By Robert Campbell
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.
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
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
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
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
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
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.