Refining capacity and tanker demand
As we pointed out in our overview and cheat sheet guide to investing crude tankers, oil differs in quality from region to region. And to make various product oils, refiners need various specifications. So refining capacity and utilization can affect the kind of oil that refiners will use. This can affect imports for crude and tanker demand.
LLS and Brent price differential
Data on refining capacity and specification is harder to come by. But there are ways around it in order to get a sense of whether the U.S. has hit a refining wall for high-quality light sweet crude that’s extracted domestically. Louisiana Light Sweet crude (or LLS) is a coastal-based benchmark that has tracked closely with imported crude price—the international benchmark, Brent crude. Until recently, LLS has traded mostly at a premium because U.S. crude is of slightly higher quality than Brent or the international average and it’s closer to domestic refiners.
LLS trading at a discount to Brent
But this relationship started to collapse in August, when LLS started to trade lower than Brent. This reflects a buildup of supply at the U.S. coast and suggests refiners can’t take as much supply as they want. If this were driven by a temporary shutdown of a major refiners of high-quality domestic oil, the discount of LLS price to Brent would likely narrow to zero over time. Yet we haven’t seen that. On December 23, it stood at $7.70 a barrel—despite narrowing from $15.83 per barrel in October. This could suggest that U.S. refineries may have hit capacity to refine U.S. domestic oil.
Citigroup’s Ed Morse’s comments
Citigroup’s head of commodities research, Ed Morse, recently noted that the current volatility seen in Brent-to-WTI and Brent-to-LLS crude spreads is a sign that U.S. refining capacity for light sweet crude is being reached. Although he noted there’s growing investment in capacity to refine further light sweet crude of approximately 700,000 barrels a day, that could take time.
Drawn conclusion and thoughts
If U.S. refiners are running out of capacity to refine domestic oil, then additional U.S. demand for crude (including exports) would support imported crude. This could help crude tankers like Frontline Ltd. (FRO), Nordic American Tanker Ltd. (NAT), Tsakos Energy Navigation Ltd. (TNP), and Teekay Tankers Ltd. (TNK). The Guggenheim Shipping ETF (SEA) could also benefit until significantly more refining capacity is added.
For more background, you can find Market Realist’s Overview of the crude tanker industry here.