Energy and Climate Change CommitteeWritten evidence submitted by Shell

Executive Summary

1. We understand the Committee is concerned by recent UK refinery closures and seeks to understand the impact this may have on UK security of supply and resilience.1

2. In considering this issue, it is relevant to note that recent refinery closures are in the context of declining demand for fuels in the UK through several factors, including: more efficient vehicles; the displacement of conventional fuels by, for example biofuels; and declining car sales. In addition, these closures have taken place within a highly competitive global oil and products market, where UK refining is mid-tier in terms of its competitiveness (17th in Europe).ⁱ UK refineries are older and as a result require significant investment, a more expensive crude diet and are geared towards making petrol, a product which is oversupplied in Europe. As a result the UK is not currently balanced in terms of supply and demand, importing diesel (where we have a “short”) and exporting petrol (where we have “length”).

3. Recent refinery closures reflect the changing supply and demand balance, and do not indicate a concern for energy security. If there were further refinery closures in the UK this would affect the economics of those which remain as over capacity is reduced, making it less likely there would be multiple further closures.

4. The UKs security of supply is ultimately a function of its ability to pull crude and products from the global market, rather than having a set level of domestic refining capacity. Through this lens, infrastructure plays a critical role. The UK as an island has resilience and security of supply through good access to local and international product via; numerous import terminals, good inland infrastructure, in terms of road and rail, and multiple domestic hauliers. There are regions of the UK which are predominantly and successfully supplied through imports, which challenges the assumption that importing leads to issues for resilience or security of supply.

5. Any intervention in the market to deliver “an appropriate baseline” could impact prices for the consumer.

Q1. What are the factors that have lead to closures of UK refineries? Why is production increasing overseas?

6. There are several factors which have led to the closure of UK refineries. Firstly, there is an imbalance between supply and demand for oil products in Europe (and globally) due to refining overcapacity and declining demand for conventional fuels.ⁱⁱ This reduces UK refinery profitability as utilisation declines and the value of the product declines as it is more difficult to find a consumer.

7. Secondly, UK refining is mid-tier in Europe in terms of competitiveness as our aging refinery portfolio requires significant investment, the refineries are generally geared to run light sweet crude (typically the most expensive crude) and produce mogas (petrol) which is currently oversupplied in Europe.

8. 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 (eg Russia) or proximity to abundant crude supply sources.

Q2. What impact (if any) has UK and EU regulation had on the UK refining industry?

9. EU directives that seek to reduce greenhouse gas emissions, such as the Renewable Energy Directive (RED) and Fuels Quality Directive (FQD) directly impact European refining. The RED requires 10% renewable energy content in transport by 2020, and the FQD requires a 6% reduction in greenhouse gas emissions in transport. Both of these directives are essentially mandating a level of displacement of conventional fuels. This demand reduction has an impact on UK refinery profitability. When a refiner has a smaller domestic market, more product is exported at a lower netback,ⁱⁱⁱ making them less profitable.

10. UK industrial competiveness is further affected where the UK implements policy which overlaps with EU policy; an example of this is the recent introduction of the UK’s carbon price floor on top of the existing EU Emissions Trading Scheme (ETS).2 National fragmentation of policy is best avoided to ensure an efficient and competitive sector.

Q3. 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?

11. As noted in response to question one, there is a structural decline in demand for conventional fuels in the UK, in addition to declining new car sales.^iv There will be further erosion in demand through increased sales of new vehicle types (ie hydrogen and electric vehicles). However, in the period to 2030, we expect to see continued strong demand for conventional liquid fuels. The RAC Foundation^v suggests that 60% of UK vehicles in 2030 will be fuelled by the internal combustion engine and Shell’s latest scenarios^vi indicate that by 2030 over 80% of the global passenger kilometers will still be fuelled by hydrocarbons alongside gaseous hydrocarbons (~10%), electric mobility and hydrogen (collectively 7%).^vii

12. The UK does not currently meet domestic demand through domestic refining. The UK is long in petrol and short in diesel and jet. The products market is global, hence refiners export their “length” and suppliers import the “short”. In the future these imbalances will continue to change, those refiners who are not able to sustain acceptable profitability in this changing environment will cease production and either close or be converted to import terminals. We expect some refiners will adapt to the changing external environment by improving their relative global competitiveness.

Q4. What is considered to be the right balance between oil products refined locally and imports and what are the current and future scenarios?

13. The definition of the right balance would depend upon the end goal being sought; whether it is to deliver supply security and resilience, create jobs or ensure affordability. Both refining and importing provide supply security and resilience. Both are susceptible to problems in the international markets, such as a crude shortage or product shortage. A prolonged structural product shortage is unlikely, as generally the world has more than enough refining capacity and connected via shipping.

