Global refining poised for massive shake-out: John Kemp
Monday, 13 February 2012 | 11:00
The dramatic collapse of European refiner Petroplus and the decision to sell or close three ageing refineries on the U.S. East Coast is only the first phase of a revolution set to sweep the global refining system over the next decade.
The current system has too many refineries in the wrong places producing the wrong fuels. It will take a massive upheaval to transform it into a system fit to meet the demands of the world in 2020. In the process billions of dollars of obsolete capital investments will have to be written off.
Refineries are being hit by a geographical shift in demand from the advanced economies towards emerging markets in Latin America, the Middle East and Asia. At the same time, the composition of demand is shifting away from gasoline and especially residual fuel oil in favour of middle distillates such as gasoil, diesel and jet fuel.
As a result, too many refineries are clustered around the North Atlantic, the Mediterranean and Japan, producing too much gasoline and heavy fuel oil, and there is not enough refining capacity in emerging markets producing middle distillates.
Location and product imbalances explain the apparent paradox that emerging markets continue to invest in new refineries, while the global market is oversupplied with capacity, and refineries are being shut or sold in the United States and Europe.
According to the 2011 edition of OPEC's "World Oil Outlook" (WOO 2011), the collapse in oil demand as a result of the recession left the global refining system with more than 7 million barrels per day (bpd) of surplus distillation capacity in 2009, the highest level since the late 1980s.
Recovering demand during 2010 and 2011 cut surplus capacity somewhat. But with likely additions in the next few years, OPEC has forecast spare capacity could approach 10 million bpd by 2015 unless some refineries close.
Excess capacity is distributed unevenly. The biggest surpluses are in North America, Europe and Japan, where demand for refinery products has been hit by the recession as well as increased vehicle efficiency and biofuels-blending mandates.
In contrast, emerging markets are struggling to meet booming demand for liquid transport fuels and other products. Countries planning major refinery expansions such as China, India, Brazil and Saudi Arabia are doing so in part to meet growing local demand and remain self-sufficient, according to OPEC.
In other instances, countries that produce heavy crudes, including Saudi Arabia, Russia and Venezuela, are turning to refining so they can export more valuable refined products rather than discounted crude.
The result is a "two-tier" refining industry in which "OECD surpluses are not seen to be deterring projects in non-OECD regions", as the WOO explains. By promoting domestic refining as a strategic objective, emerging markets have ensured refiners in the advanced economies cannot export their way out of the problem.
In some ways, locational shifts are easier for refiners to deal with than the changing composition of demand for specific refined products.
Diesel demand has been growing at the expense of gasoline, in particular in the EU, where governments have used the tax regime to promote diesel because diesel engines are more efficient. But there is a growing recognition the process has gone too far. Growing demand for diesel is no longer compatible with the technical capabilities of the refining system.
Dieselisation has left the EU refining system with a massive imbalance - producing far too much gasoline and too little distillate. As a result, the EU imports increasing quantities of distillates from the former Soviet Union, while disposing of excess gasoline by exporting it to the United States.
These trade patterns are not sustainable. Falling demand in the United States has cut the market for EU gasoline exports. Meanwhile, rising demand for distillates across emerging markets for transportation, heating and electric generators is making it difficult and expensive to continue importing diesel to meet the shortfalls in Europe.
Policymakers have no choice but to find ways to slow the spread of diesel demand and encourage more gasoline use. The EU's proposed new directive on minimum energy taxes would eliminate tax preferences for diesel by shifting taxation from a volume basis (which favours diesel) to one based on energy-content (which is neutral).
The directive itself is unlikely to bring substantial change. The EU's three-largest markets (Germany, France and the United Kingdom) already apply tax rates well above the minimum, so the directive will have no immediate practical effect. Britain has already eliminated preferences for diesel. The biggest impact is symbolic, signalling that the EU will no longer encourage diesel use over gasoline.
Booming demand for diesel at the expense of other fuels is being made worse by tighter regulations on emissions of sulphur and other pollutants from shipping under the International Convention for the Prevention of Pollution from Ships (MARPOL).
New regulations cut the maximum permitted sulphur content of marine fuels from 4.5 percent to 3.5 percent from 2011 and 0.5 percent in 2020. In the meantime, even stricter 1 percent limits are being enforced in two emission control areas (ECAs) covering the Baltic and the North Sea, which will be cut to just 0.1 percent from 2015. Two further ECAs have been proposed for the east and west coasts of North America.
So far, shipping operators have mostly met their obligations by blending high-sulphur residual fuel oil with low-sulphur middle distillates. But that is not an option in the two European ECAs and will become impossible worldwide as sulphur requirements become increasingly stringent.
The only way to comply will be to shift from burning residual heavy fuel oil to low-sulphur marine diesel or (retro-) fit expensive sulphur scrubbing technology to remove emissions from the smokestack. Complying with marine emissions requirements will therefore boost demand for middle distillates at the expense of heavy fuel oil even more in the next decade.
The shifting composition of product demand from the top and especially the bottom of the barrel to the middle poses severe challenges for older refineries that rely primarily on distillation technology.
Distillation is essentially a separation process. It yields fairly fixed proportions of gasoline, distillates and fuel oil depending on the type of crude used. Changing product demand has left distillation refineries making far too much fuel oil (and gasoline) and not enough middle distillate.
The shift favours refineries that also have conversion processes, such as fluid catalytic cracking (FCC) and coking, that are able to break up large hydrocarbon molecules under heat and pressure in the presence of catalysts and thereby cut the output of residual fuel oil in favour of lighter and more valuable products as well as saleable petroleum coke.
North American and European refineries without significant FCC and especially without coking capacity appear doomed. It comes as no surprise that three distillation refineries on the U.S. East Coast are up for sale or closure while conversion refineries on the Gulf Coast still achieve healthy profits.
Between 1990 and November 2011, distillation capacity at refineries on the East Coast (PADD 1) grew from 1.505 million bpd to 1.618 million bpd. But FCC capacity actually fell from 553,000 bpd to 491,000 bpd, and coking capacity was down from a paltry 73,000 bpd to 59,000 bpd.
In contrast, on the Gulf Coast (PADD 3), distillation capacity rose 20 percent to 8.640 million, cat cracking capacity rose 20 percent to 2.552 million bpd and coking capacity surged almost 150 percent to 1.242 million bpd.
The future belongs to conversion refineries in emerging markets. For distillation refineries in North America and Europe, on the other hand, the future is very bleak indeed.