INSIGHT: Refinery shift points to petrochemicals' future

05 August 2011 17:47  [Source: ICIS news]

By Peter Salisbury

LONDON (ICIS)--On Monday, a Mauritius-headquartered firm quietly sealed a deal that, although not momentous in and of itself, marks a sea change for the European refining industry. Petrochemicals producers would do well to learn a few lessons from the sector before it is their turn.

Essar Energy, which normally focuses on the Indian refining sector, bought the UK’s second–largest refinery, a 296,000 bbl/day plant at Stanlow in the northwest of England, from UK/Dutch Royal Dutch Shell.

Essar paid about $350m (€249) for the refinery, a fraction of what it would cost to build a new plant. The UK’s BP received $1.4bn for its last UK refinery in 2007, while several new state-of-the-art 400,000 bbl/day refineries currently being built in the Middle East are setting their owners back in excess of $10bn. Essar’s bill will come in at less than $1bn, even after it has modernised the facility.

“We have acquired it at a very low cost,” said Andrew Turpin, head of media relations at Essar. “There are a lot of refineries for sale at the moment. It is pretty much a buyer’s market.”

The trend is clear: major international oil companies (IOCs) no longer want to be refiners, and are willing to sell their plants on the cheap. And those people with the money and inclination to buy them increasingly come from Asia or the Middle East.

The logic behind quitting the refining business is pretty clear: in Europe in particular, it is a cash-intensive business that offers declining returns. On 29 July, French energy major Total reported that its refining business had returned a net profit of €197m on the back of revenues in excess of €31.5bn, a raw margin of 0.6%.

Similar stories were heard across the business when second-quarter results came out in July and August, with more pain expected in the second half of the year. Volatile oil markets, currency exchange fluctuations and overcapacity – and hence under-utilisation – have all eaten into refining margins.

“There is no doubt about it,” says Paul Hodges, chairman of UK consultancy International Echem. “Refining is in a real mess and I don’t think it is going to get better.”

IOCs make most of their money through their oil and gas exploration and production (E&P) operations, Hodges explains. Given that upstream projects are becoming increasingly complicated and expensive, oil firms have decided to focus their energy, and cash, on E&P.

Unsurprisingly, Total is doing its best to get out of the refining business. In early August, it finalised the sale of its 48.3% stake in Spanish refiner Cepsa to Abu Dhabi government-run fund International Petroleum Investment Company (IPIC) for €3.7bn, which now owns Cepsa outright. The deal meant that the French firm had cut back its refining interests by 25% since 2007. It is likely to sell more assets very soon.

US oil major ConocoPhillips's solution is to spin off its refining business into a separate company, which may or may not be sold on, while another US firm, Marathon, completed a similar spin-off of its refining business in June. The UK’s BP sold its last UK refinery in 2007, and recently indicated that it is also open to selling on its refining business. The company put its Texas City refinery on the market in February.

Should BP offload the Texas City unit, the buyer may well be part of a new breed of refinery owner like Essar or IPIC: small, cash-rich firms from developing countries, or massive state-run firms like Petrochina, which recently bought into 50% of UK-headquartered INEOS’s European refining capacity.

The strategic outlook for the new refinery owners will be quite different to those of the big, (formerly) integrated oil companies, who were trying to get the maximum profit out of every barrel of oil they produced.

For Essar, the idea is to give the company access to the UK market and to manage risks related to its Indian refinery better. The Stanlow refinery has major storage facilities and is linked to the UK oil pipeline network.  “Stanlow gives us optionality to export to the UK,” says Turpin. “If there is surplus in the market in India, we can ship it to the UK.”

IPIC’s strategy is less clear, but the company works closely with state oil firm Abu Dhabi National Oil Company (Adnoc), and is in the process of investing in refining capacity at a string of strategic locations from Pakistan to Jordan, and now Spain.

Analysts with knowledge of the company say that investing in refineries helps Adnoc secure long-term oil demand abroad. Petrochina, meanwhile, just wants access to as much oil and refining capacity as possible.

Thanks to rapidly developing countries in Asia, and China in particular, refineries are being built outside Europe and the US at a rate of knots.

In the Middle East, state oil firms Adnoc and Saudi Aramco are building a total of four major new refineries, each with a capacity of around 400,000 bbl/day.

In China, millions of barrels a day of new capacity are under development.

UK consultancy KBC sees most future refining capacity growth coming from Asia and the Middle East, as both regions struggle to meet demand, while utilisation and capacity in the US and Europe continue to dwindle.

A big question for petrochemicals producers is: "What does this mean for us?"

The idea of integrated companies that produce oil, refine it and use its derivatives to manufacture petrochemicals is over in Europe – Shell and BP sold most of their petrochemicals businesses years ago, while INEOS is happy to offload half of its refining capacity onto a foreign investor.

Only oil- and cash-rich states like Saudi Arabia, or rapidly developing countries like China, are willing to risk major new refining and petrochemicals expansions like the $20bn joint venture between the US’s Dow Chemical and Aramco at Jubail on Saudi Arabia’s Gulf coast.

As Hodges and ICIS' John Richardson point out in their new e-book, Boom, Gloom, and the New Normal, much future demand for petrochemicals will come from where the new refiners are setting up – in the developing world, where growing populations are generating new wealth and demand for basic consumer items.

When Dow Chemical's Andrew Liveris announced his company’s second-quarter results on 27 July, he highlighted just this trend – pointing out that Dow had hit record sales volumes in emerging markets – and added that he expected to see more of the same in the future.

Other petrochemicals producers would do well to pay attention, lest they go the way of the refiners.

($1 = €0.71)

By: Peter Salisbury
+44 20 8652 3214

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