Collapse in Crude Oil Spreads:Implications for Refiners

Overview
For refiners that have suffered from the pass-through effects of expensive crude oil over
the past few years, the sharp drop in crude oil prices in the second part of 2008 has offered
welcome relief in the form of cheaper feedstock costs and lower fuel prices for end-users.
However, price discounts among different grades of crude oil have seen an equally dramatic
shift, with the discounts for both heavy and sour crude oils relative to NYMEX benchmark
light sweet West Texas Intermediate (WTI) collapsing in the first quarter, driven by weak
product demand and a storage glut in Cushing, Okla., the delivery point for the NYMEX
contract. As a result, the relative cost advantage of higher complexity refiners ⎯ whose
plants are configured to process heavy and sour crudes ⎯ has been muted relative to less
flexible sweet light peers. If sustained, the collapse in spreads could dent the near-term
earnings power of deep conversion refiners, leading to either further reductions in capital
expenditure plans or additional pressure on balance sheets. Spread compressions may also
lower returns and prolong payback periods for those refinery conversion capacity upgrades
already in the pipeline and due online over the next several quarters.