to zoom out for a look at the U.S. West Coast (USWC) transportation fuel production and distribution landscape. The map below was developed for the 2015 EIA PADD 5 study. While production facilities and product flows have remained largely the same, many of the refineries shown on the map have changed hands over the nearly 10 years since this report was published. As well, Marathon and Phillips 66 have converted their Bay Area refineries to renewable fuel production. The table to the right of the figure lists the most up to date USWC refining companies, locations, and refinery capacity.
The P66 Los Angeles refinery (number 4 in the group of facilities identified on the map near Los Angeles) consists of two facilities which are five miles apart in Carson and Wilmington and are linked by pipeline. The refinery complex production capacity is 139 thousand barrels per day (kbd), producing about 70 kbd of gasoline and 40 kbd of diesel, along with other refined products. P66’s LA refinery supplies refined products to customers in California, Nevada, and Arizona by pipeline and truck.
Current gasoline production capacity in Southern California is about 541 kbd, while diesel production is 138 kbd. P66’s LA refinery closure takes about 13% of gasoline and 29% of diesel production out of the Southern California market. This leaves the market balanced for diesel but short for gasoline in the near term, requiring foreign imports. A short gasoline market, reliant on imports, will lead to an increase in retail gasoline price because of the cost to transport imported gasoline from supply sources in Korea, India, or the UK.
The transportation energy transition requires a forward-looking view of supply and demand balances
The transportation energy transition is going to get bumpy. Regulatory and market conditions are likely to squeeze other West Coast refiners out of the market before enough EVs can be adopted to further reduce demand. This will result in gasoline demand exceeding supply, which will raise prices due to increases in the volume of long-haul imports required.
Stillwater has developed a West Coast Supply and Demand Outlook, available to consulting clients, which offers a clear view of the impact of these forces on the market. Contact us to learn more.
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