JR Ewing made his fortune striking big deals and finding big oil in Texas. That is the glamorous face of the oil industry. Its less talked about stablemate is refining, a complicated, industrial process that turns Ewing’s oil into petrol, diesel and the feedstocks for making plastics. Refineries are national strategic assets yet largely ignored by the general public – unless forecourts run out of petrol.
Refining has now been dragged into the spotlight – but for the wrong reasons. Tight global margins, overcapacity and weak demand in western economies are hurting the world’s top players, including Royal Dutch Shell, Total and ExxonMobil. All blamed poor third-quarter earnings on a decline in their downstream businesses.
“Refining is a tight margin industry, highly competitive where everyone competes on cost and fuel specifications,” says Daniel Lopez, partner and managing director at Boston Consulting Group.
The main reason for today’s predicament is overcapacity at a time of weakening demand. Giant new refineries are being built in Asia and the Middle East, putting pressure on older plants in mature markets.
According to the International Energy Agency (IEA) global crude oil distillation capacity is set to have risen from 86m barrels a day in 2005 to 101m b/d by 2017 once all the planned new capacity is in operation.
“We’ve seen a rate of investment in new refining capacity in recent years that is more than triple what we saw in the early 2000s or even the late 1990s,” says Mr Lopez. The average annual new refining capacity added to the market between 2003 and 2008 was 670,000 b/d. Between 2013 and 2016 the figure is expected to be 1.6m b/d.
The situation is acute in Europe where, despite recent closures, demand is stagnating. The trend away from gasoline to diesel has had one of the biggest impacts on the industry.
Just a few years ago, European refineries would have exported the surplus gasoline to the US and west Africa. But with higher refinery outputs in the US today, in part due to rising North American crude oil supplies, it is importing less gasoline and actually starting to compete with Europe in the export markets.
IEA figures showed European demand for refined products will average 13.5m b/d this year, almost 2m b/d less than in 2008.
Most of the world’s majors, including BP, Royal Dutch Shell and Total, have responded by selling their European refineries to focus on a smaller network of strategic plants and put resources into more profitable operations such as exploration and production.
Shell announced its latest divestment in November, the sale of a stake in a Czech Republic refinery. It said the sale was “consistent with Shell’s strategy to concentrate its global downstream footprint and businesses where it can be most competitive”.
In October MOL, the Hungarian oil and gas company, said it would close its 55,000 b/d Mantova refinery in northern Italy in January, citing an “unfavourable economic environment” for refining in Italy. It will convert the site into a storage and terminal.
Other groups are shifting focus to countries with higher demand growth. Total has built a refinery in Jubail in a joint venture with Saudi Arabia, which shipped its first cargo last month. The French company approved a €1bn modernisation of its Antwerp refining and petrochemical plants in Belgium, to meet demand for greener products and be able to convert heavy fuel oil into de-sulphurised diesel and ultra-low sulphur heating oil.
The excess capacity has sharply depressed refining margins – the profit from processing oil. Total said recently refining earned it $10.60 a tonne in the third quarter, compared with $51 a tonne a year earlier.
The benchmark refining margin, according to Wood Mackenzie, the consultancy, was negative $1.30 per barrel on average for October this year. There will be some refineries in Europe losing money on each barrel of gasoline they produce, says Jonathan Leitch, Wood Mackenzie analyst.
It is not all gloom. As the majors have retreated, some nimble entrants have come in, buying up selected refineries around Europe. Gunvor, the Swiss-based commodity trader, bought two from Petroplus, the collapsed independent refiner, seeing synergies between its logistics and storage capability and refining.
Gary Klesch, the US financier whose Klesch Group, focused on industrial commodities, bought a German refinery from Shell in 2010 and is in the hunt for more. The group’s aim is to invest in refining assets and build its trading business around them.
“The economic theory is when you focus you get to optimise better than somebody who is integrated,” he told the Financial Times last month. “There is some proof in that. Whenever you disaggregate the chain …your focus is such that you are free of constraints.”
Boston Consulting’s Mr Lopez says he expects margins to recover at the end of the decade but “this will depend on real economic recovery and whether some of the planned projects are stopped.”
A further challenge is impending environmental legislation to reduce carbon emissions which could hit the industry hard.
Boston Consulting says as much as 20 per cent of Europe’s refining industry could close in a high-price carbon environment.
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