Energy and Climate Change CommitteeWritten evidence submitted by the UK Petroleum Industry Association
The UK Petroleum Industry Association (UKPIA) represents the oil refining and marketing interests of the nine main downstream oil companies in the UK that supply around 85% of the oil derived energy and products used in the UK. 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
UKPIA’s views can be summarised as follows:
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THE UK HAS SEVEN MAJOR OPERATIONAL REFINERIES
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ESTIMATED COST IMPACT OF LEGISLATION
In addition, there are other legislative costs such as the Fuels Quality Directive, which are not yet fully defined and are thus uncosted, the impact of which were not included in the study. Furthermore, IHS Purvin & Gertz estimate that 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 these legislative compliance costs and low investment returns. However, given a legislative level playing field with other refineries across the EU and globally, the report observed that UK refineries would be considered internationally competitive.
The 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 middle distillate products such as jet fuel and diesel.”
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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 in part linked to legislative measures to reduce GHG emissions from transport but also improved energy efficiency of vehicles; and competition from overseas refineries and supply sources, where the same legislation does not apply.
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, more attractive investment returns on large new complex refineries having flexibility to better meet current product demand split and a less challenging legislative background.
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 (and associated Refinery BREF).
UK:
COMAH containment policy.
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 just to meet UK and EU legislative measures alone. This figure excludes the legislative cost impacts arising from legislation such as the Fuels Quality Directive and Energy Efficiency Directive, which are not yet fully defined and are thus uncosted.
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 from 74.3 million tonnes in 2010 to 75.2 million tonnes in 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). Aviation kerosene demand has been falling during the recession, UK demand amounting to 11 million tonnes in 2012. (Source: DECC, DUKES data.)
3.3 The main fuels required in the future will be petrol, diesel, gas oil and kerosene (mainly for aviation). In addition, other products from refining—LPG, bitumen, lubricants, solvents, petroleum 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. (Source: IHS Purvin & Gertz.)
3.4 There is a mismatch 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. In addition, fuel specification changes such as the 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 of 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 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 and disadvantage UK refineries against overseas competitors.
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 We have no comment on question 6(c) regarding petroleum product prices as it is outside UKPIA’s remit.
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 Under a number of scenarios IHS Purvin & Gertz conclusions are as follows.
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 fuel required to balance demand (see also response under Question 4).
8. What steps could the UK Government take to maintain an appropriate baseline level of refining capacity?
8.1 As stated previously, UKPIA’s 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 COMAH containment policy as applied to the storage of fuel products.
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.
8.4 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 largely implemented.
9. What is the significance and potential future impact of the changing ownership of UK refineries in recent years?
9.1 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.
9.2 In the UK, there has been a change in refinery ownership in recent years with some multi-national integrated oil companies exiting refining, to be replaced by non-integrated companies (ie those without involvement in the supply chain from upstream oil exploration through to marketing) with a focus on refining.
9.3 Changing ownership can be a positive factor since it brings in new entrants that may have a different strategy, outlook and investment perspective.
Background Context
UK operating refinery capacity is ~1.5 million barrels of crude oil per day (the fouth largest in the EU). Oil currently accounts for around one-third of all the UK’s energy needs and UKPIA’s members supply around 85% of transport fuels used in the UK. (Source: DECC DUKES.)
Two UK refineries have closed between 2009 and 2012, a further two have changed ownership and one refinery remains for sale.
The main markets for products from refining in the UK are:
Retail (forecourt service stations): ~ 28.5 million tonnes per year of petrol and diesel.
Aviation: ~11 million tonnes per year jet kerosene.
Commercial: ~16.7 million tonnes per year (commercial vehicles, heating fuels and marine).
Speciality (bitumen, lubricants, LPG, solvents and petroleum coke etc): ~5 million tonnes per year.
Petrochemicals: ~2 million tonnes per year (Source: DECC DUKES).
UKPIA members also:
Invested £3 billion in fixed assets over the last five years, much of it to meet tighter fuel and environmental standards and to enhance process safety;
Operate 36 distribution terminals and 1,500 miles of pipeline;
Own around 1,600 out of the 8,700 filling stations in the UK (Source: Energy Institute/Catalist); and
8,500 jobs in refining support 54,000 jobs in the extended supply chain industries; expenditure by these employees supports a further 25,500 jobs in the wider economy, making an overall total of 88,000 jobs (Source: IHS Purvin & Gertz).
The monetary input of refining to the UK economy in a normal year is estimated at £2.3 billion (Source: IHS Purvin & Gertz 2013) and each large refinery is estimated to inject ~£60 million+ into the local economy where it is located (UKPIA publication” Fuelling the UK’s Future”).
The downstream oil sector collected ~£36 billion in duty and VAT on fuels in the last financial year. (Source: DECC DUKES.)
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