Friday, 8 November 2013

Europe: Still waiting

2013 has been another difficult year for European refiners with continuing decline in oil demand and weak refinery margins. European countries are still suffering the effects of the recession which has been affecting overall oil consumption. The ‘killer’ combination of weak demand and lack of upgrading capacity leaves many European refiners in a vulnerable position. Petroplus bankruptcy was the prime example of how the prolonged poor performance of the refining sector can affect refiners’ ability to refinance.

European refiners have been struggling to remain profitable responding to the adverse conditions by cutting refinery runs or temporarily or permanently shutting down facilities and delaying investments. Petit-Couronne in France is the latest casualty after a court in France formally rejected the two takeover bids for the refinery, ruling the bids as inadequate. The majority of the refineries that shut down were subsequently sold and converted into terminals and storage facilities. This appears to be the preferred strategy used by companies to save environmental liability costs. On the downside, refinery closures and conversion into terminals are increasing the continent’s reliance on product imports (especially for diesel and jet fuel) and raises concerns with security of supply and exposure to risks of price volatility and high costs. According to the International Energy Agency (IEA), 15 refineries with a combined capacity of 1.7 million bpd have shut down between 2008 and 2013.

The major oil companies always appear to anticipate the downward trends and have been exiting the European refining sector for many years. In the last 5 years BP, Shell, ExxonMobil, ConocoPhilips and Chevron have either shut down or sold refineries in Europe. These companies are now turning 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. As the majors exit the European refining industry, a new model of ownership is also emerging with commodity traders and Asian companies buying refining assets in Europe. Commodity traders have bought European refinery assets with the view of establishing better supply chain strategies taking advantage of their unique knowledge and expertise of the oil markets. Gunvor, in particular, will be using its position as the largest Urals trader in Europe to supply the refineries at the best possible deal. Asian refiners have a different agenda and are purchasing refining assets with the view to positioning themselves in the European markets and acquire market share for their oil exports.

Main threats

Decline in demand
The European refining industry has been suffering from a long standing structural imbalance between supply and demand of oil products for over a decade. Almost all European refineries were configured to maximise production of gasoline in the expectation of high increase in gasoline consumption. In reality, gasoline demand peaked in the late 90s and has been declining ever since.

Reduced US gasoline import requirements
It was not just weak domestic demand which affected European refinery performance during 2012 and the first half of 2013, but also the reduction in gasoline export volumes to the US. US gasoline imports were significantly reduced during the fourth quarter of 2012 and the first quarter of this year resulting from a combination of lower US demand and gasoline imports being replaced by domestic production. US refiners have increased their refining production encouraged by cheaper crude oil from unconventional sources and lower energy costs. At its peak, European refiners were exporting over 400 000 bpd of gasoline to the US, but in the first quarter of 2013 volumes of exported gasoline had dropped to 280 000 bpd. This trend is expected to continue for the foreseeable future as lower gasoline demand due to engine efficiencies and higher US refinery production will continue to displace even more European gasoline exports. The proposed expansion of the Colonial pipeline linking the US Gulf Coast to the US East Coast will reduce the need for European imports of gasoline into the US East Coast. This will seriously undermine the European refining sector as many refiners have boosted their margins in the past by exporting gasoline to East Coast of the US.  The US shale revolution has given US refiners a new lease of life providing cheaper crude oil and significantly lower energy costs thanks to historically low gas prices.

Environmental compliance
Compliance with multiple European environmental regulations is undermining competition in the European refining sector versus other refining centres not affected by similar regulations. Several layers of environmental regulations as well as constant changes in policy by the European Commission (EC) have generated a great deal of uncertainty which at the same time has led to an increase in the total costs of environmental compliance.

Threat from Asia and the Middle East
New production coming out of the Middle East and Asia will further undermine Europe’s competitive position. 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 States and Indian refiners for market share in Africa. 

Large refinery projects in the Middle East are coming on stream in the next few years and these projects will have a significant impact not just on the region supply and demand balance but also on the global refining industry.

The rapid refinery expansion in Asia and in particular in China and India is changing the refining ‘landscape’ in the region.

Some win, some lose
The weakness of the European refining sector will in the long run benefit refiners in Asia and the Middle East and even Russia. While 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 bbl of crude. This is achieved through upstream integration and cheaper energy supplies in the case of the Gulf refiners while the economies of scale, high complexity and tax incentives benefit both regions. Highly complex refineries cost more to build and marginally more to run but high complexity enables the newly built refineries in both regions to process the cheaper heavier and sour crudes and achieve considerable lower costs per bbl of product and at the same time produce a higher yield of higher value products, thus further enhancing their competitive advantage.

In 2013 the European refining sector continues to face many difficult challenges and has been under pressure due to weak domestic demand and reduction of exports to the US. The closure of unprofitable refineries has not been enough to offset the overall decline in market demand partly because of the new refinery expansions. As a consequence, European refiners have had to cut their throughputs rates that have had a negative impact on refining margins.

A combination of weak demand for oil products, increase in the price of sweet crudes, high employee wages, costly environmental legislation and competition from other regions of the world had the effect of eroding European margins. Small, low complexity and inefficient refineries have already shut down and other moderate conversion refineries are at risk of closing down in the next few years, if they cannot find the necessary investment funds to improve their technological complexity.

One of the main threats facing all European refiners in the near future comes from the requirement to comply with the IMO sulfur reduction for bunker fuel. A large number of refineries will not be able to comply with this new environmental requirement and some will be forced to shut down. As a result, increasing volumes of distillate will have to be imported into the European region raising concerns about security of supply and further exposure to price volatility.

In this context European refining will remain at the losing end whilst other global refining centres will easily gain access to the European markets and will strengthen their presence within Europe and at the same time will enhance their position as global refining centres of excellence.

The full article can be found in the November issue of Hydrocarbon Engineering

1 comment:

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