UK oil refining - Energy and Climate Change Contents

2  Pressures on the UK refining industry

Increasing global competition

7. The UK refining industry is influenced by global supply and demand. Some witnesses attributed the likelihood of further UK refinery closures to global factors that determine refining margins, including trends in supply and demand.[12] Shell reported that, at a global level, demand for refined products was increasing:

      At a global level demand for refined products is increasing fuelled by emerging markets where increased car ownership by a burgeoning middle class increases the demand for fuels.

      They added:

      Production increases are typically found in geographies where a refinery has a structural advantage either through a favourable tax system (e.g. Russia) or proximity to abundant crude supply sources.".[13]

Increased global demand was being met by refineries in the Middle East and Asia and Shell suggested that there may now be a refining overcapacity.[14] This was supported by KBC Advanced Technologies:

      "New refinery construction has continued at a pace exceeding the rise in refined product demand. New capacity is largely being added in the Middle East and in Asia - India and China in particular. These additions are strategic in nature and will transform the global market for refined products.".[15]

8. Although witnesses suggested there was a risk of markets being "flooded with products from some of these new refineries"[16], there was some optimism that there was a future for the UK refining industry. Mr Hunter, Supply Contracts and Negotiations Manager, Shell, stated:

      "I still believe that well run, well invested in refiners within the UK can survive and will continue to be healthy, but there needs to be a shake-out, and there has been a bit of a shake-out over the last few years, in order for things to rebalance. The market will change. There will be fewer refiners in Europe over the next 10 years and that is a product of global changes in infrastructure supply and demand.".[17]

9. Reducing profit margins had prompted Shell to exit a number of refineries throughout the world. Mr Hunter, Shell, commented:

      "We exited the UK, and we have exited a number of refineries across the world over the last few years, because we want to reduce our overall exposure to the global refining margin. It is a strategic decision in terms of how we want to resize our downstream business to be more profitable and more competitive. That meant that we have stepped out and sold refineries in a multitude of different countries, and one of them was Stanlow in the UK.".[18]

Mr George, Principal Consultant, KBC Advanced Process Technology Ltd, suggested that the exit of major oil companies from the refining sector was part of a 'healthy churn' and highlighted that new entrants to the market were not necessarily 'weak entrants':

      They are entering with a new motivation. If Chevron moves out and Valero moves in, Valero are keen, independent refiners who have a vision and say, "We can do something with that Pembroke refinery". If PetroChina want to come in and be refining in the UK, they have a motivation for doing that. If Essar come into Stanlow, they have a motivation for doing that. There is a new class of refiners in the UK but that doesn't necessarily mean they are any weaker than the majors that are exiting.[19]

10. The global market is changing, with a rising demand for refined oil products, and an increasing supply from the Middle East and Asia. There is still a place for the UK industry, but it will need to be responsive to the implications of shifts in global, as well as domestic, supply and demand. DECC's review should consider the longer term trends in fuel demand in domestic and export markets.

Mismatch between supply and demand

11. In the UK market, overall demand for petroleum products has been declining (see figure 3). Shell stated that demand was declining for a number of reasons including: 'more efficient vehicles; the displacement of conventional fuels by, for example biofuels; and declining car sales.'[20] Demand for different types of petroleum products has also changed: demand for diesel has been increasing while demand for petrol has been decreasing (see figure 3).

Figure 3 - Demand for petroleum products

Source: DECC, Call for Evidence on the role of the UK refining and fuel import sectors in the supply of refined oil products into the UK market, 20 May 2013, page 4

12. UK refineries are not optimised for current UK demand. The Downstream Fuel Association (DFA) suggested that UK oil refineries are optimised to produce the historic mix required rather than for current UK demands.[21] This was supported by Philips 66 who reported:

      The balance of fuels used in the UK has changed since construction of the UK refineries, with consumption of petrol decreasing, and diesel increasing. This has resulted in a mis-match between supply and demand, with an excess of petrol and insufficient jet fuel and diesel. The shortfall is met by imports from Middle East, Russia, India and the USA.[22]

Shell highlighted that the imbalance between supply and demand for oil products in Europe (and globally) impacted upon UK refinery profitability.[23]

13. Importers and storage terminals have played an important role in supplying the UK market to meet increasing demand for products not supplied by UK refineries. The DFA stated:

      Product importers have ensured short term resilience and long term UK energy robustness by supplying diesel and jet fuel according to demand. They have the logistical infrastructure and the ability to do so in an efficient, cost effective and resilient manner. Importers source refined products and components for blending through global, sophisticated and deep markets which allocate resources efficiently.[24]

We discuss security of supply in more detail in chapter 3.

