NEW YORK, April 15 Too many countries are net exporters of refined oil products and those that are not harbor ambitions to become exporters. Yet too much refining capacity is already being added worldwide and too little is being retired. That spells trouble for refinery profitability until low returns trigger more closures.
The last wave of refining capacity rationalization has largely run its course in the developed world. The United States, Britain, Germany, Canada, Japan and Australia have all seen multiple refineries close.
Yet these shutdowns have failed to keep pace with slipping oil demand in the developed world, or to offset "capacity creep" at other refineries. Indeed, some countries where oil demand has fallen precipitously, such as Italy and France, have resisted refinery closures as a means of preserving employment.
Having more than enough refining capacity to meet domestic demand is not a problem when there are export markets that need the product. Latin America's deficit in refined products, particularly diesel, has proven an important outlet for U.S. plants.
But there is a problem here. Oil refining tends to be fetishized by governments. The thinking goes, "it is bad enough to depend on outsiders for crude oil, so let's at least be able to refine all the fuel we need."
Thus, export markets for refined products are drying up. China, which already has an estimated 12 million barrels per day of refining capacity when so-called teakettle refineries are included, continues to add new facilities.
Refining capacity expansion in China has been enough to turn the country back into a net diesel exporter. China is expected to export 400,000 tonnes of diesel this month amid bloated domestic stocks and insufficient demand to mop up all the supply.
With major new capacity expansions still due to be completed in 2014 and 2015, China's emergence as a diesel exporter looks far from temporary. Indeed, with China's track record of overbuilding in other sectors, like steel and aluminum, oil traders should be cautious about assuming a return to net importer status.
NOT JUST CHINA
China alone building new refineries would be manageable. But there are massive expansions under way elsewhere. Saudi Arabia's soon-to-be-completed 400,000 barrels per day refinery at Jubail will cut deeply into the kingdom's own deficit in some oil products and increase surpluses in other categories. Jubail is only the first of three such massive refineries due on stream.
Other Middle Eastern oil producers are adding refining capacity, including the United Arab Emirates, Kuwait and Oman. Other Asian oil importers are also adding capacity.
The surge in Asian refining capacity already has analysts expecting the region will have to export fuel to Europe or elsewhere to keep its own markets in balance.
The brunt of this blow has yet to be felt. Refined products cracks, while weaker than they were at the start of the year, are still attractive to refiners. The market has not yet priced in much of the increase in diesel supply that seems to be coming.
That is probably one reason why physical crude oil markets outside of the North Sea have been showing resilience despite the battering taken by oil and other commodities in futures markets of late.
But with the world economy still struggling to shift into a faster pace of expansion, the likelihood is that these additional volumes of fuel will depress pricing once they hit the market. Lower prices for fuel could encourage refiners to cut runs, although experience shows that run cuts are slow to materialize when prices fall unless the pain is sufficiently intense.
What is probably needed to restore balance is another round of refinery closures. Uncompetitive plants in Europe ought to be the first to close. But many of these zombie refineries are kept in business due to political pressure on oil companies from governments struggling with Europe's economic crisis.
That means the pain may have to get worse than expected in order to force marginal plants in less dirigiste countries to shut down. Refineries in Britain, Canada and the United States are all at risk.
Refineries that are prime candidates for closure are merchant facilities with few competitive advantages. Delta Air Lines' experiment with a 185,000 barrel per day Trainer, Pennsylvania refinery on the U.S. East Coast looks most vulnerable.
Intended as a tool to hedge Delta's exposure to record refining margins for jet fuel, it is now giving Delta exposure to poor refining margins for oil products in general. The plant lost money in the first quarter and despite bullish predictions from the airline for its unconventional approach to price risk management, the prognosis looks poor.
The stubborn refusal of the U.S. gasoline market to return to growth - American refineries are instead resorting to exporting the fuel due to soft local demand - could prove fatal to Trainer, which still makes a lot of gasoline.
Similarly geographically isolated plants in the Canadian Maritime provinces, such as Imperial Oil's 88,000 bpd Dartmouth refinery in Nova Scotia, are also at risk. So, too, are refineries in places like Britain and Australia, where closing down operations is relatively uncomplicated.
The problem is there are too many refineries worldwide that operate on a non-economic basis. Heavy losses are tolerated in China, for instance, or parts of Europe, or the Middle East, due to ancillary concerns like employment.
That impedes an orderly rationalization of capacity. And that makes the likelihood of a tough slog through a period of poor profitability very real.