The new global refining centres
Why the refining shift from West to East is taking place
Luisa Sykes, a Senior Consultant with Euro Petroleum Consultants [EPC] explains why the refining shift from West to East is taking place
The world refining centre is shifting from West to East after more than a century of Western dominance. The Middle East and Asia-Pacific are becoming prominent refining centres with a substantial number of new refinery projects and refinery expansions scheduled to come on stream in the next few years.
According to the International Energy Agency (IEA), Asia will account for 60 per cent of the global increase in crude distillation capacity by 2018, whilst the Middle East will account for 22 per cent. The total world refining capacity, according to the IEA, is estimated to reach 106 million barrels per day by the end of 2018 and 60 per cent of the refining capacity will be in non-OECD countries.
The expansion of the refining sector in these two regions can be explained by a combination of interlinked factors, ranging from high growth in fuel consumption, easy access to capital markets and easy access to crude supply.
In addition, refinery investments are motivated, in many cases, by the need to replace costly imports with domestic production, in order to reduce the government’s ‘bill’ of fuel subsidies which are still the rigour in many of the Middle East and Asia countries.
The shift of the refining centre from West to East has to be analysed in the context of the region’s economic growth and the global changes taking place in oil markets. The demand for oil products in the mature oil markets of Europe and USA remained flat leading up to 2008 and has been in decline ever since, with the recession causing considerable demand destruction.
Whilst US refiners have been able to cope with the fall in demand, the US industry has been supported by cheap oil from unconventional sources. However, European refiners have been struggling to remain profitable, responding to the adverse economic conditions by cutting refinery runs or temporarily or even permanently closing down facilities and delaying investments.
Over recent years, Europe has seen the closure of the Italian refineries in Cremona and Roma, Harburg and Wilhelmshaven have been closed in Germany, the French refineries of Dunkirk, Reichstett and Petit-Couronne have all been forced to close their refinery gates, in the UK Teeside and Coryton have stopped production whilst the Petrom Arpechim refinery in Romania has also been closed.
Whilst European refiners continue to struggle, refiners in the East appear to be prospering. Middle East and Asia refiners can obtain competitive advantage relative to their European counterparts on the basis of lower processing costs per barrel of crude oil.
This is largely achieved through upstream integration and cheaper energy supplies, in the case of the Gulf refiners, and the economies of scale, high refinery complexity and tax incentives benefit both regions.
While highly complex refineries cost more to build and marginally more to run, high complexity enables the newly built refineries in these regions to process heavier, cheaper crudes and achieve considerably lower costs per barrel of product and at the same time produce a higher yield of greater value products, further enhancing their competitive advantage.
Relatively easy access to funding for refinery projects in the Middle East and Asia are also important factors and help explain the large number of projects currently underway in the whole region.
In Asia, the faster growth in the consumption of oil products renders the funding of refining projects significantly more appealing and easier to obtain. In contrast, refiners in the West typically struggle to attain suitable finance for their refinery investment projects, within the context of poor refinery margins and because of a general decline in oil demand within the OECD countries.
The situation could not be more different in the East, demand in the Middle East and Asia has been growing very strongly over the last several years, in particular Saudi Arabia, China and India have average growth rates of 6, 5.6 and 4.4 per cent respectively and the expectation is for this growth rate to continue to be relatively strong but at slightly reduced levels.
It is not surprising that the majority of refinery expansions and new builds are occurring in those countries. According to the International Monetary Fund ‘IMF’, China’s economy is forecast to grow at an average of 8 per cent per annum, between 2013 and 2018, whilst India and Saudi Arabia are forecast to grow at a slightly lower but still very impressive rate of 6.55 and 4.3 per cent respectively through the same period.
In the context of such high economic growth, oil demand is expected to continue to be strong in these countries, and to meet such high level of oil demand, a substantial level of refinery capacity needs to be built to accommodate the future forecasted demand.
Several new large refinery projects are either being completed or at various stages of planning and construction in the Middle East and Asia. The question being asked by many is “Are these refinery projects adequate to meet the forecasted demand or are they going to be in excess of requirements?”
