Energy and Climate Change CommitteeWritten evidence submitted by Petroineos Manufacturing Scotland Ltd

Petroineos Refining and Trading is one of the largest independent refiners trading in Europe. Our two advantaged refineries process up to 420,000 barrels of crude oil per day, and produce in the region of 19 million tonnes of fuels per annum. Grangemouth supplies the majority of fuel used in Scotland and also into Northern Ireland and the North West of England through its Terminal distribution network. Petroineos supplies 85% of the fuel consumed in it’s hinterland from Carlisle to Aberdeen, and 70% of the fuel consumed in Scotland, excluding North Sea offshore consumption (Source: Petroineos data). In the last financial year, Grangemouth Refinery generated £3.6 billion in duty and VAT on Fuels (Source: Petroineos data).

We are a member of the UK Petroleum Industry Association (UKPIA) representing the oil refining and marketing interests of the nine main downstream oil companies in the UK that supply the greater part of the oil derived energy and products used in the UK. Background information on the UK Refining Industry can be found in the UKPIA Submission to this call for evidence.

We welcome the opportunity to respond to the Committee’s inquiry on the major challenges facing the refining sector, which have potential significant implications for the UK’s future energy security of supply and resilience.

Summary Views

Petroineos’ views can be summarised as follows:

1.Oil products will continue to be an important part of the future fuel mix.

The International Energy Agency forecasts that oil will be a major source of energy to 2030 and beyond. The potential loss of UK refineries will increase our import dependency as refined oil products will still be required and the exporting of UK refining emissions resulting from closures is likely to increase overall global emissions as products are sourced from installations not subject to UK/EU environmental controls. There will also be a significant impact on UK jobs and a marked decrease in UK supply resilience.

2.Energy security and diversity of supply should be part of overall policy, consistently applied.

Meeting the UK’s future energy needs in a secure, diverse and sustainable way that also meets environmental and air quality objectives, is a huge challenge. It requires policy that is closely aligned and balanced across these key areas (see UKPIA’s paper “A Question of Balance”). Petroineos and UKPIA believe that energy and environmental policy should continue to be based on maintaining a reliable UK energy system meeting all three pillars of sustainability—economic, environmental and social.

3.Oil refining sector and its contribution to security of supply.

UK refining plays a vital role in maintaining the country’s fuel supplies but the UK’s level of imports for middle distillates such as diesel and jet fuel is already at a high risk level and close to high risk for kerosene heating oil (based on the International Energy Agency’s “MOSES” methodology). Further refinery closures could increase this exposure. Crude Oil needs to be processed in a Refinery, whether in the UK or overseas. Greater reliance on imported refined products is an option, but carries the risk of reduced supply resilience associated with a longer supply chain. Further UK Refinery closures would increase this exposure.

4.UK refining faces challenging conditions, huge legislative compliance costs but can be competitive given a level playing field.

UK refining faces a serious threat to its survival as outlined in an independent report by IHS Purvin & Gertz published 10 May 2013, sponsored by UKPIA in collaboration with the Department for Energy & Climate Change (DECC). Although long-term net refining margins are projected to average around $2.5 per barrel of oil, this masks the huge potential cash impact of additional required capital and operating expenditure in the period 2013–30 of £11.4 billion just to meet UK and EU legislative measures. Most of this would generate no return and would not be recoverable from consumers. In addition there are other legislative impacts such as Fuels Quality Directive and Energy Efficiency Directive as yet not fully defined and thus uncosted.

Furthermore, to keep pace with changing product demand trends, refineries would also need to invest some £1.5 to £2.3 billion over the same time frame which is unlikely in view of the impact of legislative compliance costs and low investment returns.

The attached graph (Source: IHS Purvin & Gertz 10 May 2013) neatly illustrates the scale of the issue facing UK Refineries:

However, given a legislative level playing field with other refineries across the EU and globally, UK refineries would be considered competitive.

The HIS Purvin and Gertz report concluded that “no industry would bear such a mandatory investment burden for no return and a consequence could be the closure of more UK refineries and greater import dependence for refined products”.

5.Time is not on our side—legislators at the UK and EU level have been slow to realise the value of refining and the threats to its survival.

There is a growing realisation of the value of the refining industry. The industry is working with DECC towards developing a policy framework for UK refining, informed by the comprehensive report from IHS Purvin & Gertz, which sets out the value of UK refining, the challenges it faces and the potential impacts on UK energy resilience.

The European Commission facilitated a Refining Round Table in 2012 to examine the issues of refining sustainability and the impact of legislation. This led to the establishment of a permanent Refining Forum—whose major output was determined to be refining industry “Fitness Checks” designed originally to examine the cumulative effect of EU regulation on the sector and consider mitigating measures. Regrettably, at the first Refining Forum meeting on 12 April 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 ie 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 concluded until the end of 2014, by which time the crucial legislation under discussion will have been concluded.

