Energy and Climate Change CommitteeWritten evidence submitted by Christopher Fox

1. The secure supply of energy at competitive prices is of vital importance to the economy of any country. In the UK the supply of gas and electricity (and in the past, coal) has always been considered of strategic importance and not considering liquid hydrocarbon fuels in a similar vein would be perverse. Liquid hydrocarbon fuels, which are almost entirely produced in oil refineries, are predominantly used as transport fuels and non-availability of even a small portion of demand will have a major impact on the functioning of the economy and the ability of the population to engage in many of their normal activities. Supply of transport fuels is relevant to almost all economic activities and to the general welfare of the population.

2. It is clearly evident from a number of past events that the short term demand for liquid hydrocarbon supplies is inelastic and hence any reduction (or expected reduction) in supply, including supply of refinery feedstock (crude oil) leads to a rapid increase in price.

3. In the UK there are presently seven oil refineries which together are able to provide around 90% of UK demand for refined liquid hydrocarbon fuels. The balance is made up by imports, including import of bio-fuels. In the last decade, the demand for refined product has declined slowly by around 1% per annum. Further detailing of this overall demand and supply is essential in order to understand potential future needs in regard to securing supply. UK refineries presently have:

A considerable surplus in capacity (vs. UK demand) for the production of Gasoline. At present approx. 30% of production is exported mainly to North America.

A deficit in capacity (vs. UK demand) for the production of Diesel fuel. The deficit (approx 10%) is imported from continental Europe and the Middle East.

A substantial deficit in capacity (vs. UK demand) for production of Jet/Kerosene fuel. Approx 30% of demand is imported mostly from the Middle East and Asia.

4. In Europe generally there is presently no overall deficit in refining capacity, there is however a broadly similar imbalance in that there is a substantial surplus capacity for Gasoline production and a substantial deficit for production of Jet/Kerosene.

5. For the last two decades profitability of UK refineries has been poor, with only modest profits in good years offset by losses on poor years. This, together with declining overall demand and the belief that this situation will continue, has led to a significant reduction in the number of refineries (and hence capacity) in the UK. Those remaining have seen only limited investment in modernisation and upgrading to meet mandatory tighter fuel specifications. There has been very little investment aimed at meeting the increasing demand for Diesel and Jet/Kerosene fuels. Simply there has not been enough profitability in the business to justify any major discretionary investment given that the oil companies and other fuel distributors are able to import fuels at fully competitive prices.

6. Overseas refineries, especially in the Middle East and Asia, are generally modern and therefore more efficient. Growing local demand allows for their continuing upgrading and the construction of new refineries. Especially in the Middle East, governments ensure a favourable financial regime both in terms of project financing and subsequent taxation, ensure provision of very low priced energy to the refineries and actively support export of refinery products as a means adding value to their crude oil. Additionally, refineries in the UK (and parts of continental Europe) face tougher environmental regulations and charges.

7. In the period up to 2030 most forecasts indicate that for the UK (and elsewhere) liquid hydrocarbon fuels will remain the dominant source of energy for road transport, though this will include many hybrid vehicles. There is however some scope for the use of gas (CNG and LNG) for the powering of large commercial road vehicles and small scale trials are already in progress. For aircraft fuel there will be negligible use of other fuels. UK Rail transport will become progressively more electric powered and there is potential for some shipping to use LNG as fuel. It must however be noted that rail and shipping represent only a very small portion of UK transport fuel demand. Fuel efficiency gains will undoubtedly continue, which will offset growth in transport demand.

8. Beyond 2030, it is almost impossible to make any forecasts in respect of road transport as there are so many technologies under development, any or several of which have the long term potential to replace hydrocarbon fuel. However at this time none of them are even close to being commercially attractive other than for some limited very specific duties. All that can be said is that it is more likely than not that a significant portion of road transport will move to alternative fuels in the period beyond 2030. For aircraft fuel any move to alternative fuels will almost certainly be well beyond 2030 as presently there are no alternatives (other than bio-fuel addition) which are even at the demonstration stage.

9. Hence in the period from now to 2030, the prospects for UK oil refining do not appear to be favourable unless steps are taken to significantly improve their financial position. A number of factors are relevant. –

There are many forecasts of future demand with a fairly broad range of outcomes. Overall it would appear that median outcome forecast is for overall demand for liquid hydrocarbon fuels to be about the same as at present. However within this it is clear that the demand for Gasoline will continue to fall significantly, the demand for Diesel will be flat or slightly higher and the demand for Jet fuel will be significantly higher. Consequently the imbalance between current UK refinery product capacity and product demand will become more pronounced.

The ability of UK refineries to export Gasoline mostly to North America will become ever more difficult as demand there falls due to rapid improvement of fuel efficiency of cars in that area.

All the demand forecasts are subject to numerous variables including but not limited to:

Overall economic performance both in UK and elsewhere.

Cost of liquid hydrocarbon fuels relative to other fuels, as a result of world prices and UK taxation.

Mode shift of passengers from cars to public transport.

Mode shift of freight from road to rail or ship.

Other constraints imposed on use of transport.

Rate of improvement in fuel efficiency of all forms of transport.

Extent of use of liquid hydrocarbon fuels for electricity generation and other non-transport uses.

Extent of use of bio-fuels.