14. DECC's written evidence suggested that the trend of rising demand for diesel is set to continue:

      The preference for increasing consumption of diesel over petrol is expected to continue at least in the short to medium term, exacerbating the mismatch of UK supply and demand of refined product. Given current market conditions and trends the UK is likely to grow increasingly short of domestically refined middle distillates such as diesel and jet fuel.[25]

Diesel demands are anticipated to increase by approximately 1 % per year and petrol demands to decrease by between 5 % and 7 % per year.[26] DECC suggested that diesel consumption in volume terms is expected to plateau from 2020 onwards owing much to more fuel efficient vehicles whilst demand for jet fuel is likely to continue to steadily increase.[27] Written evidence suggested that predicting the fuel mix beyond 2030 was difficult because of the development and penetration of future technologies which was uncertain.[28] The Minister said:

      Our refineries are petrol-facing, if you like, and not diesel-facing, and although they compete well at the moment in Europe, the long-term trend therefore puts them at a disadvantage. They are producing too much petrol, not enough high-value diesel or jet and they are less likely to compete with the refineries of the future and therefore the investment case for investing in them probably will get weaker. It is difficult to see in the long term how they are going to continue to compete in the same way that they are competing at the moment.[29]

15. The supply of petroleum products from UK refineries is likely to become less in tune with demand unless they invest in additional diesel production capability.[30] The IHS Pervis and Gurtz report into the UK refining sector found that in order to remain competitive in the future, UK refineries would need to invest £1.5 to £2.3 billion over the next 20 years. The proportion of diesel produced by UK refineries could be increased by introducing hydrocracking technology.[31] To fit hydrocrackers to existing refineries would cost approximately £1 billion per refinery,[32] but with current refining margins the cost would be unlikely to be recovered.[33] Andrew Gardiner, Grangemouth Refinery Commercial Manager of Petroineos told us:

      If you have a hydrocracking unit, which takes wax and turns it into diesel-type products; rather than cat cracking, which takes wax and turns it into petrol-type products, the UK needs more hydrocracking capacity. I think a company announced about a month ago that it was going to build a hydrocracker in Europe, and its quoted cost for a small-sized hydrocracker was about $800 million. If you want a medium-sized one, which the UK needs for every refinery, you are talking probably a £1 billion-type level.[34]

16. There is a mismatch between UK refinery supply of petroleum products and demand. The shortfall has so far been made up by the import industry. The trend of rising demand for diesel is likely to continue in the short to medium term. If UK refiners are to meet that demand they will have to invest in additional diesel production capability. It would not be necessary for every refinery to have a hydrocracker. DECC's review should calculate what extra capacity is required and explore how the necessary investment could be financed.

17. DECC's review and identification of necessary actions should address how Government can facilitate optimisation of the industry and its infrastructure to better suit UK demand and ensure a secure mix of domestic and imported supply. DECC should also take into account the potential implications of any rebalancing action for ancillary industries.

Legislative burdens

18. There are several pieces of UK and EU legislation that the UK oil refining industry must comply with. The key legislation is:


  • EU Emissions Trading System Phase III[35]
  • Fuel Quality Directive Article 7a, plus product quality/vapour pressure specifications[36]
  • Industrial Emissions Directive[37]
  • Renewable Energy Directive[38]
  • Energy Efficiency Directive[39]


  • Environment Agency proposals on product containment policy[40]
  • Government proposals for Carbon Floor pricing[41]
  • CRC Energy Efficiency Scheme[42]

DECC stated that the, 'sector is heavily regulated notably for environmental protection and safety reasons, which has significantly increased costs compared with some global competitors.'[43]

