Energy and Climate Change CommitteeWritten evidence submitted by Channoil Consulting Ltd

Current Scenario

Margins

Refining margins under severe pressure in Europe. This is due to oversupply of gasoline and a mismatch in the capability of refineries to maximise diesel and jet fuel. Also regulatory pressures in Europe are much higher than East of Suez refineries. The effect of this has been demonstrated by the failure of Petroplus and the constant reduction in capacity by the major refiners. We can only assume that the majors saw the oversupply of refining capacity earlier in the cycle and their disposals now look timely. Another reason is the forecast tightness in crude oil availability. When the majors were over producing crude oil it was necessary for them to have control of the markets, to ensure that they pushed through the maximum amount of crude oil into the consumer markets. Now they are confident that they can sell every barrel of crude oil they produce.

Table 1

REFINERY UTILISATION

Source: BP Statistical review of World Energy 2012

Table 2

REFINING MARGINS

Source: BP Statistical review of World Energy 2012

It can be seen from the above slides that, as capacity utilisation falls, then margins collapse. From 2007 there has been a steady decline in worldwide refinery utilisation rates; and correspondingly, except for US based coking refineries that benefited from the spread in the sweet light and heavy sour differential, there has been a steady erosion of margins. Gross margins of $US3–5 per bbl will not cover operating and capital costs.

We will discuss the reason behind this drop in utilisation later but for now suffice it to say that there is no immediate light at the end of the tunnel. If anything there will have to be a lot more substantial shutting-in of capacity before margins recover. This is clear from the number of new complex refineries being built or proposed in the Middle East, India and China.

Table 3

REFINERY DISPOSALS AND CLOSURES IN EUROPE 1974–2012

Company

Location

CDU capacity KBPD

Current status

New Operator

UNITED KINGDOM

BP

Isle Of Grain

Kent

150

Closed -new port

Llandarcy

Wales

80

Closed

Grangemouth

Scotland

180

Operating

Ineos/Petrochina

Belfast

N. Ireland

80

Closed

Shell

Shellhaven

Thames

180

Closed- New Container terminal

Teesport

NE England

80

Closed- New Container terminal

Ardrossan

Scotland

Closed

Stanlow

Mersey River

240

Operating

Essar Energy

Esso

Milford Haven

Wales

100

Closed-dismantled

Chevron/Gulf

Milford Haven

Wales

210

Operating

Valero

Murco

Milford Haven

Wales

120

Converting to terminal

Petroplus

Teeside

NE England

80

Closed- Oil terminal

Petroplus

Coryton

Thames

220

Closed-Terminal

 

FRANCE

BP

Vernon

Rouen

100

Closed dismantled

Dunkirk

N Coast

80

Closed dismantled

Strasbourg

80

Closed dismantled

Total

Dunkirk

N Coast

156

Closed -Terminal

Petroplus

Petit Couronne

162

Bankrupt

LyondellBassel

Berre

Provence

105

Closed

 

BELGIUM

Petroplus

Antwerp

108

Restarted by Gunvor

Petroplus

Antwerp

112

Closed Terminal

 

GERMANY

Shell

Harburg

Hamburg

110

Closed-Terminal

Petroplus

Ingoldstadt

Bavaria

105

Closed-Gunvor possible restart

 

ITALY

Tamoil

Cremona

NE Italy

80

Closed

ERG Total

Civita Vecchia

Rome

86

Closed

ENI

Gela

Sicily

105

Closed for 12 months

API

Falconara

E Coast

83

Closed for 12 months

ERG Total

Priolo

Sicily

360

80% sold to Lukoil

Since early 2000 we have seen a number of refinery closures or sale with no new replacement of primary distillation capacity. Most new additions to refineries were in upgrading and desulphurising plant. For upgrading plant, the investments have paid off handsomely and will continue to do so but these units have been subsidising the primary distillation units. So much so, that demand for atmospheric residue and VGO have never been higher and the premia paid are considerable, reflecting both the refining economics but also the competition for the grades.

Over 1 million BPD of refining capacity has closed in Europe since 2009 and if one goes further back this is just the tip of the iceberg. A further 1.0 million bpd has had an ownership transfer mainly from the major oil companies to independent traders or non European refiners.

