Baker & O’Brien, Inc.’s 2023 Q2 PRISM™ update shows that during the second quarter of 2023, refinery margins continued their decline from 2022 Q2 record highs. Average U.S. refining cash margins for the quarter remained healthy at $13.20/B, still well above the margins seen in 2021 before the Russian invasion of Ukraine disrupted energy markets.

Overall, U.S. cash margins have declined from 2023 Q1 across all PADDs. The declines in PADD 3 and PADD 5 reflect the underlying product cracks; however, cash margins fell in PADD 1 and PADD 2 despite improved product light crude oil cracks as a result of a significant drop in jet fuel prices from record high spreads in Q1 (affecting both PADDs 1 and 2) and a narrowing of the discount for heavy crude oils (primarily affecting PADD 2).

U.S. refining utilization for 2023 Q2 is up significantly by 4.8% from 2023 Q1, as the refinery turnaround season closed out in readiness for the summer travel season and increased demand. Total U.S. light product supplied was up 1.2% over the prior quarter, with surging gasoline (+6.7%) and jet (+7.5%) dampened by reduced diesel supplies (-1.2%).

The year-on-year cash margin declines reflect product cracks. Compared to Q2 2022, Q2 2023 shows a slightly reduced U.S. refinery utilization of 0.8%, a substantially lower crude oil price environment, and a more robust total product demand. Diesel demand was marginally higher (+0.7%), with gasoline up 3.5% and jet demand up 5.4%, resulting in a 2.2% overall increase.

The light-heavy crude oil price spread (WTI – WCS) weakened year-on-year and as mentioned, quarter-on-quarter, negatively impacting the margins of coking refineries that process heavy sour crude oil, contributing to cash margin decreases in PADD 2 and PADD 3 refineries.

Special Topic: Is SAF production about to take off?

The integration of renewable fuels production into oil refining continues to grow in importance as refiners invest in reducing carbon intensity to meet regulatory requirements, such as the Low Carbon Fuel Standard (LCFS) in California, and leveraging government subsidies, such as those available in the Inflation Reduction Act (IRA). We have seen a surge in the planned investment in renewable diesel (RD) projects in the United States (U.S.). In this special topic, we review whether sustainable aviation fuels (SAF) investment is likely to take off as well.

RD and SAF are typically produced from similar feedstocks, such as vegetable oils and animal fats. Since the raw feedstocks are undesirable as transport fuels for various reasons (for example, they generate a lot of smoke), the feedstocks are converted to molecules that match their petroleum-based equivalent. The most mature processing technology uses hydrogen to remove oxygen (hydrodeoxygenation) to produce hydroprocessed esters and fatty acids (HEFA). The produced HEFA stream consists of straight-chain paraffinic hydrocarbons with the “perfect” diesel characteristics, making RD a “drop-in” fuel. SAF currently requires shorter kerosene-type molecules to “drop into” Jet, which requires hydrocracking and isomerization processing, and additional fractionation capabilities. This, in turn, requires additional capital investment and operating costs. The simplified HEFA process flow diagram in Figure 1 below shows the main equipment for RD production and the additional equipment for a change to SAF production.

Figure 1 above also shows the change in yields when shifting from RD to SAF production. The conversion of a molecule of RD to SAF results in an unavoidable increase in the production of low-valued LPG and renewable naphtha due to the hydrocracking process and a decrease in higher-valued liquid yields by about 10%. Even though these by-products are “renewable,” they earn lower incentives than either RD or SAF. Hence, shifting the HEFA process from RD towards SAF results in a lower overall product gross margin.

So, what does an increase in capital investment, higher operating costs, and lower gross margins mean for SAF economics? The simple answer is that the producer needs to realize a much higher SAF price, or receive much higher incentives than RD, to make the economics work. But how much higher?

Figure 2 below breaks down the additional SAF production costs ($0.58/gal; stacked blue/gray bar to the left): including negative yield effects ($0.22/gal; dark-blue segment [negative yield indicates that the products produced from SAF are less valuable, on average than RD]), higher operating costs ($0.08/gal; gray segment), and capital investment costs ($0.28/gal; medium-blue segment).

Compounding SAF’s increased production cost — illustrated by the dark-green bar in the center — is the fact that it receives a lower RINs subsidy, is not directly eligible for California’s carbon trading program, and it yields additional lower valued LPG and naphtha. The only offsetting subsidy is that SAF is eligible to receive a higher IRA credit than RD, which is dependent on the feedstock carbon intensity. In our example above, SAF production needs an additional incentive of $1.35 per gallon to be competitive with RD production. Of course, the actual incentive for any project will depend on numerous factors, such as location, access to utilities, market access for feedstocks and products, etc.

Bottom line, what does all of this mean? In short, producing RD is currently a better investment. SAF investments likely need additional financial compensation through increased subsidies or a higher product price than fossil jet fuel. Regarding the former, additional government subsidies may be required over the long term to promote the use of limited supplies of plant oils and recycled fats for SAF and sustainable air travel. Regarding the latter, it appears that the aviation sector may be strategically willing to contract SAF supplies to show that airlines are progressing toward their stated decarbonization goals.

Given the current state of established SAF production technologies, and limited low-carbon feedstock availability, it appears that SAF from plant oils and waste fats will be produced as an alternative to — not in addition to — RD. Therefore, additional incentives and/or higher SAF prices appear to be a requirement for SAF production to take off.