INSIGHT: Global refining margins putting pressure on the UK market

07 August 2013 14:31  [Source: ICIS news]

By Cuckoo James

LONDON (ICIS)--This week the chairman of Shell UK forecast oil and gas production will continue in the North Sea for decades to come despite the region’s mature fields, especially after recent tax breaks favouring investment in older fields.

But the country’s policy makers have been keenly reconsidering the vulnerability of the downstream oil refining sector, a weakness which has accompanied slow economic growth and a competitive global marketplace.

The sale of the Coryton oil refinery in Essex by Swiss owner Petroplus, which filed for bankruptcy in January 2012, and its conversion into a diesel import terminal by Vopak, Shell and Greenergy, has come as a shock to some.

The plant previously supplied 20% of London and the South East’s fuel.

In the wake of the Coryton shutdown, the country's Department of Energy and Climate Change (DECC) ordered an inquiry into pressures on the UK oil refining industry and the implications for security of supply.

The Energy and Climate Change Committee has since then published evidence from several respondents, including key industry players, on major hurdles that could potentially lead to more refinery closures.

The Committee is appointed by the House of Commons to examine the expenditure, administration and policy of the DECC and its associated public bodies.

Refining is a politically sensitive issue for the UK as the need to import fuel could mean higher prices for consumers already grappling with a slow-growth economy.

A major issue highlighted by UK refiners is the high exposure to global refining margins.

Refining is a highly global business. Transporting diesel and petrol on tankers around the globe is only as difficult as shifting crude oil.

And increased global demand for refined oil products has been met by new refineries in the Middle East and Asia – India and China in particular.

Oil major Shell, which gave evidence to the Committee, has suggested that there may now be a refining overcapacity globally, with the excess supply exerting pressure on refining margins around the world.

The rising tide of global supply, and more recently high upstream crude oil prices, has contributed to the UK oil refining capacity shrinking from eighteen refineries in the late 1970s to seven today.

Roger Hunter, supply contracts and negotiations manager at Shell, said: "We exited the UK, and we have exited a number of refineries across the world over the last few years, because we want to reduce our overall exposure to the global refining margin.”

Closing refineries are a major concern. The UK is extremely reliant on many of these products refined from crude. Especially high in demand are petrol - or gasoline - and diesel, which are mainly used for transport. Kerosene is another popular crude product, used extensively as fuel for passenger jets.

In 2012, refined oil products provided around one third of the primary energy used in the UK.

Domestic production has, however, been in decline since the middle of the last decade, and despite lower consumer demand driven by high fuel prices and a slow economy, imports have increased.

Two UK refineries have closed between 2009 and 2012, and the loss of further UK refining capacity could threaten energy security and continue the rising dependence on imports.

Some products already present a high risk to UK energy security, especially diesel and jet fuel.

The UK dependence on imports is currently at 56% for jet kerosene, 48% for diesel and 44% for heating kerosene, according to US-based oil refining company Phillips 66.

Part of the reason behind low margins is wrong product configuration, many argue. UK refineries were built in the 1960s and 1970s, and market leaders back then were confident the high demand for petrol would continue.

But now refineries in the UK are faced with the need to optimise diesel production in line with rising domestic demand if they are to maximise margins and better compete with imports.

The Minister of State for Energy, MP Michael Fallon, said: “Our refineries are petrol-facing, if you like, and not diesel-facing, and although they compete well at the moment in Europe, the long-term trend therefore puts them at a disadvantage.”

Diesel demand is anticipated to increase by approximately 1% per year and petrol demand to in fact decrease by 5-7% per year.

“They are producing too much petrol, not enough high-value diesel or jet and they are less likely to compete with the refineries of the future, and therefore the investment case for investing in them probably will get weaker,” Fallon said.

The mismatch between supply and demand would result in a loss of profitability for the UK refining sector, and consequently loss of investor confidence, the evidence suggested.

Complicating matters is an additional estimated investment of £11.4bn needed to meet UK and EU legislative measures alone in the period 2013-2030.

But despite the negative data, all is not lost, says one of the world’s leading oil majors.

“The UK’s security of supply is ultimately a function of its ability to pull crude and products from the global market, rather than having a set level of domestic refining capacity,” Shell said.

Diesel supply security might not even be a thing to worry about, if it all goes the way social liberal political party the Liberal Democrats would want.

The party has just this week unveiled proposals to ban millions of petrol and diesel cars from UK roads by 2040, and it might become official party policy if it gets enough votes at next month's party conference in Glasgow.

If the Liberal Democrats and their radical plan get a say in the corridors of power anytime soon, the country might no longer need to worry about rising imports or closing refineries.

Or maybe more tax breaks hold the key.

By: Cuckoo James
+44 (0) 208 652 3214

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