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.
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
- 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]
UK
- 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 [http://www.environment-agency.gov.uk/business/topics/oil/145808.aspx]
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 post-Buncefield-compliant....it
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 (http://www.ukpia.com/files/pdf/therolefutureoftheukrefiningsector.pdf) 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
http://ec.europa.eu/clima/policies/ets/index_en.htm Back
36
http://ec.europa.eu/environment/air/transport/fuel.htm Back
37
http://ec.europa.eu/environment/air/pollutants/stationary/ied/legislation.htm Back
38
http://europa.eu/legislation_summaries/energy/renewable_energy/en0009_en.htm Back
39
http://ec.europa.eu/energy/efficiency/eed/eed_en.htm Back
40
http://www.environment-agency.gov.uk/business/topics/oil/145808.aspx Back
41
http://www.hmrc.gov.uk/climate-change-levy/carbon-pf.htm Back
42
https://www.gov.uk/crc-energy-efficiency-scheme, 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 (http://www.ukpia.com/files/pdf/therolefutureoftheukrefiningsector.pdf) 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
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Ev 85 Back
67
Q 29 Back
68
Q 30 Back
69
Q 205 Back
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