Refining Trends and Outlook

2019 TXOGA Property Tax Conference

Karl Bartholomew, PE, ASA, MRICSManager, US Property TaxShell Oil Company

1March 2019

Agenda

▪ Historical market overview

▪ Boiling Oil

▪ Refining & petrochemical economics

▪ Refining transactions

▪ Challenges & Concerns

Any views and opinions expressed in this presentation are the sole views and opinions of the presenter and do not

any way represent the views or the opinions of Shell Oil Company or any of its affiliates.

2March 2019

Fundamental Rules of the Road (for valuation)

◼ Unless building a thermonuclear device, ensure a material balance (lbs in = lbs out)

◼ Economics beats technology – every time!

◼ You cannot forecast history

◼ Those who forget the lessons of history are doomed to repeat them

◼ Rising tides float all ships

◼ Correlation does not automatically mean causality

◼ Stewart’s Corollary: Politics beats economics – every time!

◼ Ziesmer’s Corollary: Remember there’s math, then there’s government math

◼ An industrial facility (like a refinery / chemical plant / gas plant) is just a wide spot in the line between producer

and consumer

March 2019 3

The storyboard is as important as the numbers

Historical market overview

1March 2019 4

Oil Price History

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Global, U.S. marker prices for oil

WTI

Brent

March 2019 5Source: EIA

Heavy Oil Discount

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$/ba

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US HOD (WTI-Maya) Cdn HOD (WTI-WCS)

March 2019 6Source: EIA, Pemex, ICIS

Major crude fields - 2010

March 2019 7

Source: 2011 ENI

World Oil & Gas

WTI

Urals

Major crude fields – 2017

March 2019 8

Source: 2017 ENI

World Oil & Gas

Urals

WTI

Major crude oil production changes by country2010-2017

March 2019 9

(2,000,000)

(1,000,000)

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Source: EIA International Energy Statistics

US Shale oil productionSource: EIA

10March 2019

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US Shale gas productionSource: EIA

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11March 2019

Supply (Feed) + Hardware = Demand (Product)

Boiling Oil

2March 2019 12

Global oil demandSource: BP Statistical Review of World Energy 2018

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March 2019 13

Refining throughputSource: BP statistical review of world energy 2018

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14March 2019

U.S. Refining CapacitySource: EIA

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US Operable Capacity US % Utilization TX GC % Utilization

March 2019 15

US net import/export balance crude & productSource: EIA

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16March 2019

Operating RefineriesSource: EIA

March 2019 17

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Refining & petrochemical economics

318March 2019

Renewables (Ethanol RINs)Source: Valero

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March 2019 19

Refining economics indicatorsSource: Company filings, SEC

March 2019 20

Steam cracker light feed advantage

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March 2019 21

Olefins Additions

◼ First wave of new capacity additions well underway◼ (Source: ICIS)

◼ Second wave to come post-2020

◼ CP Chem Orange; Penn Chem

March 2019 22

Source: CP Chem

Source: Author

Chemicals economic indicatorsSource: Company filings, SEC

March 2019 23

Refining Transactions

424March 2019

PAR Pacific – Tacoma, WA

March 2019 25

PAR Pacific – Tacoma, WA

March 2019 26

Chevron – Pasadena, TX

March 2019 27

Refinery Transactions

Year Location Buyer Est. FMV $MM2015 Chalmette PBF 3052016 Torrance PBF 1582016 Newcastle PAR Pacific 1142016 Dickinson Tesoro 662017 Superior Husky 4352018 Tacoma PAR Pacific ~150-1752019 Pasadena Chevron ~190-220

March 2019 28

U.S. refinery sales - % RCN

March 2019 29

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Inland Coastal WTI 3-2-1 LLS 3-2-1