Of the 1.0 million bpd of closures since 2008, about 800 kbpd of refining capacity has been converted into oil terminal capacity resulting in around 3 million cubic meters of additional storage capacity.

The following table shows the most recent closures and changes:

Table 4

EUROPEAN REFINERY CHANGES 2012

Country

Refinery/owner

Capacity
000bpd

 

Status

Date

Belgium

Antwerp/Gunvor

108

Restarted

May

 

Czech Rep

Paramo/Unipetrol

20

Closed down

May

 

France

Petit Couronne/Petroplus

162

In Administration

June

Berre/LyondellBasel

105

Closed down

January

 

Germany

Hamburg/Shell

110

Convert to Storage

June

Ingoldstdt/Gunvor

100

Restarting

Q4

 

Italy

Gela/ENI

105

closed 12 months

June

Rome/ERG-Total

86

Convert to storage

Q3

Falconara/API

83

closed 12 months

December

 

Switzerland

Cressier/Vitol

68

Restart

August

 

United Kingdom

Coryton/Petroplus

220

Convert to storage

July

Changes

What has brought about this change in refining margins and utilisation? The main reason is the reduction in demand:

Fig 1 shows the changes in demand for ground transportation fuels; this being the most significant market for petroleum products, which is impacting on refinery revenues. Jet fuel is another, but that is another story.

Table 5

It can be seen that in Europe and Eurasia the demand for gasoline has been falling steadily whilst diesel has been growing, however the total demand shows a reduction since 2006.

The actual reduction in demand is 1.3 million bbls per day. This reduction in demand is continuing and we will deal with demand forecasts later.

However there has also been an increase in capacity which has reduced refinery utilisation. As with all capital intensive industries if the plant is not run at full capacity the unit costs increase dramatically.

Table 6

WORLD REFINING CAPACITY

000 bpd

2009

2010

2011

Expected

2015

Consumpt.

2015
% of total

2009
% of total

Change

Europe & Eurasia

24,624

24,435

24,570

510

25,080

14,814

24.99%

27.08%

-2.08%

Africa

3,012

3,192

3,317

770

4,087

3,336

4.07%

3.31%

0.76%

Middle East

7,819

7,923

8,011

1,235

9,246

8,076

9.21%

8.60%

0.62%

Asia Pacific

27,685

28,405

29,135

2,820

31,955

28,301

31.84%

30.44%

1.40%

N America

21,127

21,008

21,382

420

21,802

23,156

21.72%

23.23%

-1.51%

S & C America

6,679

6,653

6,590

1,595

8,185

6,241

8.16%

7.34%

0.81%

Total

90,946

91,616

93,005

7,350

100,355

83,924

100.00%

100.00%

2.80%

Source: BP Statistical review 2011

The table 6 above shows the effect of new capacity and it is also compared with demand for 2011. It can be seen that the spare capacity at present is almost 9 mbpd and demand will have to increase by a further 16.4 mbpd if spare capacity is to be fully utilised. I think it would take a brave man to forecast that this increase is likely to be maintained.

We have calculated that the demand growth by 2015 will reach 85.2 mbpd, but this leaves an amazing large gap in spare capacity of 16.4 mbpd. The consequences of this spare capacity will be more closure of old inefficient and high cost refineries.

The most likely target for refinery closures has to be Eurasia with some 10 mbpd of spare capacity.

We have looked at demand growth in the world and the following table 7, shows that the even without allowing for the unknowns, such as the penetration of hybrids and liquid renewable fuels, the growth in Europe and Eurasia is not going to reduce the surplus refining capacity currently installed.

