THE GREAT LOCKDOWN WILL HASTEN REFINERY INDUSTRY RATIONALIZATION
Slump in margins intensifies pressure, John Kemp writes.
LONDON Coronavirus and the cyclical slump in petroleum consumption are accelerating a long-term rationalization of the global refining industry and a shift eastward in its centre of gravity to Asia.
Refinery margins for making middle distillates such as gasoil and jet fuel have plunged to their lowest since 2009 as lockdowns and recession have cut fuel consumption by millions of barrels per day.
Much of this is cyclical and will unwind if and when the major economies and their fuel consumption recover and stocks of gasoline and diesel return to more normal levels.
But the crisis is compounding the long-term challenge for smaller, older and simpler refineries, especially in North America and Europe, faced with a growing competition from more modern mega-refineries in Asia.
Refinery margins, the difference between the prices at which refineries purchase crude and sell refined products, have historically aligned with the business cycle.
At the top of the cycle, capacity constraints become binding and refiners struggle to make enough fuel, fattening margins. When the cycle turns down, there is too much capacity, and margins shrink.
But the present recession is the worst for nearly a century and the impact has been concentrated in the petroleum-dominated transport sector because of lockdowns, so refiners have faced unprecedented cyclical pressure.
In April, U.S. refiners were forced to cut their crude processing by 20 per cent compared with the previous five-year average as fuel consumption slumped, and refiners in other parts of the world have faced similar problems.
Pressure on margins has been particularly acute in this instance, however, because the expanded OPEC+ group of major crude exporters and U.S. shale producers have also cut their output of crude oil.
Consequently, the production-consumption balance for crude has tightened faster than the balance for fuels such as gasoline and distillate. Crude stocks are falling while fuel stocks remain bloated for the time being.
Refiners are now being squeezed on both sides of their business: there are too many refineries chasing not enough crude (raising input prices) and too few fuel users (depressing output prices).
The result is low crude processing rates, lots of idle capacity, poor margins and poor profitability across the global refining sector.
The Great Lockdown has been a common shock felt by refiners around the world, though some sectoral end-users and major economies are emerging faster than others.
But the slump in margins and profits is intensifying the competitive pressure on the oldest, smallest and least complex refineries, mostly in Europe and North America.
Fuel and petrochemical markets around the North Atlantic area have become mature while growth has shifted to western, southern and eastern Asia.
China’s oil consumption has been increasing at a compound rate of 6 per cent per year for the last quarter of a century while India’s has been rising at almost 5 per cent and the Middle East has seen 3 per cent growth.
In contrast, North America’s consumption has risen by just
0.4 per cent per year since 1995 and Europe’s consumption has actually fallen at an average rate of 0.2 per cent.
Total oil consumption in Asia and the Middle East surpassed consumption in Europe and the Americas for the first time in 2018 and the gap has widened in 2019 and 2020.
To satisfy growing consumption, new refineries have been built across Asia, while refineries in Europe and North America have seen little new investment (with the exception of export-oriented plants on the
U.S. Gulf Coast).
The new generation of refineries in Asia are larger (able to achieve economies of scale) with more modern and sophisticated equipment (able to process poorer quality, cheaper crudes and produce more high-value products).
The new mega-refineries in Asia are therefore more price competitive than their older counterparts in Europe and parts of North America.
European and some American refineries have become reliant on the locational advantage of being near end-users as well as crude sources such as the North Sea and U.S. shale.
But the crude market is growing more global, even in the case of shale, as a result of U.S. exports. Fuel markets remain regional; nonetheless inter-regional shipments are becoming more common, intensifying competition.
Asia’s mega-refineries dominate their own fast-growing markets; are increasingly competitive in third markets such as Africa; and are even penetrating the home markets of the European refiners.
Margins and profitability are under structural as well as cyclical pressure in Europe and parts of North America and their problems are not easy to reverse without expensive investment, which has not been forthcoming.
European refineries in particular are struggling to attract investment because their market is saturated and could shrink if policies to encourage widespread uptake of electric vehicles are successful.
Europe’s refineries are hamstrung by their small scale, aging equipment, lack of a locational crude advantage and a shrinking home market. While some will cling on by cutting costs, others will have to close.
Coronavirus and ensuing recession have worsened these long-term structural problems and are likely to accelerate the conversion of several European refineries into import terminals and tank farms.