Feature article

Geert Van de Wouw of Shell Global Solutions takes a look at the European refining sector

16/06/2007

Hydrocarbon Engineering

Geert Van de Wouw of Shell Global Solutions takes a look at the European refining sector, highlighting some of the key issues the industry is facing

To give an opinion on the European refining market we need to look at its place within a global context. Oil markets have become increasingly integrated and the sector has developed sophisticated means of using trade flows to meet shortages in individual markets, not only regionally but globally.

This global integrated network relies on all of its elements working together to meet the demands of customers and legislators providing products that are at the very heart of modern economies.

The refining business serves markets whose demand is cyclical, and the industry in turn responds and faces margin cycles. Each refiner has to take decisions that are not only right to meet short-term demand but are right for the longer term health of the business. These can then provide a market response that is consistent and sustainable through the highs and lows of the refining cycle.

Run cuts are likely to be needed in downturns in the future as they have in the past. However, trade flows have been developed to plug regional market gaps and dissipate surpluses, which soften the impact of regional supply and demand fluctuations on refiners, not only overall but also by product.

The exceptionally high demand growth in recent years has created a much closer match between global supply and demand. One benefit for the industry is the resultant high margins that have been experienced in refining. This fits with the cyclical nature of the business, and reflects a strong demand particularly for light products, the diminishing spare crude supply and seeing refineries working closer to capacity. 

Figure 1 – Historic perspective for margins and differentials

In this recent period of high margins, trade flows have been working well to relieve the supply/demand tensions that Europe has experienced with growing dieselisation.

With sales of diesel cars continuing to grow, now accounting for 49% of the total European car market¹ and could potentially reach 55% of new passenger vehicles by 2012², Europe has seen gasoline production exceed demand.

To reduce this excess, large gasoline surpluses have been exported to other regions, particularly the US. It is expected that the US will continue to import gasoline, but excess production in Latin America is likely to mean that the Atlantic Basin, as a whole, will have an excess of gasoline sooner than previously expected. Importantly, this is expected to be a long-term effect, as additional industry capacity in the US progressively reduces imports, which will likely bring prices under increasing pressure.

Whilst exports of gasoline continue, Middle East refiners have identified a real opportunity in the European short in gasoil and are increasingly ready to supply product to help to fill that gap.

Beyond Europe’s markets, we are seeing a global refining expansion programme in order to meet increasing global demand. This has to be approached with caution as the refineries take time to come on stream and with the cyclical nature of the business, there is a potential for over-capacity and pressure on margins. National oil companies feature strongly amongst the list of expansion and new build projects, although there is a strong presence from local independents. There is also perhaps the largest wave, since the 1970s, of additional conversion capacity.

The trade flows have helped the industry achieve a much greater balance between local and regional supply and demand at times of exceptionally high demand growth. However, the trade flows, have created an increasingly global market which could put pressure on regional markets in the future, should global demand growth not exceed these global capacity additions which are realised.

Figure 3 – Trade flows ensure the right balance

With this in mind key players in the European market need to show a sustained commitment to Europe to help to ensure the security of supply that customers and governments are aiming for.

Demands on refining

So how is Europe linked to global markets and how do they work together to ensure continued supply?

The problem everybody faces is to accurately predict how quickly capacity additions will proceed. Current plans see the global industry upgrading capacity during the next five years faster than at any time in history. There is a real risk of overshooting – at least in some markets.  However, project costs are escalating as materials and construction resources come under increasing strain to deliver, and this in turn is causing deferral or cancellation of some projects.

Predictions are that within Europe itself there are likely to be differing demands, with light oil products falling off in Western Europe and growth continuing in the Mediterranean and Eastern Europe. Biofuels penetration, increasingly enforced by mandates, is likely to reach 10% in the coming years.

Research from PIRA shows that by 2015, Europe will have flat light product demand and an imbalance of 70 million tonnes per annum (mtpa) length in gasoline and a 25 mtpa shortage of gasoils. 

Taking the macro global level demands, CERA’s views agree with other independent work published in the last year that by 2015 it is likely to grow to between 90 and just over 100 million barrels per day (mbpd).

Helped by the planned distillation capacity increases, 8.5 to 11 mbpd will be added in the same period. The new capacity has a global spread with the Middle East accounting for 36%, India 19%, China 18%, Americas (primarily the US) 21%. Europe, however, is likely to account for just 6 %, or some 500 thousand barrels per day. If expansion in the Middle East outstrips demand growth east of Suez, European markets will have to adapt as trade flows work to dissipate any excess product. This is particularly true if new refining assets are fully utilised by refiners, who will be keen to recoup their substantial capital investment as quickly as possible.

The challenges for European refiners also need to be seen in the context of the outlook on crude supply and where that supply is sourced. Currently, crude primarily comes from West and North Africa, Latin America, the Middle East, the Former Soviet Union (FSU) as well as North West Europe.

Within Europe, it is acknowledged that North Sea supply is going to significantly reduce. However, there are differing opinions of anywhere between 20 and 50% on the rate of that decline, against 2004 production levels, particularly after 2010. This has a material impact on forward planning for crude supplies and refining capacity.

Figure 5 European dependence on North Sea Crude

Figure 7 – Demand forecasts vary

CERA sees output down by 2010 to some 5000 kbd from 6500 kbd whilst PIRA forecast sees a reduction of 500 kbd. Wood Mackenzie is the most pessimistic - a reduction of 1500 kbd. Looking further forward to 2015, PIRA is the most optimistic. It has built in some ‘yet to find’ growth and sees an overall reduction of 1200 kbd – around 20% decline compared with 2004. Wood Mackenzie sees a fall of 2700 kbd, a highly significant 50%.