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Impact of new capacity increases in global markets
The large volume of new refining capacity coming on stream in Asia and the Middle East will change the supply and demand balance in the whole region and will make a significant impact on other regions. Organization of the Petroleum Exporting Countries ‘OPEC’ estimates 7.2 million barrels per day of new crude distillation capacity worldwide will be added over the next 4 years.
Two-thirds of the new investment is planned to occur in China, India and Saudi Arabia. As indicated in Figure 1, China will take the lead, with an estimated capacity increase of 2.2 million by 2016 and an additional 2.8 million barrels per day coming on stream by 2020.
India plans to add another one million barrels per day of refining capacity by 2016 and at least another one million barrels by 2020. Several large refinery and petrochemical projects are scheduled in Saudi Arabia, Kuwait and the UAE which would add at least another 3 million barrels per day of capacity over the next 8 years.
These large scale Middle East refining and petrochemical projects will be targeting export markets in Asia as well as the Western markets of Europe and North America. These new supply outlets will intensify traditional trading flows across the globe, and it is expected that some new ones will be established.
Jet fuel exports from Asia towards Europe are expected to increase, with diesel export trade likely to be firmly established from Asia and the Middle East into Europe, whilst fuel oil will continue to flow out of Europe towards the East.
The rapid increase in refining capacity within a historical short time frame is likely to create temporary imbalances between supply and demand in the regions and to a certain degree this is already happening in China.
The economic slowdown in China led to lower domestic fuel consumption, with growth down to 4.8 per cent in 2012 from 5.2 per cent in 2011 and 12.7 per cent in 2010.
As shown in figure 2, the lower domestic consumption has resulted in an excess of supply which it had to be exported.Currently, China has been exporting on average 90,000 barrels per day of diesel and 135,000 barrels per day of gasoline whilst still importing substantial volumes of fuel oil. The country is expected to continue to be a net exporter of products over the short term until domestic demand catches up with the newly installed capacity.
The slower growth in domestic fuel consumption in China is also motivated by the on-going effort to improve conservation and efficiency (to meet the five-year plan requirements), however these efficiency drives will be partly offset by the Chinese government’s desire to build strong strategic reserves.
Despite the slowdown in China’s domestic markets, it is still expected that the forecasted increase in oil product demand within China will soon surpass the installed capacity by as early as 2016, (as illustrated in figure 3 below).
It is forecasted that China will be importing 1.3 million barrels per day of oil products, assuming a domestic oil demand growth of 5 per cent per year and a refining capacity increase of 2.2 million barrels over the next 4 years.
India will continue to be a net exporter of oil products. Private companies such as Reliance and Essar will continue to prioritise exports over selling into the domestic markets, since these exports are more profitable, due to the system of oil product subsidies imposed within the Indian domestic markets.
The Middle East will remain a substantial net importer of products until 2017 when the new refineries in Saudi Arabia, Kuwait and UAE will start up. Saudi Arabia is expected to reduce gasoline imports by 50 per cent following the Jubail refinery start-up, which is planned at the end of this year.
It is expected that Saudi Arabia will achieve further reductions of gasoline and diesel imports post2017, when the two large Jazan and Yanbu refineries come online.
As these new Saudi Arabian refineries will most certainly be targeting the more profitable exports markets, the kingdom will continue to import oil products from other refining centres.
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Intense competition for market share
Over the medium term there is a potential risk of refinery overcapacity built in the two regions between 2016 and 2020 when the bulk of the refinery projects will be completed and brought on stream. This will however be a temporary problem, as long term the forecasted oil product demand is expected to outstrip the new expected capacity increases.
The serious threat is not a regional imbalance between supply and demand, but a problem of future competition between Gulf refiners and Indian refiners for a share of the global markets. Middle East refineries are being built to target export markets placing them in direct competition with Indian refiners.
Temporary refinery overcapacity and excess product supply will exacerbate the problem and lead to intense competition between the refiners in the Gulf and India, as the two refining centres focus on export markets. This will affect profit margins and put less efficient refiners under extreme financial pressure.