The industry has always assumed the Fitness Checks would include existing and planned legislation and called for a moratorium on any further legislative pressure until the outcome of the Fitness Check was known.

Responses to Questions Posed by the Committee

1. What are the factors that have led to the closure of UK refineries? Why is production increasing overseas?

1.1 Refinery closures

The key factors are: weak refining margins and the huge investment demands associated with legislative compliance (as outlined above); flat or reducing demand for transport fuels, as a result of demand destruction linked to legislative measures to reduce GHG emissions from transport and improved energy efficiency of vehicles; competition from overseas refineries and supply sources.

1.2 Increasing overseas production

Production overseas is increasing, for example in the Middle East and Asia, because of the proximity to rapidly growing markets (Asia), more attractive investment returns on large new refineries with the flexibility to meet current product demands and a less challenging legislative background. Most of these are in the Middle East and the USA and are also supported by structural cheaper feedstocks.

2. What impact (if any) has UK and EU regulation had on the UK refining industry?

2.1 The key legislation impacting upon the sector includes:

EU:

EU Emissions Trading System Phase III.

Fuel Quality Directive Article 7a, plus product quality/vapour pressure specifications.

Industrial Emissions Directive.

Renewable Energy Directive.

Energy Efficiency Directive.

UK:

Environment Agency proposals on product containment policy.

Government proposals for Carbon Floor pricing.

CRC Energy Efficiency Scheme.

International regulation such as MARPOL Annex VI/IMO specifications for low sulphur shipping fuel and the IEA’s rules on Compulsory oil stocking obligations also impacts refining and downstream oil.

2.2 IHS Purvin& Gertz estimate the required refinery capital and operating expenditure in the period 2013–30 to be £11.4 billion to meet UK and EU legislative measures alone. This figure excludes the legislative impacts such as Fuels Quality Directive and Energy Efficiency Directive as yet not fully defined and thus uncosted.

These costs (as shown in the diagram in Section 4 of the summary) ensure that UK Refining is unsustainable going forwards with expected income not meeting costs.

3. What part will refined oil products play in the UK’s energy requirements and transport in particular to 2030 and beyond? What mix of products is likely to be required and how well does this match with current UK refining capacity?

3.1 The International Energy Agency forecasts that oil will be a major source of energy to 2030 and beyond, accounting for over 80% of EU transport fuel. The projections for UK demand are similar, IHS Purvin & Gertz forecasting that oil product demand will increase only slightly between 2010 and 2030.

3.2 Within the transport sector, however, a combination of fiscal and energy efficiency factors has encouraged a shift towards diesel powered vehicles as a result of which petrol demand has declined from a market share of 73 % in 1990 to around 41% in 2012 (18 billion litres) with diesel now accounting for 59% (26 billion litres).

3.3 Aviation kerosene has been falling during the recession, UK demand amounting to 11 million tonnes in 2012, but is forecast to begin increasing again. (Source: DECC, DUKES data.)

3.4 The main fuels required in the future will be petrol, diesel, gas oil and kerosene mainly for aviation. In addition, other products from refining like LPG, bitumen, lubricants, solvents, carbon coke and feedstocks for the petrochemical industry will continue to be important. Future road fuel demand is forecast to remain flat but diesel demand is likely to continue growing slightly while petrol will continue to decline but more slowly than in recent years. Demand for aviation fuel is closely linked to future recovery in GDP but potentially could grow rapidly in the future. (Source: IHS Purvin & Gertz.)

3.5 There is a miss-match between refinery output and demand. UK refineries, in common with those across the EU, produce an excess of petrol and not enough middle distillates like diesel and jet fuel. The shortfall is met by imports which reduces UK Energy Resilience. Similarly the petrol length is exported, which can lead to issues with Refinery resilience if buyers are not found. In addition, fuel specification changes associated with the UK’s Renewable Transport Fuel Obligation and MARPOL marine fuel sulphur reduction will increase the demand for middle distillates.

4. What is considered to be the right balance between oil products refined locally and imports and what are the current and future scenarios?

4.1 The IEA model for Short Term Energy Security (MOSES), comparing oil imports to demand, considers 46% import dependence as high risk. The UK is already at a level of 56% imports for jet/kerosene and 48% for diesel.

4.2 Under a future UK refinery closure scenario, this import dependence would increase to 78% and 77% respectively (Source: HIS Purvin and Gertz Report May 2013) for these products by 2030, which would have serious implications for supply robustness of these products.

5. What are the factors, both domestic and international, that will determine the future viability of the UK refining industry?

5.1 Legislators cannot directly influence commercial conditions affecting the refining sector, which in a global market are influenced by a complex number of factors. However, legislative impacts highlighted in 2 above will have a serious impact upon profitability.

