Condensate Splitters Face Gulf Coast Headwinds Kinder ...

1 ? Condensate Splitters Face gulf Coast Headwinds Kinder morgan throughput lower than area refineries. Trafigura Doubles Corpus Bet By the end of June, the second plant built in Corpus Christi, Texas, to process ultralight shale crude known as Condensate , which is produced in the close-by Eagle Ford basin, is due on line. All the capacity at this 50 thousand barrel/day, or mb/d, plant owned by Magellan Midstream Partners is committed under a long-term contract with Trafigura, which is also committed to 50 mb/d throughput at the first Corpus Christi Condensate splitter at Buckeye Processing Hub. These Condensate Splitters a type of simple refinery were conceived at a time when stranded and discounted feedstock made the economics look good. By early 2018 about 260 mb/d of new splitter capacity will have come on line at the gulf Coast . However, throughput at the first of these plants operated by Kinder morgan in Houston under a processing deal with BP has been far lower than at regular gulf Coast refineries, suggesting that these investments will struggle in current market conditions.

2 In September 2016, we reviewed the first year s performance of the 100 mb/d Condensate splitter operated by Kinder morgan at its Galena Park terminal on the Houston Ship Channel (see Kinder morgan splitter ). This note provides an update on Kinder morgan 's plant performance as well as a review of other Splitters operating in or planned for the Texas gulf Coast . Kinder morgan Operations The Kinder morgan splitter consists of two identical 50 mb/d units that came on line in March and July 2015, respectively. Feedstock is delivered via a lateral to Kinder morgan 's 300 mb/d crude and Condensate pipeline (known as KMCC) from the South Texas Eagle Ford Basin. BP is committed to process 84 mb/d of Condensate through the Kinder morgan splitter under a long-term take-or-pay contract that requires it to pay throughput fees whether the capacity is used or not. Data reported by Kinder morgan to the Railroad Commission of Texas, the RRC, which regulates the state's oil and gas industry, provides detailed insight into the plant s operation.

3 The data shows that three KMCC shippers have delivered Condensate to the splitter since it began operating. During 2015 and 2016, an average 57% of the feedstock came from BP, ConocoPhillips delivered 28%, and 15% came from EagleHawk Field Services (75% owned by BHP Billiton and 25% owned by Kinder morgan ). BP s relative share of deliveries declined to 43% on average during the first quarter of 2017 as the company shipped less Condensate than usual on the KMCC pipeline in March. A Condensate splitter is a simple refinery that uses atmospheric distillation to break down the feedstock into its component fractions. The resulting outputs are best described as blend stocks because they need to be blended with additives or further processed to produce end-use products such as gasoline. Morningstar Commodities Research 19 June 2017 Sandy Fielden Director, Oil and Products Research +1 512 431-8044 Data Sources for This Publication Energy Information Administration CME Group Railroad Commission of Texas To discover more about the data sources used, click here.

4 Condensate Splitters Face gulf Coast Headwinds | 19 June 2017 Page 2 of 6 Page 2 of 6 Page 2 of 6 Page 2 of 6 Page 2 of 6 Page 2 of 6 Page 2 of 6 Page 2 of 6 The Kinder morgan splitter 's throughput during its first year of operation averaged 72% of operating capacity much lower than the 90% average refinery throughput for Texas gulf Coast refiners over the same period as reported by the Energy Information Administration (see green and red lines in Exhibit 1). During its second year of operation, the splitter ran at just 68% of capacity compared with the gulf Coast average of 88%. Poor refining margins account for the Kinder morgan splitter s low throughput compared with more sophisticated refineries in the region. We estimated that plant margins (blue area in Exhibit 1) by multiplying four key product output yields (propane, naphtha, jet kerosene, and diesel) with monthly average regional prices and subtracting the monthly average price of Eagle Ford Condensate at the wellhead.

5 These estimates are artificially high because they do not take Condensate transport costs from the wellhead or processing costs into account, but they do indicate relative plant economics. The margins declined more or less continuously during the first year of operation from a high of over $18/barrel in April 2015 to $12/barrel in March 2016. Margins began to recover in July 2016 and peaked at $14/barrel in February 2017 before declining to $13/barrel in March. splitter utilization follows a similar pattern to the margins, indicating that BP reduced or boosted throughput according to market conditions. The splitter throughput only came close to BP s volume commitment in November 2015 (82 mb/d) and October 2016 (79 mb/d), indicating that they preferred to write off throughput charges rather than process more Condensate during much of the past two years. Exhibit 1 Kinder morgan Condensate splitter Margin and Utilization Source: RRC, EIA, CME Group, Morningstar $/barrel MarginSplitter UtilizationTexas GC Refinery Utilization Condensate Splitters Face gulf Coast Headwinds | 19 June 2017 Page 3 of 6 Page 3 of 6 Page 3 of 6 Page 3 of 6 Page 3 of 6 Page 3 of 6 Page 3 of 6 Page 3 of 6 splitter Economics Two factors have hurt splitter margins since the start of 2015.