Table 7

PROJECTED DEMAND GROWTH AT 20% GDP EFFICIENCY

GDP%

20%

2012

2013

2014

2015

Europe & Eurasia

1.5%

0.30%

14,858

14,903

14,948

14,993

Africa

2.5%

0.50%

3,353

3,369

3,386

3,403

Middle East

2.5%

0.50%

8,116

8,157

8,198

8,239

Asia Pacific

5.0%

1.00%

28,584

28,870

29,159

29,450

N America

3.0%

0.60%

23,295

23,435

23,575

23,717

S & C America

2.5%

0.50%

6,272

6,304

6,335

6,367

Total

84,479

85,038

85,601

86,168

Terminals

The conversion of redundant refineries to oil terminals continues apace and the effect of this, is that the terminals that have been converted usually have larger tank sizes and deeper water jetties. This in turn facilitates the importation of ever larger parcels of clean products. We are all aware of the export of heavy fuel from Europe/Carribean to the Far East in VLCC’s but we are now starting to see the importation of larger, up to Suezmax, size parcels of clean fuels being imported into Europe. It is expected that European product imports from the Middle East will rise to about 160 million tonnes by 2015 from around 120 million tonnes today.

This will have the effect of increasing the scrapping rates for VLCC and reduce the demand for new buildings, but will also keep rates depressed for some time to come.

As this process accelerates it will interesting to watch what the Governments of Europe will do when the concept of strategic interest begins to be debated.

Regulation

One of the major issues that refineries in the developed world have to face is regulations. These regulations range from:

Health and Safety.

Emissions Controls.

Specification tightening.

Labour laws.

Human Rights Laws.

Land Pollution laws.

And a host of others.

These regulatory restrictions cost refiners anywhere up to $2.00 per bbl, however it is unlikely that these costs can be recovered in the marketplace as the competition will not necessarily be confined to refineries within the same regulated geographical area. Due to the nature of free market arrangements through organisations such as the WTO and the European Union, no anti-competitive tariff can be imposed. Thus imports of clean fuels from places such as the Mid East Gulf and India can be imported unrestrictedly if the excise duty is overcome; this is relatively small in most cases.

The tightening of specifications is a major cause of cost to a refinery. Stringent limits on sulphur, benzene and others have required a substantial investment in refinery equipment and furthermore the reduction of sulphur and benzene results in even greater use of energy. This gives rise to more emissions of CO2, Nox, and SOx. All these pollutants are regulated and thus more cost is incurred in containing them.

The latest IMO regulation that bunker fuel in Emission Control Areas are subject to a maximum limit of 0.1% sulphur content is likely to have a major impact on refining margins.

Up to now bunker fuel has been the main outlet for heavy fuel production in European refineries. This limit is unlikely to be achieved by desulphurisation of the residual fraction. Therefore it can only be met by increased production of Marine Gas Oil. This is the major constraint on refineries at present and Europe is importing middle distillate, mainly from the FSU but also from India and the Middle East. Any further increase in demand will only exacerbate an already fragile situation.

Competition

Size and efficiency.

Apart from the Russian refineries, there are no truly massive scale refineries in Europe. The large refineries are in the Middle East, The Americas and the Far East. You will note that the largest European refinery is the Shell Pernis facility in Rotterdam at 406,000bpd.

Table 8

Rank

Owner

Location

Crude Capacity bpd

1

Reliance

Jamnagar India

1,241,000

2

Paraguna

Venezuela

940,000

3

SK

S. Korea

817,000

4

LG

Yosu, S Korea

650,000

5

ExxonMobil

Sinagpore

605,000

6

ExxonMobil

Baytown, Tx, USA

563,000

7

SaudiAramco

Ras Tanura, S Arabia

550,000

8

Formosa Petroleum

Taiwan

520,000

9

S-Oil

Onsan S. Korea

520,000

10

ExxonMobil

Baton Rouge, La. USA

503,000

12

Shell

Palau Bukom, Singapore

458,000

13

BP

Texac City, TX, USA

446,000

14

Kuwait Pewtroleum

Mina al Ahmadi, Kuwait

446,000

15

Rosneft

Angarsk, Russia

441,000

16

CITGO

Lake Charles, La, USA

440,000

17

Shell

Pernis, Netherlands

406,000

18

Sinopec

Zhenai, China

403,000

19

Saudi Aramco

Rabigh, S. Arabia

400,000

This gives the clear picture that efficiency and scale are considerable players in the market.