Gulf refineries will also have to look for new markets in the Mediterranean basin, USA and Africa, placing themselves in direct competition with European refiners.
The system of domestic fuel subsidies currently in operation in many countries of the Middle East and Asia make the domestic markets less appealing and less profitable and therefore refiners in the regions will turn to export markets for higher financial rewards.
Saudi Arabian refiners are likely to adopt a similar strategy and will be keen to explore and use their competitive advantage in the global markets. Saudi Aramco strategy to seek joint venture partnerships with International companies as well as Chinese National oil companies appears to serve that purpose.
Indian refiners will already feel under threat by the imminent start-up of the new Jubail refinery, as they face the prospect of losing a significant portion of the Middle East oil products market and at the same time having to compete with a refinery of superior complexity in the global markets.
This summer Saudi Arabia will import around 290,000 barrels per day of diesel and 150,000 barrels per day of gasoline and a significant volume of that product will come from India.
The growing competition from global markets will be fierce and Indian refiners will be further undermined by the competitive advantage that the Gulf refiners will be able to gain from access to cheaper oil through upstream integration and favourable geographical location.
While Indian refiners will feel under threat from Gulf refiners, the market most affected by these regional developments will be Western Europe.
In the coming decades, there will be one important question on everyone’s mind: Can refiners in Europe compete with such large scale low cost refineries of the Middle East and India?
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Competitive threat for European Refiners
The European refinery sector is still the largest in the world with 23.9 million barrels per day, representing 26 per cent of world refining of capacity. However, the European refining position is being eroded by poor margins and a major mismatch between supply and demand. Refiners in Europe produce excess gasoline which is exported mainly to the USA Atlantic coast.
However, reductions in USA import requirements are placing European refineries under more additional pressure to find new markets. European refiners not only face the prospect of losing market share in North America but also face the challenge of having to compete with Gulf refiners and Indian refiners for market share in their alternate market of Africa.
European refiner’s competitive position continues to be undermined by reduced exports to the USA, compliance with strict European environmental regulations and continued weak demand for domestic oil products.
European refiners are stuck in a vicious circle of needing to invest in bottom of the barrel upgrading facilities, but not being able to generate enough returns to justify such investments.
The European refining industry will have to undergo a period of restructure with poor performing refineries being forced to close as it becomes increasingly more difficult for them to find the investments and finances necessary to stay in business.
In Europe the most determinant factors contributing towards refinery survival will be scale, location and level of complexity. European refiners enjoying a competitive advantage based on these factors will be significantly better placed to continue operating in spite of the current weak margin environment.
Small and low complexity and low conversion refineries will be at risk of closure as they are unable to compete with their much larger competitors and will be unlikely to be able to justify costly upgrading investments.
As the European refining industry is declining, Asia and the Middle East is expanding and positioning themselves as prime refinery centres with a competitive edge and the ability to dominate the global refining industry.
Russia is also positioning itself to become a prominent exporter of oil products. The Russia refining industry is the third in the world only behind China and the US but has for many years been undercapitalized.
The situation will change in the near future with major upgrading projects taking place across Russia. Russia will prioritise the export of diesel and heating oil and export logistics are being expanded and improved. The expected increase of diesel exported from the Russia ports will also affect future Asia and Middle East diesel trade flow to Europe.
Role of the National Oil Companies and Joint ventures in the Refining Industry
There are two aspects of significant in the context of refinery expansion in Asia and in the Middle East regions; the first of these is the role played by the National oil companies (NOC’s) and the second is the increasing significance that joint ventures are playing in refinery projects.
The NOC’s in many countries of the Middle East and in China are responsible for approximately 90 per cent of all refining investment, but these NOC’s are also frequently seeking partnerships with International oil companies to strengthen their competitive position in refining markets and at the same time share in the risks associated with building such world scale facilities.
The joint ventures Saudi Aramco are setting up with Chinese Sinopec and with International companies are perfect examples of strategic alliances to strengthen corporate expansion objectives.