5.2 IHS Purvin & Gertz forecast that future UK refining margins are projected to average around $2.5 per barrel of oil. However, over the period 2013 to 2030, the total cost of such legislative items adds up to around $1.85 per barrel, of which only an estimated small proportion might be passed on to the consumer because of international competition. These legislative requirements would entail capital expenditure of £5.5 billion over the period to 2030, much of which would generate no return on investment.

5.3 This scenario seriously impacts the viability of the refining industry and furthermore makes it highly unlikely that the estimated £1.5 to £2.3 billion capital expenditure that refineries need to meet changing demand trends would be made.

5.4 IHS Purvin & Gertz commented that “We believe that no industry would bear such an investment burden for no return. It would be highly likely that, when faced with such a large mandatory capital expenditure requirement that provides no return on investment, UK refiners could be forced to close more UK refineries.”

6. What impact would the closure of UK refineries have on (a) energy supply security (b) environmental objectives and (c) the price of petroleum products in the UK?

6.1 The impact of further refinery closures on supply security is highlighted in the response to question 4 above.

6.2 The impact upon UK environmental objectives is difficult to measure. Clearly any emissions generated by the closure of a UK refinery would reduce the UK’s domestic emissions. However, demand for the products previously produced would be met by imports from overseas thus increasing overall global emissions, particularly for CO₂.

6.3 While it is difficult to comment on how the price of petroleum products may change in the future, the reducing supply of UK refined product and the need for purchased imported fuel in an ever more competitive global market would suggest that the price of petroleum products would increase should UK Refineries close.

7. What would be an appropriate baseline level of refining capacity in order for the UK to remain broadly self-reliant in an emergency?

7.1 It is difficult to provide a definitive answer on this as the level in the future may vary depending on a range of factors such as the state of the economy, vehicle efficiencies, and ambient weather conditions.

7.2 Under both the steady state scenario (the number of refineries and capacity remains at 2012 level) and the modest investment scenario (investment to upgrade some secondary upgrading processes), the current imbalances in the UK supply demand balance become worse. Under both these scenarios the UK would be in a worse supply position than in 2011 before the closure of Coryton refinery. Exposure to the international refined product markets would remain, with significant imports of diesel and jet required to balance demand.

8. What steps could the UK Government take to maintain an appropriate baseline level of refining capacity?

8.1 As stated previously, Petroineos’ firm view is that a strong and healthy indigenous refining sector ensures the nation’s “base load” of transport fuels, chemical feedstocks and other vital products is maintained. This requires a better balance between energy and environmental policies both in the UK and at the EU level.

8.2 The UK Government should examine the impacts of UK legislation, particularly Carbon Floor Price, CRC Energy Efficiency Scheme and containment policy proposals as applied to the storage of fuel products including the PPC Regulations which are a subset of the Industrial Emissions Directive (IED).

The headline costs of meeting the requirements of the PPC Regulations for the Grangemouth Refinery are £95–110 million for SOx and NOx emissions.

It should also examine the current duty treatment for product shipments between UK locations to ensure a level playing field for UK products against imports from outside the UK; further details of this can be found on Page 127 of the report from IHS Purvin and Gertz.

8.3 Ideally, these issues should be contained in a policy framework for the sector which we hope will be developed by DECC, informed by the findings of the report from IHS Purvin & Gertz.

The UK should not “gold plate” European Directives with additional ones specific to the UK. Two specific examples of this for Petroineos are as follows:

(i)The UK has a 15 minute air quality objective for SO₂ which is additional to the EU Requirements. This led to the Refinery having to invest £32 million in a Tail Gas Treatment Unit many years ahead of the future IED requirement to upgrade in 2018.

(ii)The IED legislation states that the only Refining of Mineral Oil and Gas is covered by the Directive. However UK regulation expands the remit of the activity to include the Refining of Mineral Oil or the loading, unloading and storage of crude oil. This brings crude handling facilities at Finnart under the PPC Regulations.

However, the most vital and pressing need is for the UK Government to make urgent representations to the European Commission in regard to the “Fitness Check” process outlined in point 5 in our Summary Views above. The Fitness Checks must include consideration of Fuels Quality Directive Article 7a and the Refinery BREF linked to the Industrial Emissions Directive, and be concluded before the end of 2013 NOT 2014, by which time the crucial legislation under discussion will have been concluded.

9. What is the significance and potential future impact of the changing ownership of UK refineries in recent years?

In any mature industry sector like refining there will be changing ownership due to the strategy and policy objectives of individual companies. Given the global nature of the industry there will be competing investment projects not just in the downstream sector but also in upstream exploration.

Changing ownership can be a positive factor since it brings in new entrants that may have a different strategy, outlook and investment perspective.

However it can be concluded that the exit of the UK Refining industry by the global Oil Majors highlights the critical state the sector is currently operating in and the future outlook.

We thank you for the opportunity to contribute to this important debate and would be pleased to elaborate on our views should the Committee so wish.

May 2013