The UKPIA argued that the burden of legislation was the key issue that hampered the UK petroleum industry's competitiveness, stating that: 'the capital expenditure and costs related to legislation would largely eliminate the projected refining margin in UK refineries in the period to 2025' (See figure 4).[44]

Figure 4 - Estimated cost impact of legislative requirement on UK refineries vs. projected margin

Source: IHS Purvin & Gertz, The role and future of the UK refining sector in the supply of petroleum products and its value to the uk economy, 10 May 2013, page 4 (forecast in Constant 2012 Dollars per barrel)

19. The IHS Purvin and Gertz report estimates that , in addition to investment required to upgrade infrastructure and remain competitive, UK refineries will need to invest £5.5 billion of capital to meet UK and EU legislative measures in the period 2013-2020. Cost will also be incurred to operate new equipment, to purchase EU allowances and to pay for the UK's target carbon floor price. This figure excludes the legislative impacts of the Fuels Quality Directive and Energy Efficiency Directive which as yet are not fully defined.[45]

20. Phillips 66 expressed concern that some legislation disadvantages UK refining by adding costs which other competitors do not have to bear:

      UK legislation which is not applicable to refineries in other countries, is not based on sound science, and/or which favours one technology vs others disadvantages UK refining by adding cost which many competitors do not have to bear or do not bear to the same degree.[46]

Oikos Storage called for "a level playing field to be maintained across all operators from a health, safety and environmental perspective.". [47]

21. The Environment Agency issues environmental permits to oil refinery operations as required by EU and domestic legislation. It regulates refineries in England under the European Union Integrated Pollution Prevention and Control Directive (IPPCD), which is transposed into law in England by the Environmental Permitting (England and Wales) Regulations 2010 (EPR). In 2007 it conducted a review of overall environmental standards required of oil refineries and concluded, 'the costs and benefits are reasonable'.[48] In oral evidence Mr Mitchell said:

      I note in most of the evidence that you have received that the focus is entirely on the costs rather than the costs and the benefits. There are well established benefit figures for, for instance, reductions in sulphur dioxide emissions and when you put the costs against those benefits the cost benefit looks positive.[49]

Mr Mitchell conceded that there were likely to be increased costs in the future.[50]

22. The Environment Agency also forms part of the Competent Authority with the Health and Safety Executive to deliver the environmental aspects of the Control of Major Accident Hazards regime. In written evidence it said:

      [...] a Regulatory Impact Assessment [] showed that upgrading facilities to containment policy standards did not involve grossly disproportionate cost for the sector (refineries and distribution terminals).[51

In written evidence the UKPIA stated, however, that the Environment Agency's assessment is misleading:

      This is clearly misleading, since there is no doubt that the level of investment required to meet improved emissions abatement and UK Containment Policy requirements, along with other operational constraints imposed by challenging SO2 emissions limits, have severely impacted refinery profitability and cash generation to fund configuration changes to meet changing demand.[52]

23. Some witnesses suggested that the UK is 'gold plating' European Directives.[53] The Minister told us: 'I am concerned about the cumulative impact, not so much the gold-plating, the fact that there are so many regulatory proposals that will involve extra cost for our refineries.'[54] Mr George, KBC Advanced Process Technology Ltd, told us "if there is not some kind of level playing field for European refiners they are going to face the brunt of economic forces that are coming from outside of Europe."[55] But he went on to say that "there is no reason to think that the regulatory burden in the UK or in north-west European or in Europe in general is the ultimate killer blow".[56].Mr Hunter, Shell, suggested:

      The regulatory burden that comes from Europe is clearly an issue for the refiners in Europe, including that of the UK. The underlying demand decline in countries like the UK and Europe is also a problem for European and UK refiners. I think we all acknowledge that there is a problem there for the sector and that there needs to be some rationalisation.[57]

24. In 2012, in response to concerns regarding the sustainability of the oil refining industry and the impact of legislation, a Refining Round Table was established. It has proposed refining industry 'fitness checks' designed to examine the cumulative effect of EU regulation and consider mitigation measures. However, Petroineos highlighted that terms of reference have yet to be produced for the fitness checks, and questioned the usefulness of the likely timescale:

