The global refining landscape has been changing over the past decade, but the rapid demand destruction associated with the global pandemic has flipped the sector on its head. Many refineries in the U.S. and around the world have been changing their refined products or closing entirely. Luckily the wave of closures in the United States and Europe does not signal an end to global refining, but more of a shift in output priority and refining location. Companies and countries are moving away from refineries only designed to make gasoline and diesel, favoring those with the additional capability to refine crude into petrochemicals and plastics.
- The coronavirus pandemic has sped up a shift in the refining sector to retool existing facilities to alter product outputs or decommission legacy pants entirely. Refinery slates are being adjusted to produce less gasoline and diesel while trying to optimize processes that include more petrochemical production. This is being driven by an overcapacity in refining space as an additional 2.2 MMBPD was added in 2019 before fuel demand plummeted nearly 30% in 2020.
- The world market for gasoline, diesel, and jet fuel growth has been relatively flat, around 0.7%-0.9% per year while petrochemical demand growth has been about 4% per year. In less developed areas, petrochemical demand is expected to double every 12 to 15 years. This growth is in addition to the existing petrochemical use of developed nations. Fuel usage in developed areas cannot grow at the same pace as electrification of vehicles, mandated emissions standards, and traditional fuel replacement keep the demand curve flat.
- European refineries have seen margins impacted by reduced demand, falling from a typical €12/bbl to about €1/bbl margin in northwest Europe. Many European refineries are transitioning to produce more biofuels and are issuing “green” bonds for low-carbon investments.
- The U.S. has had six refineries, representing 3% of domestic capacity, announce they will be shutting down or converting to alternative fuels in the last three months. Domestic refining capacity reached a record of 19.0 million barrels per calendar day (b/cd) in January 2020, but this trend will likely not continue into 2021. Low prices will inhibit capital and mandated green initiatives will require less refining to meet greenhouse gas emissions standards.
- China is investing its refining infrastructure into building new mega-refineries to create enough gasoline and diesel for their growing economy as well as generating petrochemicals and plastics needed for cheap exports. The country currently has at least four projects with about 1.4 million barrels per day of crude-processing capacity under construction. While U.S. E&P companies may benefit from additional Chinese imports of light, sweet crude, China is positioning itself to assume global refining market share when other countries reduce their capacity.
- Refinery closures do not signal an end to global refining, but more of a shift in priority and location. Low prices, carbon neutral mandates, and coronavirus related demand destruction has forced many refineries in the U.S. and Europe to adjust output products or close completely. With the possibility for crude demand to return to pre-pandemic levels in the near future, China has recognized this opportunity and is investing in mega-refineries to create both fuel and petrochemicals.
At the start of the global pandemic in March and April, refineries around the world had to cut back on processing amid collapsing demand. Many across the globe, like those in the United States, saw their percent utilization of operable refinery capacity drop about thirty percent to decade lows in April. However, there is a structural problem underway in the downstream sector – refinery overbuilding has led to too much refining capacity and now is leading to a wave of closures. After several years of heightened investment, the oil industry has spent tens of billions of dollars in refineries around the world, including about $52 billion in 2019 alone . These massive expenditures led to 2.2 MMBPD of new refining capacity, a record amount, coming online in 2019 which has created overcapacity in the global refining space. The 2.2 MMBPD increase in refining capacity last year stands in stark contrast to the rather weak demand growth of 0.8 MMBPD . As a result, many refineries could be on the chopping block unless they are agile enough in their refining processes to allow them to weather the storm. Companies and countries are moving away from refineries only designed to make gasoline and diesel, and are favoring those with the capability to refine crude into petrochemicals and plastics. This is a move industry leaders hope will stave off the demand destruction from gasoline and diesel in the future. Refineries capable of changing their slates to continue operating at optimum capacity will do so while others will be forced to close. This reduction in overall operating capacity is opening the door for other global market participants to take advantage of the situation, allowing other countries to become leaders in global refining.
Open and Close
The question becomes, why are some refineries shutting their doors amid depressed oil prices while brand-new mega projects in China have recently been given the green light? Well, the growth in refining capacity and refinery investment are mainly driven by the demand of petroleum products which runs parallel with the growth of human and vehicle population . By 2025 a world population of around 8.1 billion and more than 100 million vehicles on roads are expected. Therefore, refined products from the oil and gas industry will continue to be necessary, regardless of a shift towards “clean and green” energy. Older refineries have been shutting down at a steady pace over the past decade, and the virus simply sped up this process as a result of depressed prices.That does not mean refining capacity has also been on a steady decline. The billions of dollars that have been invested into refineries has largely been to increase capacity, re-tool their slates, and ultimately alter outputs. In other words, investments are going towards the refurbishment, upgradation, and expansion of existing refinery facilities to increase efficiency and will propel oil refining market growth .
