INTERACTIVE: Global refinery earnings could halve by 2035 on climate risk

03 November 2017 11:36 Source:ICIS News

LONDON (ICIS)--An independent think-tank has prompted investors in the refining industry to reassess risks from clean technologies and climate regulations and to be wary of future investments as falling demand for oil could halve the industry's earnings by 2035.

“We consider that prospective investors should be wary of all new refinery investments, whether the build out of greenfield capacity or upgrades and expansions to existing facilities,” the financial think-tank Carbon Tracker said.

The UK-based institute, which published the report titled Margin call: Refining Capacity in a 2°C World, carries out research and analysis on the impact of energy transition on capital markets and the fossil fuel industry.

Their latest study, published close behind a similar study on upstream oil and gas, questions how limiting the rise of global warming to 2°C – dubbed the “2D scenario" - might affect the oil industry’s refining assets up to 2035.

Refineries constitute roughly a quarter of oil majors’ assets, if petrochemicals are included.

Andrew Grant (pictured), a senior analyst at Carbon Tracker who co-authored the report, said to ICIS this week: “A 2°C pathway sees oil demand peaking followed by major rationalisation in the global refining industry. Many players will exit the market rather than haemorrhage cash. Investors should beware that the risk of wasting capital extends to all new investments, including expansions or upgrades to existing facilities.”

The International Energy Agency (IEA) has described as “immense” the challenges to achieving the 450 Scenario under which oil demand peaks in 2020 at just over 93m bbl/d and declines at 1.3% per year thereafter – which is another basis of the study – as “are immense”.

“There is an infinite number of oil demand scenarios. It is not necessary that this scenario might happen, but there is a chance it might happen. And that probability isn’t 0% and so the study looks at what might happen if it does,” Grant said.

The study is agnostic about the stages in which oil demand might drop all the way to 2035 under the 450 Scenario, Grant asserted, but is clear about the downside from a risk management perspective.

Around a quarter of current global refining capacity will shut by 2035 if global warming is limited to 2°C, and earnings and asset values will halve, according to the Carbon Tracker study.

Oil demand will decline by 23% from 2020-2035, thereby forcing refiners to cut run rates.

Once run rates consistently hit 75% of capacity and margins fall to $1.50/bbl, closures – especially for older, simpler refineries and those in OECD nations – will be inevitable, based on historic analogues.

“It is not too surprising really. Refining is a capacity-based business. It is based on processing a certain amount of oil every year. It might be that higher margin refiners are resilient to this. But you could be one of the refineries that get pushed out of the market in a low oil demand world,” Grant said.

Earnings will halve from an estimated $147bn in 2015 as refiners process less oil at lower margins, he added.

“You’ve got this margin effect and the volume effect that will combine to reduce industry earnings over a period.”

The rate of technological change in road transport could also take the industry by surprise, the report states.

The IEA in its World Energy Outlook 2016 said that under the 450 Scenario oil demand would mostly drop because of greater uptake of electric vehicles and biofuels, a key vulnerability the oil sector tends to underestimate, according to previous research done by the think-tank.

“As it happens, in the 450 [Scenario] the transport sector will realise a greater downturn in the oil demand,” Grant said.

Diesel, gasoline and jet fuel products currently bring in the highest margins for refiners and constitute around 70% of global product yield.

The study also takes regional differences into account, forecasting that about two thirds of firm investments that go ahead in the next five years are in the Middle East and Asia, Grant said.

“There might be strategic reasons for building refineries in that region. On a global basis, if demand falls, you don’t need any more refineries,” said Grant.

“However, to the extent that additional new investments are added, more capacity might need to be pushed out to end up with the 2°C world.”

Thumbnail picture: Refinery in Michigan, US
Source: Jim West/imageBROKER/REX/Shutterstock

Interview article by Cuckoo James

By Cuckoo James