6 The first, as we explained last September (see Kinder morgan splitter ) was lower Condensate production in the Eagle Ford resulting from the 2014 price crash as well as an end to crude export regulations in December 2015. These factors combined to reduce a surplus of stranded Condensate at the gulf Coast . Refiners preferred not to process this glut of Condensate , causing significant price discounts that made stand-alone Splitters attractive. The second negative factor was that splitter -refined product output did not reflect market conditions. The average Kinder morgan splitter -refined product output is 60% naphtha, 25% jet fuel, and 12% diesel. Naphtha is primarily used as a gasoline blending stock. Therefore, splitter margins depend on the relative performance of gasoline versus jet fuel and diesel. Because of the buoyant gulf Coast export market for diesel and higher-than-normal gasoline inventory (see our May note gulf Coast Refiners Burn Up the Surplus) diesel and similar middle distillates like jet fuel have provided better returns than gasoline, putting Splitters at a disadvantage over refineries that can process heavier crudes like Louisiana Light Sweet that produce higher distillate yields.

7 Rest of the Fleet Next, we review other existing and planned Condensate Splitters on the Texas gulf Coast . Thanks to the railroad commission's records, we have better information for Kinder morgan than the other Splitters , but all the indications are that these plants are also either being underutilized or brought on line later than planned, while operators wait for better market conditions. Exhibit 2 shows the seven existing or planned Splitters in Texas, including Kinder morgan 's. Of these, the oldest is the 60:40 BASF/Total joint venture 75 mb/d plant that has operated in Port Arthur, Texas, since 2000. This splitter is part of a larger refinery and petrochemical complex, not stand-alone, meaning its economics are tied to downstream processing of the outputs rather than pure plant margins. All the other Splitters in the list have been built in the past three years or are expected on line by the end of 2018. In Corpus Christi, one 50 mb/d splitter is currently operating and another is about to come on line.

8 The first is a Buckeye/Trafigura 80:20 joint venture plant at the Buckeye Processing Hub. This plant has had two 25 mb/d units operating since 2015. The throughput data for the plant has not yet been reported to the railroad commission, but pipeline records indicate feedstock deliveries to the plant averaging only 11 mb/d during 2016, with many months without Condensate delivery. All the capacity at this plant is committed to trader Trafigura, which is paying the Buckeye joint venture a processing fee regardless of operation. In its 2016 annual accounts, Trafigura reported a hedging loss on the tolling fees to run the Buckeye Splitters of $ million in 2016 and $ million in 2015. This data suggests that Trafigura is processing limited Condensate volumes and losing money on its processing commitment. Condensate Splitters Face gulf Coast Headwinds | 19 June 2017 Page 4 of 6 Page 4 of 6 Page 4 of 6 Page 4 of 6 Page 4 of 6 Page 4 of 6 Page 4 of 6 Page 4 of 6 Exhibit 2 Planned and Operating gulf Coast Condensate Splitters Source: Company presentations, Morningstar Meanwhile, adding insult to injury, Trafigura is committed to another 50 mb/d of Condensate splitter processing about to come on line in Corpus Christi.

9 The Magellan Midstream Partners 50 mb/d Condensate splitter was originally expected on line during 2016 but was delayed by a dispute with Trafigura that was resolved early this year. According to Magellan investor presentations, the plant is expected on line by late second-quarter 2017, the end of June. It remains to be seen whether Trafigura will decide to process more Condensate through this unit or pay up the throughput fees until market conditions improve. Public information regarding the 28 mb/d Petromax Condensate splitter located on the Houston Ship Channel is hard to come by. Owned by Bayview Refining Company, the plant is a joint venture investment between Sunoco Logistics (part of Energy Transfer Equity) with a 49% interest and an unidentified private equity partner. Although on line since July 2015, the plant has yet to report operational data to the railroad commission. Because of its location in the Ship Channel, we believe it to be supplied via the same KMCC pipeline as the Kinder splitter , probably at least in part by EOG Resources, the largest shipper on that pipeline.

10 Petromax has secured long-term contracts to supply diesel and jet fuel to the Department of Defense that are presumably met from splitter output. Another proposed Condensate splitter on the Houston Ship Channel is a Targa Resources project at Channelview, with 100% of its 35 mb/d throughput capacity contracted to Noble Group. The Targa splitter was announced in March 2014, but it was delayed after the oil price crash caused Noble to revisit project economics before committing prepayments in 2016. This splitter is now being built and expected on line in the first quarter of 2018. The fate of a planned Centurion Midstream Condensate splitter , expected to be completed close to the Mexican border in Brownsville by the end of 2017, is unclear. During 2016, Centurion unveiled its Delaware Basin Express project to gather crude and Condensate at a Permian Basin terminal in Orla, Texas, and ship it by rail to Brownsville for export or processing through a 50 mb/d splitter .