Inland refining economics

Coastal refining economics

U.S. refinery sales - $/complexity barrel

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March 2019 30

Astra – Petrobras

Crown-AstraPetrobras-Chevron

U.S. Oil - Trailstone

Trailstone-PAR Pacific

Challenges & Concerns

531March 2019

Challenges & Concerns

▪ IMO forecasts all over the map

▪ Some show major spikes; others spike up then moderate

▪ Reliance on cost

▪ Asset Ledger Cost ≠ Reproduction Cost ≠ Replacement Cost ≠ Fair Market Value

▪ All sales aren’t distressed sales

▪ As prices go up (as %RCN), intangibles or goodwill will increase

▪ Seller’s (or buyer’s) WACC ≠ Discount rate for Income approach

▪ IMHO, direct cap or market multiple won’t properly value complex properties

March 2019 32

Forecast accuracy

March 2019 33

Short-term forecast accuracy

March 2019 34

What is IMO and how does it impact refining?

▪ IMO – International Maritime Organization

▪ Starting January 1, 2020, no more high sulfur fuel oil can be sold as bunker fuel

▪Compliance will be met by:

▪Onboard ship scrubbers

▪Marine diesel

▪More resid destruction (cokers)

▪ Lighter crude slate

▪Cheat

▪Historical forecasts on new regulations overestimate impact, duration

March 2019 35

Many forecasts

Year forecasted

Maya 2-1-1

2017 23.602018 38.502019 31.30

March 2019 36

Income Approach

◼ Real-world transactions look mostly at an income approach for bidding

◼ Often at much higher discount rates than a company’s WACC or taxing authorities schedules

◼ Direct capitalization or market multiple approach is too simple

◼ Discounted cash flow model is the proper approach due to volatility in hydrocarbon markets

◼ Terminal value assumption can make or break valuation

◼ Multiple margin scenarios appropriate to consider

◼ Third party forecasts

◼ Forecast using historical look-backs (3-5 years)

March 2019 37

Income Approach Challenge

◼ Winning bidder paid ~ $1.9 billion

◼ Client bid ~ $1.3 billion for refinery – finished 2nd among bidders; 3rd was $1.2 billion

◼ Why the difference?

◼ Winning bid assumed conversion of refinery from light sweet crude oil to heavy Canadian feed ($3+ billion)

◼ Assuming discounted crude price generates margin for project, net present value would be $.5-$.7 billion higher

◼ Actual result – winning bidder didn’t do the crude conversion; overpaid for the assets

March 2019 38

Cost Approach challenges

◼ Fixed Asset Listing from an accounting system is often not equal to Reproduction Cost New

◼ Often companies capitalize expense items due to accounting policies (turnarounds, maintenance, etc.)

◼ Retired assets not consistently removed

◼ Obsolescence almost always understated

◼ Operating cost obsolescence can be determined from benchmark studies

◼ External/economic obsolescence is always present; often not included

◼ Future regulatory capital (10 ppm gasoline; flare gas recovery; new bunker fuel sulfur, methane from wells)

◼ More in-depth analysis or discussion can yield solid, factual evidence of obsolescence

◼ Needs support from operations at the facility

March 2019 39

Cost Approach example

◼ 40 year old gas plant was severely damaged from Hurricane Katrina

◼ Insurance policy dictated one part of plant (if not rebuilt) to be valued using cost approach

◼ A third party consultant for insured determined “depreciated replacement cost value” of 75% of RCN

◼ Based on extrapolating 4%+ sustaining capital spending over past 5 years to plant’s operating life

◼ Analysis overlooked

◼ 1. Spending was for emergency patching of one utility boiler and included no other maintenance capital

◼ 2. Plant was technically obsolete and last of its vintage in operation

◼ Final settled value was ~ 20% of RCN

March 2019 40

Lessons on Approaches to Value

◼ No one approach gives you the “correct” answer

◼ Buyers make bids based on discounted cash flow modeling

◼ Transaction price paid represents a fair market value data point

◼ Start the Cost approach with a good data basis, consider all forms of obsolescence exist

◼ All three approaches have strengths, weaknesses, but properly done, should yield similar values

◼ Most important – numbers are only 50% of the answer. The story behind the numbers are often more important.

March 2019 41

Questions and answers

42March 2019