      "Regrettably, at the first Refining Forum meeting on April 12th 2013 no Terms of Reference for the Fitness Checks were produced. A verbal update by DG Enterprise not only stated that the Fitness Checks would be not be retrospective i.e. not examine legislation currently under discussion (which precludes consideration of Fuels Quality Directive Article 7a and the Refinery BREF linked to the Industrial Emissions Directive), but further that the Fitness Checks would not be concluded until the end of 2014, by which time the crucial legislation under discussion will have been concluded.".[58]

      Mr Hunt, Director General of UKpia, was concerned that the Fitness Checks:

      "would only examine existing regulation, i.e. what has already happened, so it would be a very nice exercise in how well we impose that regulation. It will not look at the key bits of regulation that are going through, which as I explained are article 7A of the Fuel Quality Directive and something called the Refinery BREF."[59]

25. The Minister accepted that the industry could not cope with new regulatory costs and agreed with concerns about the scope of the proposed fitness checks:

      "One obvious thing Government must not do is to burden them with unnecessary new regulatory costs that increase the capital budget and will not be affordable. That is why we are looking extremely hard at some of the regulatory proposals that are floating around at the moment. In respect of the Commission's intention to hold what they call a sector fitness check, for example, I am concerned that the particular remit is a little too narrow and excludes some of the new regulatory costs. [...] I have written this week to Commissioner Tajani to ask him to widen his check to encompass some of the other regulation that affects refineries, not least the Fuel Quality Directive and the Industrial Emissions Directive."[60]

A copy of this letter is printed as an Annex to this report.

26. DECC's review must address how the legislative burdens on the industry can be rationalised, and should quantify the extent to which the UK refining industry faces higher legislative and regulatory burdens than its European and global competitors. DECC should also examine whether the burden is evenly spread across the domestic refining and importing parts of the industry.

27. We support the Minister's appeal to the Commission to ensure that the scope of the EU Fitness Checks includes the cumulative impact of both existing and forthcoming EU legislation. The UK Government should press for the swiftest possible timetable for completion of the checks.

Infrastructure investment

28. As we have mentioned in paragraph 19 above, more than £5.5bn worth of investment will be required, to comply with UK, EU and global legislation. But UK refineries will also need to finance infrastructure investments to ensure the UK industry is better able to deliver an appropriate range of products to meet current levels of demand. We heard mixed evidence on whether this investment was available. Mr Gardner, Petroninios, told us that the refineries struggled to fund some strategic investments:

      "UK refiners have not been able to economically modify the big investments of their refineries to move out of petrol-making equipment into diesel-making equipment, because their spend is driven to staying in business, i.e. their stay-in-business spend on containment policy or things related to Buncefield and infrastructure, or spend on the sulphur dioxide reductions and things like that. The legislative spend is taking up any free cash and also putting refineries into debt."[61]

29. On the other hand, Mr Owens, CEO of Greenenergy International, described significant investment in terminals:

      "investment is almost at an all-time high. If one walks around the terminals and looks at what is going into these terminals, it is quite impressive. They are not tanks. They are not just tanks. They are actually very high-tech. We have world-leading technology in how we do things and we transform parts of the infrastructure. For instance, if you look at Teesside, maybe three, four, five years ago it had a very fragile supply chain. Now it has one of the most robust and structured supply chains anywhere in the UK. The same is happening on the Thames. We are going through a window at the moment of fragility following the closure of the Coryton Refinery, but it has been covered ...through blending and other things London and the south-east will have very robust supply logistics with quite a significant surplus capacity compared with what the region could conceivably need.".[62]

Mr Horton, Managing Director, Okios Storage, told us "We have spent £50 million in the last three years on upgrading the facilities at Oikos. It is is state-of-the-art. We can show most of Europe that what we have done is the best in class.".[63]

30. We asked what could be done to facilitate the required investment. Witnesses did not ask for tax breaks: Mr Gardner, Petronios, said "my personal view and my company's view-is that a tax incentive probably is not the answer".[64] But refineries may need to borrow money for infrastructure investment. Essar Oil has suggested that independent refiners typically struggle with a weaker balance sheet:

      Whilst it can be argued that independent refiners are more committed to the long-term sustainability of the UK refining business, they typically struggle with a weaker balance sheet. As such, investments can only be financed via operating cash flow, and in periods of low margins, turnarounds or incremental legislative costs, via additional bank loans.[65]

Christopher Fox suggested that, to secure the future of UK refining capacity, the Government consider providing 'soft loans' to refineries to, 'invest in processing units needed to increase the proportion of diesel and Jet/Kerosene product [...]' and ' [...]to allow for the upgrading of existing diesel production to Jet fuel.[66]

31. There is considerable investment in the refining industry, although much of it is primarily directed at compliance with legislative and regulatory requirements. DECC should identify appropriate actions to incentivise investment. As part of this it should look at access to finance to ensure that the industry can also invest so that it can supply the optimal balance of products to meet market demands.

UK transportation duty

32. We were told that there was an inequality in the duties charged to domestic refiners as opposed to importers, when they were moving products around the UK. Mr Gardiner, Petronios, said that importers did not have to pay duty on their imports while UK refiners did, including when they transported their products by sea: "importers are allowed to bring product into the UK duty-suspended. Any UK refiner, if it has to move product around the shores of the UK, has to pay duty on it, and losses on shipping could equate to a $5 a tonne impact".[67] He went on to say:

      "If we are moving product from, say, Grangemouth into the Humber, that product passes out of Grangemouth. It becomes duty and VAT-able at the minute it passes out of Grangemouth on a ship. A ship typically has losses on it. By the time it turns up in the Humber there is less product there, but it is not only that the hydrocarbon is a loss for the company; there is also the duty on the company.".[68]

We raised this issue with the Minister. He stated:

      "that is a key part of our review, to look at the balance between refiners and importers as to how the duty is fairly distributed and whether there is a case for rebalancing the duty between the two. That is a very important part of the review and I think you have really put your finger on one aspect of where our refineries may be at quite a significant disadvantage.".[69]

33. If UK refineries are paying Duty for moving oil products around the UK, and Duty is suspended for importers bringing products into UK, there is a clear disadvantage for UK refineries. We recommend that DECC examine the case for rebalancing duties between refiners and importers. The matter appears to be straightforward. Developing a wider package of reforms should not delay the Department in acting on this issue straight away.

12   Qq141-143 Back

13   Ev 73 Back

14   Ev 73 Back

15   Ev 58 Back

16   Q 158 Back

17   Q 158 Back

18   Q 167 Back

19   Q 169 Back

20   Ev 73 Back

21   Ev 51 Back

22   Ev 42 Back

23   Ev 73 Back

24   Ev 51 Back

25   Ev 39 Back

26   Q 70 Back

27   Ev 39 Back

28   Ev 85 Back

29   Q 184 Back

30   IHS Purvin & Gertz, The role and future of the UK refining sector in the supply of petroleum products and its value to the UK economy, 10 May 2013 ( Back

31   A process which breaks heavier crude oil components into lighter components, including diesel and jet fuel. Back

32   Q 60 Back

33   Q 4 Back

34   Q 60 Back

35 Back

36 Back

37 Back

38 Back

39 Back

40 Back

41 Back

42, Ev 46 Back

43   Ev 39 Back

44   IHS Purvin & Gertz, The role and future of the UK refining sector in the supply of petroleum products and its value to the UK economy, 10 May 2013 ( Back

45   Ev 42 Back

46   As above Back

47   Ev 55 Back

48   Ev 76 Back

49   Q 117 Back

50   Qq 118-123 Back

51   Ev 76 Back

52   Ev 71 Back

53   Ev 46, Q 28 Back

54   Q 197 Back

55   Q 158 [Mr George] Back

56   Qq 158-159 Back

57   Q158 Back

58   Ev 46 Back

59   Q 33 Back

60   Q 186 Back

61   Q 36 Back

62   Q 67 Back

63   Q 67 Back

64   Q 38 Back

65   Ev 61 Back

66   Ev 85 Back

67   Q 29 Back

68   Q 30 Back

69   Q 205 Back

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© Parliamentary copyright 2013
Prepared 26 July 2013