In the refining sector, the Saudi Aramco joint venture with Total at the Jubail refinery and the joint venture with Chinese Sinopec in the Yanbu refinery project (YASREF) illustrate how the model can be of mutual benefit for the companies involved in terms of sharing risk and accessing markets.
The major oil companies always appear to anticipate the downward trends and have been exiting the European refining sector for many years. Since 2003, Total has slashed its refining capacity on the European continent by 24 per cent, while Royal Shell and BP have reduced their by 40 per cent.
These companies are now turning their attention to the Middle East and Asia in search of more lucrative deals in the downstream sector of the industry, taking advantage of the industry boom in the two regions. A similar strategy is being carried out by Saudi Arabian and Indian refiners but this time in reverse, by aiming to win market share in the West.
Indian refiner Essar has bought Stanlow refinery in the UK, with the aim of obtaining a foothold in the UK market and at the same time gained access to additional financial funding by becoming quoted in the London stock exchange. Saudi Aramco moved into the USA refining sector by purchasing the three Motiva refineries, in partnership with Shell.
These alliances are established to win market share and consolidate their positions in the global refining markets.
The emergence of both Asia and the Middle East regions as exporting refining centres marks a fundamental shift in global refining, from being predominantly based in the West to increasingly being expanded towards the East, in order to take advantage of high oil consumptions in those regions.
While the substantial investments in refining capacity does not appear to create a long term overcapacity problem, the export strategies adopted by the refiners in the two regions will undoubtedly lead to intense competition for global market share and will undermine less efficient refiners in all areas of the globe, but particularly those based in the West.
As export markets are estimated to continue to be more profitable for Eastern refiners than home domestic markets, Eastern refiners will be unlikely to want to switch to selling into their own domestic market, unless there are significant changes in the system of domestic fuel subsidies within their own countries.
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Europe’s refining sector trudges slowly back towards the dark ages
Europe has shut down at least 1.7 MMb/d of refining capacity in the last five years as the economic recession and new projects in the Middle East and Asia have cut into its traditional export markets.
According to an IEA report, refinery utilisation in Europe is down 75%, and the future does not look much brighter. Since 2008, 15 European refineries, representing 8% of the continent’s capacity have been closed.
According to a report by The Wall Street Journal, European demand for gasoline has fallen 17 per cent over the past five years. Michel Bénézit, president of Europia, a trade association for Europe’s refiners, says that the refining sector would need to invest $21 billion.
In a seperate article published by the journal, Pedro Miras, chairman of Spain’s emergency oil stockholding agency, Cores, and chair of the International Energy Agency’s standing committee on oil emergency questions, says the closures “could affect security of supply, not today, but in the long term.”
European concerns came full tilt when Petroplus, one of the largest independent refiners in Europe, filed for insolvency at the beginning of this year.
“We were ultimately not able to come to an agreement with our lenders to resolve these issues given the very tight and difficult European credit and refining markets,” said Jean-Paul Vettier, chief executive of Petroplus. The company had committed a total of $1.75 billion of debt that matures from 2014 which it would be unable to pay without lending from European banks.
“The European reﬁning industry has gone through numerous cycles, but this time many of the changes are likely to prove permanent and we expect the current trends of falling demand, rising imports, increasing European legislation, growing competition from emerging markets and eroding margins to continue,” says Michiel Soeting, Global and European Head of Energy and Natural Resources at KPMG.
But Soeting also points out that the European downstream sector might have some hope. Petrochemical demand is expected to continue growing in the future, driven by Asian demand, but more interestingly, upgrades and improvements are currently inexpensive and could help position a European downstream revival in the long term future.
About the author
Luisa Sykes is a Senior Consultant with Euro Petroleum Consultants [EPC] based in the United Kingdom. Luisa has over 20 years of experience as a consultant and financial analyst for oil and petrochemical projects. EPC is a technical oil & gas consultancy with offices in London, Dubai, Moscow, Sofia and Kuala Lumpur. They are also the organisers of leading oil & gas conferences and training courses. Please visit www.europetro.com for further details.