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Shale Gas Adds to Refiners' Woes-- Robert Campbell is a Reuters market analyst. The views expressed are his own. -- By Robert Campbell NEW YORK, Jan 17 (Reuters) - The U.S. natural gas industry, reborn through the shale gas revolution, has emerged as another source of pain for beleaguered oil refineries as natural gas liquids (NGLs) grab market share from petroleum in America. As the market for liquid fuels in the United States has declined in recent years, petroleum has borne more of the brunt, losing share to biofuels and, increasingly, NGLs. This is starting to hurt. Already battered by dreadful margins for making gasoline, refineries' main product, they are now being attacked in the specialty market for petrochemicals feedstocks as well as in the cutthroat propane business. While neither of these categories are major markets for refineries, weak pricing and lost market share complicate efforts to boost output to capture strong diesel prices. For the most part, refineries lack the facilities needed to turn these so called "light ends" into other, more valuable fuels. This means that any attempt to process more crude oil to make more diesel fuel means the refinery will also produce more light ends as byproducts. If there isn't a market for the extra light ends produced when squeezing out a bit more diesel, refiners will likely have to forego the chance to add to distillate volumes. That helps explain why refinery runs have stayed relatively low even as distillate cracks have risen. The irony is that petrochemicals feedstocks are actually a growing part of the U.S. liquid fuels market. The problem is oil is increasingly priced out of this segment. Ethylene, the building block of most petrochemicals, can be made a number of ways, but the most popular techniques use naphtha, a gasoline-like refined oil product, or ethane, a byproduct of some natural gas production. The shale gas boom has transformed the U.S. petrochemicals industry, which was written off for dead a few years ago due to the high cost of oil-derived feedstocks. By switching to cheap ethane from costly naphtha the U.S. industry has become one of the lowest-cost ethylene producers in the world in recent years. ETHANE WAVE Output of ethane at U.S. natural gas processing plants has soared to nearly 1 million barrels per day, driven by the surge in U.S. natural gas output and operators' scramble to shift into more liquids-rich gas to compensate for the sharp fall in North American gas prices. As ethane prices tend to closely track natural gas prices, petrochemicals producers are determined to source much of their feedstock needs from ethane rather than oil-derived products, like naphtha. A number of producers have already announced plans to switch away from oil-derived feedstocks where possible, notably industry heavyweight Dow Chemical , which is returning to growth in its home country after flirting with getting out of basic petrochemicals altogether just a few years ago. No surprise that petroleum derivatives share of the petrochemicals market has plunged this year by a third from the 2006-10 average. Independent oil refiner Valero flagged weak petrochemicals feedstock prices as one of the reasons it would make only a slim profit in the fourth quarter even as it liquidated inventories and reaped accounting gains. It will not get any easier. Oil refiners losses in petrochemicals market share are expected to accelerate. Enterprise Products Partners , the United States' top natural gas liquids shipper, expects ethane to capture another 160,000 bpd of market share from oil by 2015. The situation is similar in the propane market. Primarily a heating fuel in the United States, propane consumption has been drifting lower in recent years. But again refineries are facing a dogfight for market share. Natural gas processors' output of propane rose sharply last year. Although some of these volumes found their way into export markets, infrastructure limitations make it difficult for U.S. producers in many parts of the country to ship propane out of North America. Not surprisingly propane prices have fallen heavily. On the Gulf Coast, propane is worth some $50 a barrel less than Light Louisiana Sweet crude oil. Never a profitable product, propane is now increasingly costly to produce for refineries. SHALE GAS OVERSUPPLY? For now oil refiners look set to bear the brunt of the impact of shale gas on the liquids sector. Consumers are enjoying cheaper prices. But natural gas liquids are the remaining support for many independent gas producers' profits, with prompt U.S. natural gas futures falling below $3 per million BTUs on burgeoning supplies and warm weather. The question on many gas producers' lips is how long will the prices of major natural gas liquids like ethane and propane hold up? With few export options, the market logic that saw gas prices crushed by rising supply will eventually overwhelm the NGL sector. That could well trigger upheaval within the shale gas industry, where many producers are drilling with more of an eye to holding onto leases than the returns on capital implied by current gas prices. Already the better-capitalized members of the industry, including the world's oil majors who have been adding to their positions even as the market hurtles to oversupply, are betting on a bloodletting that will curb drilling and bolster prices. But if that shakeout comes it will bring little relief to oil refiners. After all, once gas prices recover somewhat drilling is likely to resume with a vengeance given the wide spread of hydraulic fracturing technologies and relatively low barriers to entry to the shale gas sector. That positions the U.S. petrochemicals industry as a likely growth sector and one which may well grab market share from competitors in Europe and Asia that are stuck with petroleum-based feedstocks. It also means Atlantic basin refineries have lost market share permanently in the petrochemicals sector, adding to the competitive pressures that look set to force the closure of a number of plants in Europe and the Americas this year.
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