Published on Monday, January 6 2020
Authors : George Hoekstra, Hoekstra Trading LLC – Guest Writer

Mr. Hoekstra is a 45-year veteran of the petroleum industry, with an extensive background in hydroprocessing technology. Turner, Mason & Company (TM&C) once again welcomes his independent thoughts (not necessarily the same as TM&C’s) on the progress refiners have made and the challenges they continue to face in meeting Tier 3 gasoline sulfur standards.

The Tier 3 Motor Vehicle Emission and Fuel Standards Final Rule was enacted in June 2014.  It mandates a 10 ppm average sulfur limit for all gasoline sold in the U.S., with full effect January 1, 2020. 

After spending five years in the shadows, the Tier 3 issue came back into the spotlight at 3pm on June 24, 2019.  That’s when EPA posted the number 20.51 on their Gasoline Standards web page.  It was the official measure of the U.S. annual average ppm sulfur in gasoline for 2018.  The number seemed very high to many people including financial analysts and oil trade media who thought we were already at, or at least much closer to, 10 ppm.  They immediately started asking questions about industry readiness for the January 1, 2020 deadline.  

In today’s blog, I give an abridged biography of the Tier 3 gasoline issue, focusing on three milestones: its enactment in June 2014, its return to the spotlight in June 2019, and its future outlook. The title of the blog is, “So, Get Ready Here I Come”; from the 1966 Motown hit by made famous by The Temptations and The Supremes.

Tier 3 in June 2014 – “So fee, fi, fo, fum, look out baby ‘cause here I come”

When it was signed into law in 2014, ten years and $tens of millions had already gone into defining the Tier 3 program and estimating its cost.  The refining capital investment requirement was estimated at $2 billion to fund revamps and new build fluid catalytic cracking (FCC) feed hydrotreaters and gasoline hydrotreaters.  During the rule-making process, comments from refiners had emphasized the need to allow enough lead time to choose hydrotreating technologies and licensors, secure permits and engineering resources, procure and install equipment, and make tie-ins during scheduled FCC turnarounds.  Uncertainty about the sulfur credit system was also a concern, especially among small refiners.

When it finally appeared in the Federal Register in 2014, The Tier 3 Rule provided nearly six years lead time for the industry to prepare and included the following provisions:

3-year extra lead time for small refiners;

• Five-year life on use of Tier 2 credits;
• Opportunity for early Tier 3 credit generation;
• Exemption on gasoline that is exported;
• 80 ppm refinery gate sulfur cap; and
• 95 ppm downstream sulfur cap.

These provisions were intended to address the industry’s concerns by reducing the need for new build units, allowing time for refiners to access capital and engineering resources, creating incentives for early compliance, opening outlets for noncompliant gasoline, and easing compliance by small refiners.

EPA was optimistic about timely compliance, and for good reason.  Refiners had been heavily involved throughout the Tier 3 rule-making process.  In 2014, one-quarter of U.S. refiners were already undercutting FCC gasoline (i.e., lowering its end point), which was already reducing gasoline sulfur by 50%, resulting in over-performance against the Tier 2 sulfur specification, and generating a healthy bank of Tier 2 sulfur credits.  Moreover, some well-equipped refineries could turn up severity on existing hydrotreaters to further reduce gasoline sulfur and capitalize on the incentive to generate and bank early Tier 3 sulfur credits.

There was also a well-established, active market for trading gasoline sulfur credits, and 56% of Tier 2 sulfur credit trades were inter-company trades.  That showed refiners were using the sulfur credit system as designed to facilitate early compliance.   

In 2014, all signs pointed to a smooth six-year phase-in period with ample time for capital investments, early compliance, and early credit generation.  The projections said that by January 1, 2020, we’d have 80 new or revamped hydrotreaters, 85% of the U.S. gasoline pool would be at or under 10 ppm sulfur, and the credit bank would have an ample supply of Tier 3 sulfur credits.

Tier 3 in 2019 – “So fiddle-lee-dee, fiddle-lee-dum, look out baby ‘cause here I come … I’m on my way”

Fast-forward five years to June 2019 – The Tier 3 requirements were indeed coming on schedule, but the investments, early compliance, and early credit supply were not.  In fact, the Tier 3 phase-in plan stalled, almost from the start.  Since 2014, we have gained only a handful of new or revamped FCC-train hydrotreaters, only 16% of the U.S. gasoline pool is at or under 10 ppm sulfur, and the credit bank is almost empty.  