14. Leaving the market to find the right balance between refining and importing is a robust way of creating efficiency and competition and thus providing the lowest cost to the consumer.

Q5. What are the factors, both domestic and international, that will determine the future viability of the UK refining industry?

15. Reference our response to question 1.

Q6. What impact would the closure of UK refineries have on (a) energy supply security b) environmental objectives (c) the price of petroleum products in the UK?

Energy supply security

16. The oil and products market is a global market and adjusts to make up any shortfall from closures. UK refineries will only close if they are uneconomic and if one were to close, this would help the margins for those who remain, making subsequent closures less likely. In the event of a refinery closure, we could expect a short-term supply disruption. In the recent case of the Petroplus Coryton refinery closure, there was limited supply disruption. The Coryton refinery is being converted into a new deep draft terminal, which will deliver supply security by connecting the UK directly to the international market. It would not appear that the closure has not resulted in any negative impact on supply security.

17. There are regions of the UK where a refinery closure would have a larger impact on resilience due to high demand and limited alternative supply options (eg nearby import capacity).

Environmental objectives

18. In relation to the impact on environmental objectives if a refinery closes in the UK and product is sourced in Europe, the EU ETS will act to ensure refiners operate within an overall ETS emission cap.

19. It is difficult to speculate on product flows, however newer more efficient overseas refineries which could supply the UK in the event of domestic closures may have a lower GHG footprint than those in the UK.

Price

Any intervention in the market could affect prices for the consumer.

Q7. What would be an appropriate baseline level of refining capacity in order for the UK to remain broadly self-reliant in an emergency?

20. If self-reliance is defined as a having a match between domestically refined product and domestic demand the UK is not self reliant today. It is difficult to envisage an emergency which could be mitigated by having a set baseline level of domestic refining capacity. In the case of an international incident such as the closure of the Straits of Hormuz, there could be a global shortage of crude which could impact all refiners. In case of a domestic supply disruption, refineries pose a higher risk of long term disruption than importing.

21. The UK’s Compulsory Stocking Order (CSO) aims to mitigate the impact of global supply shocks. CSO requires all refiners and importers to hold stocks or tickets to provide cover^viii in case of supply disruption in the market. With the introduction of an agency to centrally manage these stocks, as is currently proposed by DECC, we believe this is a robust system to provide mitigation for disruption.

Q8. What steps could the UK Government take to maintain an appropriate baseline level of refining capacity?

22. Reference our response to question 4. Any consideration on an appropriate “baseline” should be taken within the context that a significant proportion of domestic supply comes from imports and that resilience is also a function of critical infrastructure such as pipelines, terminals, jetties etc. Intervention in the market could impact the price for the consumer.

Q9. What is the significance and potential future impact of the changing ownership of UK refineries in recent years?

23. UK refineries all have different international operators. The change in ownership that we have seen in recent years from integrated IOCs (ie those who have an interest in the whole supply chain) to specialist refining companies reflects a trend which we are seeing across Europe and the US.

Shell Footprint

Shell operates three refineries in Europe; Pernis in The Netherlands, Rhineland in Germany and Federicia in Denmark and in the UK downstream Shell owns a jet fuel import terminal in the Thames; joint ventures in pipelines and logistics, a main fuels import terminal (a joint venture with Vopak and Greenergy) at the former Coryton refinery (currently under conversion) and a significant presence in the retail sector with over 1,000 retail sites.

May 2013

References

ⁱ Wood Mackenzie Report on UK Downstream oil infrastructure, 2009

ⁱⁱ There is a decline in demand for petrol and a slight growth in demand for diesel to reflect the changing vehicle pool. Overall for transport fuels the trend is a decline in demand. (Wood Mackenzie Report on UK Downstream oil infrastructure, 2009)

ⁱⁱⁱ A summary of all the costs associated with bringing one unit of oil to the marketplace, and all of the revenues from the sale of all the products generated from that same unit. The netback is calculated by taking all of the revenues from the oil, less all costs associated with getting the oil to a market. These costs can include, but are not limited to, importing, transportation, production and refining costs, and royalty fees.

^iv IPPR Decoupling oil and transport, 2011

^v RAC foundation report on low carbon cars and fuels, 2013

^vi Shell New Lens scenarios: A shift in perspective for a world in transition

^vii Based on global passenger vehicle kilometres

^viii Cover is either crude or product in storage – as a proportion of normal supply volumes