One may ask, why invest billions refurbishing one refinery when another is being shut down? Similar to feuding bakeries on opposite sides of the street, each refinery uses unique ingredients to make different products. A refinery in California might be tooled to process heavy crude oil from the region to make construction materials while a refinery on the Gulf Coast may be set up to process light and sweet WTI crude to produce naphtha for petrochemicals. Additionally, the refinery shift is largely geared towards the future of the industry. As discussed in several prior RP periodicals like Consumer Demand and Refinery Run Recovery, transportation makes up for 68% of domestic crude oil demand, but it won’t stay that way forever. All around the world, gasoline, diesel, and jet fuel are the primary products that come from crude oil. However, the world market for these products is currently exhibiting flat to slow growth of around 0.7% to 0.9% per year, regardless of the pandemic . This is due in part to the impacts of traditional fuel replacement, like methanol, ethanol, and LNG, in addition to the slow but steady increasing electrification of the transportation fleet and mandated improvements to global fuel efficiency standards. In comparison, the global petrochemical market is growing at nearly 4% per year . This shift has occurred for a multitude of reasons including worldwide population growth, increasing income and wealth, and aging population in developed areas of the world. While that gap of 0.7% vs. 4% seems large now, it is set to exponentially rise since demand for petrochemicals in less-industrialized areas of the planet is doubling every 12 to 15 years . Meanwhile, demand in parts of the world that are already consuming the most petrochemicals per capita are still strong and growing. As the population of many developed oil-consuming countries begins to age, more people enter a retirement lifestyle and their consumption of transportation fuels generally decrease while consumption of petrochemicals increase. It is this precise trend that started the phaseout of refineries tooled to only make specific petroleum fuels and focus on refineries that have the capacity to accommodate the growing petrochemical market.
The pandemic initially cut global fuel demand 30% and refiners temporarily idled plants. As consumption has not yet returned to pre-pandemic levels and less travel may be here to stay, the possibility exists that many European plants could close permanently due to the pandemic’s impact on margins and inventories . Refining margins are still a long way from where they were a year ago, despite the easing of lockdown measures. Gasoline margins have averaged little more than €1/bbl in northwest Europe in the third quarter, compared with more typical levels of around €12/bbl for the time of year . The current desolation in refining economics is reminiscent of the aftermath of the financial crisis of 2008-09 that led to the shutdown of nearly 1.4 MMBPD of crude capacity in Europe from 2009-12 . Unfortunately, product inventories are also problematic with levels high enough that even rising demand cannot absorb the supply. With margins tanking and inventories rising, some have tried to make adjustments to their refining portfolio. In Europe, Total is making the clearest moves as it agreed to sell its 110,000 BPD Lindsey refinery in the UK to trading firm Prax Group as part of a longer-term focus on integrated refining and petrochemical plants. Unfortunately many investors have little hope in pursuing a path that goes against the region’s push towards cleaner energy.
There is still hope for many of these European refineries on the brink of failure, and it does not come in the form of integration but rather in the form of a transition. Several European countries have begun issuing specialized “green” bonds to fund projects tied to the energy transition . Green bonds play an increasingly important role in financing assets needed for the low-carbon transition put forward by the European Green Deal, underlining the need for long-term signals to direct financial and capital flows to green investments . With the overwhelming success of Total’s La Mede biofuel producing refinery in southern France, before green bonds were even in place, this just might be the future for struggling European refineries.