However, as the North Sea crude supply declines, supplies of crudes with similar bulk properties are coming from a range of sources in West and North Africa and FSU.

With the decline rate of the North Sea supplies being something of an unknown quantity, refiners may have to find replacements quickly.

Once supply is secured, and irrespective of supply developments outside the region, what will happen to the regional demand for product? While there is broad agreement that demand will continue to grow for total European oil products, at least for the next few years, the detail of demand forecasts varies.

It is likely that regional mogas oversupply could double by 2015. This is due to a falling demand caused by continued dieselisation and new elements, such as biofuels coming to the market.

Although refinery responses with investment in current technologies might succeed in containing the mogas length to its current level in Europe, reductions in US imports mean that it is unlikely to be sufficient.

Whilst current European production would increasingly be unable to meet Europe’s total diesel/gasoil needs, planned capacity expansion together with increases in biofuels and fuels from the Gas-to-Liquids technologies will mean that it is more closely balanced.

The impact of biofuels to manage greenhouse gas (GHG) emissions is an issue that is vexing refiners. It is a constantly developing product and the market to supply it is being driven by mandates laid down by EU legislation. The impact on road fuels is that from the start of 2009, fuel suppliers have to monitor and report on the GHG (Greenhouse Gas Protocol) and from 2011 until 2020 a 1% every year reduction in GHG emissions has to be achieved.

Although refiners are able to choose the crude they process, there is little flexibility in the total crude supply available to the EU under reasonably economic and secure terms. This does make it difficult to achieve an overall emission reduction at a European level by differentiating crudes according to their potential to generate CO2.

Refining processes need to be addressed if the new direct emission standards are to be met. The consumption of energy in the refining process typically represents around 1 to 4 % of the crude itself. Refineries have made great strides in improving their energy efficiency.  Solomon Associates research shows about a 13% reduction since 1990. It is a trend that will continue but not at such a rate as improvements are likely to be between 5 to 10% in the next 10 years.
 
With crude getting heavier and refiners keen to gain the financial benefits of conversion capacity, refineries are getting increasingly complex, leading to additional energy requirements. CONCAWE estimates that the additional gasoline and diesel/gasoils specification changes have led to a 4-6% CO2 intensity increase, while the evolution in demand, particularly with deepening gasoline imbalances, has led to up to a 10% intensity increase. Solomon concludes that the European refinery intensity will increase by at least 10 – 20 % in the forthcoming decade, more than compensating for the impact of mitigation measures.

Using ethanol blending to decrease well-to-wheel CO2 emissions has also initiated much debate about how to balance the use of foodstock and feedstock for fuels manufacture and the impact that the latter will have on feedstock markets.  This dilemma will not resolve itself until competitive technology is used to develop the second-generation cellulose material based biofuels.

The environmental benefit of ethanol blending will also be felt at the refineries as CO2 emissions actually decrease as gasoline production falls. However, this holds only if refineries can effectively shift production toward other desired products. This does bring with it a need to invest in plant at the same time reduced gasoline production mean falling margins.

Figure 9 – European fuels getting cleaner

Responses to the market

The challenges that the industry faces in some ways are now very different from those of ten years ago. Underpinning it all is the need to secure European supply. Strategies for this not only have to deal with growing regulations but also product complexities.

For instance, with the European shift to diesel looking set to continue, how will that demand be met?  Environmental legislation is changing – and will continue to do so – what needs to be done to meet the new regulations? The qualities of crude are changing; how will that be dealt with?

On the other hand the margin cycle which concerned refiners in previous decades is still relevant today. High crude prices may help to soften the downturn but the industry is not afraid to invest in greenfield capacity and technological advances which to help see an expected capacity creep of about 1% per year. This is the equivalent of adding a new refinery every three years.

To protect themselves against lower margins refiners are wanting to increase conversion capacity but they need to consider whether they want to change the products they supply. For example, are simple refiners prepared to invest in conversion capacity to make products that will find a ready market now but, face an oversupply in a few years time?

Biofuels is expected to continue to assist in reducing CO2 emissions and offer refiners new production opportunities. However, if direct emissions in refineries need to be improved significantly beyond the marginal energy efficiency improvements available, refiners may need to look to CO2 capture. Some refiners will consider the use of technologies, which combine concentrated CO2 production and the increase of refinery complexity such as gasification. Certainly, all refiners need to be aware of possible regret investments, which may hinder their long-term development.

Selective investment needs to be taken so that it offers flexibility and responsiveness to the customer, government and societal needs and aspirations whilst, at the same time, recognising that the business is cyclical. This in itself brings its own set of business responsibilities.

While the security in the supply chain is only as strong as its weakest link, unplanned downtime in refineries is a major value driver or value destroyer especially when margins are high. Asset integrity will remain a management prerequisite to ensure that maintenance programmes seek to minimise unplanned downtime, which can have an impact on the whole supply chain. The challenge remains to do this throughout the margin cycle as costs come under increase pressure in the coming years and refiners experience escalating operating and project costs.

With all the issues that are facing European refiners the one thing that can be said with any certainty is that the future is an uncertain place with all the challenges in terms of the environment, new legislation, ensuring continued crude supplies as well as changing market demands.

The refiners that are likely going to succeed are the ones who maintain a global perspective on supply and demand so that they are geared to meet different market needs and ensure that the supply chain is optimised and can manage change effectively.

It is a fascinating time to be involved in refining as legislative changes, developments in fuels and new fuels are all vying a place on the agenda.

Ends

¹ Figures from Pricewaterhousecoopers New Car Price Index Feb 2006.
² CONCAWE