Why was there such a big difference between the expected and actual phase-in results? That is certainly a difficult question, with no definitive answer(s), but I can provide some personal thoughts:  Sufficient capital investments likely didn’t come because many refiners were not completely aware of the difficulties and costs of the Tier 3 task. The early compliance didn’t come because many refiners seemed to be slow to learn about those difficulties, and when they did learn, they chose not to bear the costs until it was mandatory; and, without early Tier 3 compliance, there could be no Tier 3 credits in the bank.  

Those are just my short answers.  There are certainly many other factors.  But I would summarize that I believe the root cause was that early Tier 3 strategy decisions were based on inaccurate information about the true difficulties and costs of the task.

Compared to other parts of the world (including California), the U.S. gets a much higher proportion of our gasoline from the FCC process train, in the form of “cat gasoline.”  Our cat gasoline contains a lot of sulfur, almost all of which must be removed to make 10 ppm blended gasoline.  To get such deep desulfurization reliably and profitably on our cat gasolines with our existing equipment is more difficult and costly than people were led to believe.  Sixty percent of refineries in the U.S. are not well-equipped to do this job without destroying an excessive amount of octane and/or accepting costly new constraints on refinery feeds and operations.  The prescribed capital investments, which did not occur, were aimed directly at this weakness in the U.S. refining infrastructure. Without those capital investments, the cost of compliance will be five times higher than was expected.

The Outlook for Tier 3 – “twiddle-dee-dee, twiddle-dee-dum, look out baby ‘cause here I come”

There’s no stopping the Tier 3 requirements.  Gasoline suppliers are now adapting in real time to get the pool down to 10 ppm sulfur at minimum cost with existing infrastructure.  The necessary adjustments will be made, new constraints and bottlenecks will be encountered, and costs will be incurred.  These adaptations will take their toll on profits via lower gasoline and octane production, lower cracking margins, more unplanned downtime, and higher cash outlays for purchase of high-octane blending components and sulfur credits. The changes will have big impact on the distribution of oil downstream earnings in the next few years.

This is my contrarian outlook, which continues to be supported by the facts on the ground:  The U.S. average gasoline sulfur level is still over 20 ppm.  Refiners are increasing purchases of alkylate to replace FCC octane barrels now being destroyed in gasoline desulfurizers running at higher severity.  The market price of octane in the U.S. has risen steadily to an all-time high.  And the price of Tier 3 sulfur credits has gone straight up, quintupling in three years.  These are all direct indicators of the 2020 octane/sulfur squeeze.

The Race is on – “I hope I’ll get to you before they do …”

The race is on to 10 ppm sulfur.  By the new rules, every gallon over 10 ppm must be offset with equal ppm-gallons of overcompliance, or credits.  The octane-barrel and the Tier 3 credit are precious commodities.  This means important decisions remain for U.S. refiners whose profits depend heavily on gasoline and octane:  What should our gasoline sulfur targets be?  How will we rebalance octane production?  How will we reoptimize FCC-train and reformer operations? How will Tier 3 affect our cycle times and turnaround schedules?  How do our incremental costs for octane barrels compare to our competition? Will we be buyers, or sellers, of sulfur credits?  What catalyst changes should we make? What capital investments should we make today?

These are all challenging new business decisions that should be made using best available information.   Both Hoekstra Trading and TM&C are well positioned to provide refiners the necessary information to support this decision-making.   Hoekstra Trading has focused on the technological aspects of deep desulfurization of gasoline and compiled significant real life, hard data from pilot plant and commercial field tests.  This data has been compiled in a series of three reports, information on which can be obtained by contacting George Hoekstra, President, Hoekstra Trading LLC, george.hoekstra@hoekstratrading.com +1 630-330-8159. 

TM&C can provide a broad range of consulting assistance for refiners on Tier 3 issues.  Our regulatory compliance group works in conjunction with our Industry Outlook team to analyze and forecast the economic impacts and dynamics of all critical regulatory issues, including Tier 3 and associated credit-pricing.  Since our organization works extensively with the upstream, midstream and downstream market segments of the industry, we are well positioned to understand various gasoline supply and demand scenarios.  This includes the gasoline supply balances of refiners, importers and gasoline blenders and the associated impacts of supply point disruptions.  Call (214) 754-0898 or email us at any time if you have questions or consulting needs regarding Tier 3 or any other regulatory compliance issue(s).