Extent of use by transport of alternative non-hydrocarbon fuels and use of gas (CNG and LNG) as a fuel for large commercial vehicles.

Taxation regime for UK refineries relative to refineries elsewhere.

Emissions regime for UK refineries relative to refineries elsewhere.

Rate of increase of refinery capacity worldwide versus increase in world demand.

10. The changing ownership of UK refineries reflects the fact that the integrated “Oil Majors” all have taken the view that they should focus their capabilities and capital into areas which will provide them with assured future long term profitability, namely large scale exploration and production with refining only in advantaged parts of the world such as the Middle East (favourable energy and feedstock costs) and Asia (rapidly growing demand). As a result refineries in the UK and elsewhere in Europe and North America have either been closed, converted to import terminals or been sold the smaller oil companies who are focussed solely on refining. The smaller oil companies are likely to provide some revival of interest in upgrading their newly acquired refineries as they represent their core business. However these companies, almost by definition, are less financially robust and are therefore limited by their balance sheet, both in the short term and longer term. Hence such companies have a much higher risk of financial distress and even insolvency as was the case with Petroplus which led to the closure of both Teesside and Coryton refineries in the UK.

11. The loss of further refining capacity in the UK will have a number of consequences. These include:

Increased risk of shortage of supply of oil products. This could occur due to a political crisis (especially if related to the Middle East) or a temporary shortage due to refinery outages around the world. Whilst the UK holds some stored reserves it is likely that any disruption extending beyond two to three weeks would require government imposed measures to conserve remaining stocks. It is to be noted that the ability to obtain alternative supplies of oil products is, in case of failure of normal supply, far more restricted than alternative supply of crude oil.

Whilst in normal supply conditions it is probable that the cost of imported liquid hydrocarbon products would be no higher than those supplied from UK refineries, there is, for the reasons stated above an enhanced risk of price spikes in the event of shortages.

There would be a need to increase the level of reserve stock holding as a contingency for non-supply of imports. Simply to comply with existing EU rules would necessitate moving from current approx. 2mth supply to 3mth supply if all products were to be imported. This has a cost in terms of capital tied up.

If all oil products were to be imported, there would be an adverse impact on Trade Balance typically in the range £1–1½. billion. per annum.

If all refineries were to be closed there would be a loss of employment (direct & indirect) probably in the range of 15–20,000.

LPG is a relatively small, but valuable product from refining of crude oil, which is used in industry, transport and for domestic heating. It would be possible to import this, but it would require the construction of additional specialised ship offloading and storage facilities. Ship transportation costs are relatively high and therefore it is almost inevitable that cost to the consumer would rise.

Much of the chemical industry uses certain refinery products as feedstock. In most cases this could be supplied by importing, though this would probably result in some increase in cost which could make UK companies less competitive in world markets. For certain products (eg Polypropylene requiring Propylene feedstock) the unit cost of importing feedstock is likely to be significant to the extent that there is a probability that UK production would cease.

12. There are a number of measures which UK government should consider in order to secure the medium term (to at least 2030) future of existing refining capacity in the UK. Listed below are some possible measures which could be considered. It is unlikely that any one alone would be sufficient to achieve full retention of refining capacity. These include:

Offer soft loans to refineries specifically to invest in processing units needed to increase the proportion of Diesel and Jet/Kerosene product relative to Gasoline. The amount of investment needed would be substantial, certainly well in excess of £1 billion. if a significant step change is needed. It would of course be essential for the recipients to guarantee to produce the additional fuel over a period of years.

Offer soft loans to allow upgrading of existing Diesel production to Jet fuel. Given that Jet fuel is of a very similar composition to Diesel, the cost of required processing units is much less than for conversion from Gasoline production (per above).

Provide incentives for owners of large commercial vehicles to purchase vehicles powered by gas (CNG or LNG) instead of Diesel. Such vehicles are already technically proven and already in use on a limited scale. They presently have a higher capital cost than diesel vehicles but are cheaper to operate and have a significantly lower level of CO2 and other harmful emissions. This would require the establishment of an adequate chain of gas fuel stations around the country, but the scale of this chain can be significantly less than that needed for cars to be gas powered. Also there are issues related to weight of gas fuel tanks on cars.

Extend the existing scheme for purchase of low emission urban buses. Urban buses are particularly suited to use of hybrid power systems which offer fuel savings of 15–20%.

Provide incentives for car owners to switch to gasoline instead of diesel fuel. At present fuel duty on diesel and gasoline for road vehicles is at the same rate per unit volume. However diesel fuel generates approx 15% more CO2 emissions than gasoline fuel on an equivalent volume basis. It therefore may be reasonable to adjust duty rates to provide equivalence based on emissions. This would encourage a switch back to gasoline fuel reversing the trend of the last 20 years and reduce the present imbalance between refinery output and domestic demand.

Ensure that environmental regulations and taxes applying to UK refineries are not significantly more onerous than those imposed elsewhere.

If no steps are taken to retain present refining capacity, then it is almost inevitable that further closures will occur. If this “no action” approach is to be taken, then a contingency plan must be developed in order to minimise the economic and other impacts of closures.

13. A detailed analysis of the issues related to the UK refining sector is provided by the report prepared for DECC by Purvin & Gertz June 2011 “Developments in the International Downstream Oil Markets and their Drivers, Implications for the UK Refining Sector.”

May 2013

Prepared 25th July 2013