By John Kemp
LONDON Feb 9 The dramatic collapse of
European refiner Petroplus and the decision to sell or close
three ageing refineries on the U.S. East Coast is only the first
phase of a revolution set to sweep the global refining system
over the next decade.
The current system has too many refineries in the wrong
places producing the wrong fuels. It will take a massive
upheaval to transform it into a system fit to meet the demands
of the world in 2020. In the process billions of dollars of
obsolete capital investments will have to be written off.
Refineries are being hit by a geographical shift in demand
from the advanced economies towards emerging markets in Latin
America, the Middle East and Asia. At the same time, the
composition of demand is shifting away from gasoline and
especially residual fuel oil in favour of middle distillates
such as gasoil, diesel and jet fuel.
As a result, too many refineries are clustered around the
North Atlantic, the Mediterranean and Japan, producing too much
gasoline and heavy fuel oil, and there is not enough refining
capacity in emerging markets producing middle distillates.
Location and product imbalances explain the apparent paradox
that emerging markets continue to invest in new refineries,
while the global market is oversupplied with capacity, and
refineries are being shut or sold in the United States and
According to the 2011 edition of OPEC's "World Oil Outlook"
(WOO 2011), the collapse in oil demand as a result of the
recession left the global refining system with more than 7
million barrels per day (bpd) of surplus distillation capacity
in 2009, the highest level since the late 1980s.
Recovering demand during 2010 and 2011 cut surplus capacity
somewhat. But with likely additions in the next few years, OPEC
has forecast spare capacity could approach 10 million bpd by
2015 unless some refineries close.
Excess capacity is distributed unevenly. The biggest
surpluses are in North America, Europe and Japan, where demand
for refinery products has been hit by the recession as well as
increased vehicle efficiency and biofuels-blending mandates.
In contrast, emerging markets are struggling to meet booming
demand for liquid transport fuels and other products. Countries
planning major refinery expansions such as China, India, Brazil
and Saudi Arabia are doing so in part to meet growing local
demand and remain self-sufficient, according to OPEC.
In other instances, countries that produce heavy crudes,
including Saudi Arabia, Russia and Venezuela, are turning to
refining so they can export more valuable refined products
rather than discounted crude.
The result is a "two-tier" refining industry in which "OECD
surpluses are not seen to be deterring projects in non-OECD
regions", as the WOO explains. By promoting domestic refining as
a strategic objective, emerging markets have ensured refiners in
the advanced economies cannot export their way out of the
In some ways, locational shifts are easier for refiners to
deal with than the changing composition of demand for specific
Diesel demand has been growing at the expense of gasoline,
in particular in the EU, where governments have used the tax
regime to promote diesel because diesel engines are more
efficient. But there is a growing recognition the process has
gone too far. Growing demand for diesel is no longer compatible
with the technical capabilities of the refining system.
Dieselisation has left the EU refining system with a massive
imbalance - producing far too much gasoline and too little
distillate. As a result, the EU imports increasing quantities of
distillates from the former Soviet Union, while disposing of
excess gasoline by exporting it to the United States.
These trade patterns are not sustainable. Falling demand in
the United States has cut the market for EU gasoline exports.
Meanwhile, rising demand for distillates across emerging markets
for transportation, heating and electric generators is making it
difficult and expensive to continue importing diesel to meet the
shortfalls in Europe.
Policymakers have no choice but to find ways to slow the
spread of diesel demand and encourage more gasoline use. The
EU's proposed new directive on minimum energy taxes would
eliminate tax preferences for diesel by shifting taxation from a
volume basis (which favours diesel) to one based on
energy-content (which is neutral).
The directive itself is unlikely to bring substantial
change. The EU's three-largest markets (Germany, France and the
United Kingdom) already apply tax rates well above the minimum,
so the directive will have no immediate practical effect.
Britain has already eliminated preferences for diesel. The
biggest impact is symbolic, signalling that the EU will no
longer encourage diesel use over gasoline.
Booming demand for diesel at the expense of other fuels is
being made worse by tighter regulations on emissions of sulphur
and other pollutants from shipping under the International
Convention for the Prevention of Pollution from Ships (MARPOL).
New regulations cut the maximum permitted sulphur content of
marine fuels from 4.5 percent to 3.5 percent from 2011 and 0.5
percent in 2020. In the meantime, even stricter 1 percent limits
are being enforced in two emission control areas (ECAs) covering
the Baltic and the North Sea, which will be cut to just 0.1
percent from 2015. Two further ECAs have been proposed for the
east and west coasts of North America.
So far, shipping operators have mostly met their obligations
by blending high-sulphur residual fuel oil with low-sulphur
middle distillates. But that is not an option in the two
European ECAs and will become impossible worldwide as sulphur
requirements become increasingly stringent.
The only way to comply will be to shift from burning
residual heavy fuel oil to low-sulphur marine diesel or (retro-)
fit expensive sulphur scrubbing technology to remove emissions
from the smokestack. Complying with marine emissions
requirements will therefore boost demand for middle distillates
at the expense of heavy fuel oil even more in the next decade.
The shifting composition of product demand from the top and
especially the bottom of the barrel to the middle poses severe
challenges for older refineries that rely primarily on
Distillation is essentially a separation process. It yields
fairly fixed proportions of gasoline, distillates and fuel oil
depending on the type of crude used. Changing product demand has
left distillation refineries making far too much fuel oil (and
gasoline) and not enough middle distillate.
The shift favours refineries that also have conversion
processes, such as fluid catalytic cracking (FCC) and coking,
that are able to break up large hydrocarbon molecules under heat
and pressure in the presence of catalysts and thereby cut the
output of residual fuel oil in favour of lighter and more
valuable products as well as saleable petroleum coke.
North American and European refineries without significant
FCC and especially without coking capacity appear doomed. It
comes as no surprise that three distillation refineries on the
U.S. East Coast are up for sale or closure while conversion
refineries on the Gulf Coast still achieve healthy profits.
Between 1990 and November 2011, distillation capacity at
refineries on the East Coast (PADD 1) grew from 1.505 million
bpd to 1.618 million bpd. But FCC capacity actually fell from
553,000 bpd to 491,000 bpd, and coking capacity was down from a
paltry 73,000 bpd to 59,000 bpd.
In contrast, on the Gulf Coast (PADD 3), distillation
capacity rose 20 percent to 8.640 million, cat cracking capacity
rose 20 percent to 2.552 million bpd and coking capacity surged
almost 150 percent to 1.242 million bpd.
The future belongs to conversion refineries in emerging
markets. For distillation refineries in North America and
Europe, on the other hand, the future is very bleak indeed.