Energy and Climate Change CommitteeWritten evidence submitted by Essar Oil UK Limited

Summary

A. Essar Oil UK is a subsidiary of Essar Energy plc, which is listed on the London Stock Exchange. Essar Oil UK owns and operates the Stanlow Manufacturing Complex, the UK’s second largest refinery. It has a nameplate throughput capacity of 296,000 barrels of oil per day (bpd), and a Nelson complexity of 8.2. However, our current optimised configuration gives Stanlow a 240,000 bpd operating capacity with an effective complexity of around 10.

B. The refinery, located on the south side of the Mersey Estuary close to the major cities of Liverpool and Manchester, supplies 15% of UK transport fuels. It has an annual production of two billion litres of jet fuel, three billion litres of petrol and 3.5 billion litres of diesel.

C. We are a major regional employer with over 1,000 staff, an additional 500 contractors on site and a further 5,000 people employed indirectly through the extended value chain, contributing an estimated £60 million each year to our local economy.

D. Together with other UK refiners, we face an extremely challenging refining environment with margins depressed and likely to remain so for many years ahead. In addition, as players in a highly competitive global industry, current UK and proposed European legislation places us at a severe disadvantage compared to our competitors based in other parts of the world.

E. The fact that we do not operate on a level playing field risks serious consequences for the viability of UK refiners and our national fuel energy security going forward.

F. The loss of UK or EU refining capacity would be detrimental to an improved global environmental footprint. Less polluting EU businesses will be forced to close in favour of heavier polluters in other parts of the world not subject to the same stringent controls.

G. We urge the UK Government to work with the refining industry to identify the most effective, balanced and pragmatic solutions to deliver truly sustainable solutions for the environment, economic growth and employment opportunities.

H. We welcome the decision of the Energy and Climate Change Committee to examine the facts surrounding this important debate and are pleased to be able to contribute.

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 It is clear depressed margins and substantial investment costs associated with legislative compliance, both at national and European level, have played their part. We have seen a changed product demand profile leading to mismatch between refinery output and demand, with UK refineries producing a significant excess of gasoline and not enough middle distillates (like diesel and jet fuel). Refiners therefore struggle to sell surplus gasoline internationally, with diesel and jet fuel shortfalls being met by imports.

1.2 Overseas producers—in Russia, the Middle East and Asia—are not subject to the same huge legislative compliance costs, so have a marked commercial advantage. They are closer to emerging markets and with newer and more complex refineries, are better positioned to meet the specific product demands of the modern market. New capacity in Asia has in general been built in the anticipation of demand growth in the emerging markets, leaving short term surplus volume, exacerbated by lower than expected GDP growth in these regions, which is being exported to Europe.

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

2.1 The UK refining industry does not operate on a level playing field within a highly competitive and fluid global market. Legislation has had and will continue to have a material impact on the future sustainability of the sector. For our Stanlow refinery, Purvin & Gertz estimate these annual legislative costs at £125 million, before factoring in an additional £75–350 million per annum for the EU Fuel Quality directive article 7a alone when it passes into law. Not only would independent refiners like Essar Oil UK find it difficult to source funding for such high annual investment requirements, but the reduced profitability would even put the viability of such advantaged refineries as Stanlow in doubt.

2.2 On a UK level, the following will have significant impacts: CSO obligations; Carbon Floor Pricing; CRC Energy Efficiency Scheme; COMAH containment policy.

2.3 On an EU level, the following will have significant impacts: EU Emissions Trading Scheme Phase III; Industrial Emissions Directive (plus associated refinery BREF); Renewable Energy Directive; Fuel Quality Directive; Renewable Energy Directive.

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 Even as we move towards a low carbon economy, oil will remain an integral part of the UK energy mix for decades to come. IEA projections show oil will be a major source of energy to 2030 and beyond, accounting for over 80% of transport fuel even then.