Operating Costs

Size and efficiency generate lowest refining unit cost. This, plus the burden of regulation has been the major cause of the closures of the European refineries. It is axiomatic that within a refining cluster, the refinery with the lowest cost will dictate the margin. With variable operating costs of around $2–3 per barrel for the most efficient refineries, it is clear that this is what is happening and that refining margins are being driven down towards the lowest variable refining cost. Any refinery that now wishes to upgrade, cannot possible recover the capital costs with the current spare capacity in the system.

Demand

We have touched on demand earlier, but this is the critical area for the future direction of refining margins.

Road Transport Fuels

There has been a dramatic change in automotive engine efficiency in the last ten years and it is unlikely to stop here. New technologies are constantly being developed on the Formula 1 circuit. This work has led to VVT, EGR and a whole host of developments driven by the holy grail of increasing MPG or Litres per 100 kilometer.

We have also witnessed the current political obsession with replacement of petroleum with so-called renewable fuels. This is driven by Directives that have as an objective 10% of all transport fuels to be from these renewable sources by 2020. This is only likely to happen in the developed economies, i.e Europe and N. America. However, as we are concentrating on Europe, it will have the largest effect on refinery output.

During the 80’ and 90’s we saw a massive shift from gasoline to diesel in the road transport sector, we expect a similar shift to hybrids in the next two decades.

These will not necessarily be just electric/gasoline hybrids but more significantly we see a shift to CNG/gasoline hybrids. We have already seen a deep penetration of CNG in the mass transit and local Government owned bus fleets in Europe and this will accelerate as new and cheaper sources of gas are discovered.

We do not believe that electric cars are the future. They are simply not flexible enough. In fact on 28 September the FT announced that Toyota had stopped all development work on purely electric cars. Electricity is an energy that is good for transmission but not for traction.

All this activity will have one major effect, which is to change the shape of the barrel and to put more capital expenditure demand on refineries to meet this changed barrel.

Primary Crude Oil Demand

Starting with primary demand for crude oil we have used projected GDP growth and then applied a 20% energy efficiency factor to arrive at primary crude oil demand. Table 9 below shows that growth in crude oil demand may be a lot less than previously forecast, the reason for this is the substitution by gas and alternatives.

Global demand is already tailing off in the thermal demand for oil and this is due to the increased capacity in shale gas and coal. The result has been the collapse in the price of gas and coal.

Table 9

Putting this into numerical context it can be shown that global demand will remain largely flat with most of the growth in demand being in the Asia Pacific region and a corresponding flat demand in the rest of the world.

Table 10

The alternative to capital expenditure in upgrading in Europe is to move refining capacity to where it is cheaper to operate and under less strict regulatory regimes.

Furthermore, as the product tanker and its concomitant reception facilities improve, the economics of refining will be critical in the winner of the battle between long haul crude oil versus product movement from less costly refining centres.

The shift from Europe to the Middle/Far East of refining capacity will also have a major effect on the demand for VLCC’s, with a resultant increase in the demand for Suezmax and Aframax product carriers.

The latest IMO regulations for 0.10% Sulphur content in ECA’s also means that shipping companies are looking for alternatives to heavy fuel oil as a means of propulsion. These alternatives can be LNG and or nuclear. If this comes to pass and we have already seen Shell launch a LNG powered barge on the Rhine, then the heavy end of the barrel will become more distressed than it already is and that would sound the death knell for those refineries without cokers.

The Future

So what is the future for refineries in Europe?

Firstly they are certainly not going to be relieved from depressed margins for some time soon. Even though margins are attractive at the moment, due to special circumstances; refinery fires and the depression of sweet crude prices due to the increase in light sweet increased availability in the US from shale oil discoveries.

If they cannot compete on margins at this level, there will be no investor appetite for further capital expenditure.

The sale or closure of refining and marketing systems by the major oil companies in Europe is a pointer as to where the market is headed.

The predicted pressure point in the future will be crude oil production, not refining capacity. Therefore margins will revert to type.

Refined products deamand may change further if gas makes big inroads into the automotive and marine propulsion industry.

Will the political masters change all this by giving oil refineries strategic protection from imports?

No matter what politics dictates, the economic pressure will ultimately win through as subsidies cannot last forever.

The answers lie in the future but for the time being there is no clear way forward for the European refiners.

April 2013

Prepared 25th July 2013