United States Trajectory
For U.S. refineries, the severe demand destruction that occurred this spring led to the worst financial performance in recent history. Not only did refiners produce less diesel, motor gasoline, and jet fuel in the second quarter than any quarter in recent memory, their refining margins were sharply lower than the historical range; a one-two punch that hit their bottom lines hard . In the last three months, six U.S. refineries representing a little less than 3% of total U.S. refining capacity have announced they are shutting down or converting to alternative fuels, affecting communities from California to Louisiana . Experts have noted that as the coronavirus pandemic and the ongoing shift away from fossil fuels continues across the United States, it makes some of the plants obsolete. While exaggerated by extended low prices, those trends were developing even before the coronavirus pandemic struck and they have accelerated over the last few months. Most major oil companies were expecting oil demand to decline sometime in the future. Several of them now say the peak will come faster and at least one, BP PLC, has said demand may have already peaked . As a result, the industry is turning to plants that can process everything from sweet West Texas oil to Canadian bitumen that’s the consistency of tar . If the end is near, it is time to be versatile which is why many are looking to integrate refineries with petrochemical plants that produce precursors for plastics and other consumer products. Oil companies hope this will stave off the decline in demand for gasoline and diesel fuel in the near future . The desire to build more complicated, integrated refineries is further proven by the fact that the peak number of refineries was reached back in 2017 and just three years later, the United States is down six refineries. Yet, U.S. operable atmospheric crude oil distillation capacity, or refining capacity, increased 0.9% in 2019, reaching a record of 19.0 million barrels per calendar day (b/cd) in January 2020 . This is up 0.2 million b/cd from the previous record of 18.8 million b/cd the year before . Even though the number of refineries has been falling steadily, capacity has grown. Unfortunately, capacity in 2021 will not experience this same trend. With low prices and green initiatives being pushed forward, it seems domestic refineries have reached their peaks and are now starting their long decline. In California alone, refining will have to fall 4% to 7% per year to meet the state’s greenhouse gas reduction goals . If declines are pushed off until 2025, more dramatic cuts ranging from 20% to 80% a year will be required . With refineries being modified to diversify end products, shutting down, or transforming into green energy refineries; the United States seems to have turned its back on the dominance of crude oil refining power.
With European and U.S. based companies shying away from more investments in hydrocarbon refining, China is investing tens of billions of dollars in new mega-refineries even as its fuel demand is expected to peak within five years. The country is raising the risk it will flood the region with cheap exports. At least four projects with about 1.4 million barrels per day of crude-processing capacity, more than all refineries in the U.K. combined, are under construction . That’s after the country already added 1 million barrels per day since the start of 2019. Even though Chinese refining capacity has nearly tripled since the turn of the millennium as the country’s oil giants tried to keep pace with the rapid growth of diesel and gasoline consumption in the country, the new mega-refineries under construction in places like Zhejiang, Jiangsu and Yantai will be geared toward turning crude oil directly into petrochemicals and plastics . This decision is not surprising after the realization that those sectors will be what drives global oil demand into the future as electric vehicles (EV’s) become more and more common.
The mismatched building boom further underscores how rapidly clean energy and electric vehicles are changing the industrial landscape in China, especially after Xi Jinping’s pledge in September to go carbon neutral by 2060 . It also positions the country to be an even bigger exporter of fuel, endangering refinery operations from South Korea to Australia, even in Europe . Luckily, Chinese oil producers will be unable to keep up with the dramatic uptick in refinery operations forcing China to import crude oil from abroad. This is especially prevalent for E&P operators in the United States who are quickly taking over crude import market share in Asian markets. In uncertain times, one thing is becoming certain. China is positioning itself to continue taking over market share globally by expanding refining capacity while the rest of the world appears to be going in the opposite direction.
The coronavirus pandemic has accelerated the trend of refinery closures. According to IHS, the damage caused by the virus to demand is likely to be structural and permanent. In fact, IHS’ Director for Chinese Coal and Power Xiaomin Liu said: “our current estimate is there’s going to be about 1 million barrels a day refining capacity that is facing closure threat, out of which, 60% will be in non-China territories” . It is important to note that over the next five years, the industry as a whole has another 6 MMBPD of new refining capacity in the works. The refineries that are facing closure do not signal an end to global refining but more of a shift in priority and location. JBC Energy agrees by stating: “in this difficult environment, efforts by the more resilient refiners, not only in Asia, to gain market share may further contribute to pushing out the most vulnerable players, ultimately leading to some [pricing] pressure relief in the medium to longer term” .
While the rest of the world seems to have turned their backs on downstream operations, China appears to be doing the opposite. On a fundamental level, the world had too many refineries after the global pandemic decimated crude oil demand and eliminated many bottom lines. Now China is taking advantage of worldwide closures, recognizing an opportunity to squeeze in and take over a sector in which they had no control before. Many of these refineries were already redundant, but a wave of closures is coming as global crude oil demand is likely returning to pre-pandemic levels in the near future. A possibility exists that more crude products will be demanded than can be processed or refined. China has recognized this future opportunity and stepped in to take advantage of the situation at the expense of many other countries. While more energy developed nations are touting policy moves to force refinery closures as a step towards carbon neutrality, further investigation shows it is simply a shift in refining direction and power.