3.2 There has been a major change in the refined product market in the UK, with a significant decrease in demand for gasoline (from 73% in 1990 to 41% by 2012) and gas oil and a significant increase for jet fuel and for diesel (which now stands at 59%). Fiscal policy, increased engine efficiency and the dieselisation of cars has driven this change. During the recession, demand for aviation fuel has also fallen.

3.3 Looking forward, the main demand for transport fuel will be for gasoline, diesel, jet fuel and gas oil. Road fuel demand is forecast to remain flat but within this group, demand for gasoline will continue to fall, albeit more slowly, while diesel will rise. Recovery of national GDP will influence the demand for aviation fuel. In addition, other products from refining such as LPG, bitumen, solvents, carbon coke and feedstocks for the petrochemical industry will continue to be important.

3.4 As previously stated, UK refineries produce a significant excess of gasoline and not enough diesel and jet fuel. These shortfalls will need to be met by imports and as these increase over time, our reliance on other sovereign states will grow. We estimate that only Russia and the Middle East will be providing any incremental diesel and jet shortage.

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 UK government should consider as a matter of the highest priority the implications for our national energy security. The independent IEA’s own model for Short Term Energy Security (MOSES), which analyses oil imports compared to demand, considers 46% import dependence as high risk. The UK figures are currently 56% imports for Jet & 48% for Diesel.

4.2 The difficulty will be in reducing the amount of gasoline produced in UK refineries whilst increasing the yields of diesel and jet. Unfortunately investments into hydrocracker technology (over £1 billion per refinery) are not expected to remunerate. Resilience will thus likely require a combination of some further refineries shutting and the Government providing incentives for further diesel/jet incentives and increased environmental investments.

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

5.1 To be viable UK refineries need to operate at a high utilisation rate and at a competitive cost level.

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 Government has clearly identified security of supply in other energy sectors such as electricity generation as a priority. In this context, it is worth noting that UK refiners currently supply over 34% of total UK energy.

6.2 We believe there would be a significant threat posed to our national energy security if our reliance on imports is allowed to increase from a level already classified as one that is high risk, especially with incremental diesel and jet largely being sourced from Russia and the Middle East. Whilst some further refinery closures are expected, the Government should consider incentives into building more diesel and jet capacity to improve transport fuel resilience.

6.3 Should the new EU environmental legislation be passed and implemented as per the initial proposals, a larger number of refineries in the UK are going to be at risk. The global environmental footprint would actually also worsen if UK (and EU) refiners were to close. This is because lost product supply would be met by non EU refineries often with less stringent environmental controls.

6.4 The market would determine the price of products. However, an acute dependence on imports would expose the UK to potential external pricing factors it could do little to mitigate or influence. These could be to the detriment of both the national economy and the consumer.

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 We refer to the IEA’s approach used in its Model for Short Term Energy Security (MOSES), which considers imports compared to demand as discussed in Purvin & Gertz study.

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

8.1 As a matter of urgency, the Government should insist that the European Commission take a common sense approach to the question of their Refining Forum Fitness Checks, and ensure these are completed quickly and comprehensively. In the meantime, a moratorium should be declared on any further legislative impacts on the refining sector until the impact assessment has been concluded, effects digested and an action plan agreed.

8.2 At national policy level, the UK Government should define the role they see the UK refining industry playing in helping to safeguard future energy resilience. They should explain whether they consider a UK dependent on imports for strategically important fuels to be acceptable. Clarification on that key issue will help shape investment decisions on the part of UK refiners and provide the basis on which they can confidently approach the capital markets to raise funds.

8.3 As a key player in the UK refining industry, we would welcome the opportunity to work with the relevant departments within Government to help formulate effective, balanced and pragmatic solutions to deliver truly sustainable solutions for the environment, economic growth and increased employment opportunities.

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

9.1 The Stanlow refinery was acquired by Essar Oil within the last 20 months from its previous owners and is now a fully independent site that is a committed player in the downstream sector. We are determined to thrive in this space and have introduced a number of strategic initiatives to continue the growth of the business.

9.2 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.

May 2013

Prepared 25th July 2013