By John Auers and Brian Mason
In reviewing the refinery construction landscape, the early 80’s hit “Only Time Will Tell” from English supergroup Asia comes to mind. The title of that tune, which continues to be used in popular tv shows (Cold Case, Family Guy) and video games (Metal Gear series), very well expresses the uncertainty regarding which projects will actually be built and when they will be ready for start-up. There is certainly no dearth of project proposals around the world, but as always, both macro and project specific factors and developments will determine the success of each individual project and the overall level of capacity additions and refinery upgrades. The macro factors include product demand growth (both overall and by type), changes in the quality of the types of crude being produced, regulations (fuel specifications, permitting, etc.), and a variety of others. Project specific factors such as the strength and commitment of sponsors, quality of process design and management teams, regional/local construction costs, and many others will also be critical to the success of individual projects..
Two specific developments that will be influencing refinery project decisions over the next few years are worth noting. One of these is the International Maritime Organization’s (IMO) regulations to reduce the sulfur content in bunker fuel from 3.5% to 0.5% beginning in 2020. This is the first ever global wide fuel specification rule and will both drastically increase the demand for marine diesel and decrease demand for resid-based bunker fuel. This will in turn cause price reactions which will incentivize a variety of refinery projects, including resid destruction units such as delayed cokers, resid hydrotreating units, and facilities to further increase distillate yields. The second is a growing view that the world is moving towards “Peak Product Demand”. This view has been aided by government policies (most of which are still prospective) to move away from carbon and towards non-petroleum alternatives. Although global demand growth has actually “ramped up” significantly (as discussed in our June 5 blog ), over the past three years due to low prices, refiners around the world are definitely taking a cautious view towards spending on petroleum refining due to their worries about “peak demand”. This is especially the case for very large projects which require significant capital and take years to complete.
Turner, Mason & Company has been monitoring global refining projects for over a decade as part of our Crude and Refined Products Outlook (C&RPO) and more recently has added a more detailed report which specifically focuses on refinery projects, our Worldwide Refinery Construction Outlook (WRCO). In both of these products, we review virtually all of the refinery projects currently being considered around the world, and analyze all of the factors mentioned above (regional product supply and demand, crude supply dynamics and capabilities, project sponsors, construction costs, etc.). Based on this analysis, we determine which projects we believe have the greatest probability of moving from dream to reality. We also forecast start-up dates, the ultimate cost of the project and its impact on product and crude S&D by product type and crude quality. In today’s blog, we highlight some of the methodology we employ and some preliminary outcomes (subject to changes when we finalize our analysis) of our soon to be released editions of the C&RPO and the WRCO.
The Global Picture
Over the next five years, we expect global hydrocarbon demand to increase by about 7 million BPD. This represents an annual increase of about 1.4 million BPD, which is slightly less than our forecast last year and also a bit less than the recent elevated levels. Global refiners have announced new refinery additions or expansions to existing refineries which would add 24.5 million BPD of capacity over the same time period (a bit higher than our forecast last year). This potential imbalance is made even worse by the reality that alternate fuels (ethanol, biodiesel, CNG, LNG, etc.) are expected to grow by about 800 MBPD through 2022. This means that if all announced refining additions were to be successfully completed, the potential supply for refined products would grow at a rate about four times as fast as global petroleum demand. Clearly, not all of these projects can be economically built and undoubtedly the majority will be cancelled or postponed.
Our current list of announced new refineries and expansions encompasses 236 projects (our Announced list). Not all of these projects include crude-processing additions, as many are involve the addition of downstream units, focused on either upgrading product slates or desulfurizing products to respond to increasingly stringent regulations. Over one-third of these projects are new, grassroots refineries, while the remaining are expansions or modifications to existing sites.
Regional Developments
Expected continued strong growth in product demand has made the Asia Pacific region the leader in project activity, both in recent history and for the foreseeable future. Through 2022, it has the largest number of new projects (69), which represent almost 30% of the total list, while the Middle East is second at 42 (18% of the total). A number of projects in other regions where demand growth is expected to be strong, Africa and Latin America, also have a pretty strong representation on our Announced list. The largest of the Announced global additions are proposed new refineries in Maharashtra, India (1.2 MMBPD), Al-Zour, Kuwait (615 MPBD), Kitimat, Canada (550 MBPD) and Olokola, Nigeria (650 MBPD). If all of the Announced projects were completed, the total cost would be over $800 billion. This would equate to an annual construction expense of over $160 billion.
While the U.S. has 33 Announced projects, the crude capacity additions amount to only about 1.5 million BPD. Up to about five years ago, large projects were being completed in the U.S. which were designed to process heavy Latin American and Canadian grades. With the growth of lighter shale crudes, the expansion projects have been smaller in scope. The push toward lighter grades has even slowed in the last two years as a result of the removal of the crude export ban, which, when still in place was a major driver for actual and potential expansion. Refiners in the U.S. also have to keep in mind that incremental product make will have to be exported (on a country-wide basis) due to the surplus refined product environment.
What Determines Project Success
Many projects are announced without sufficient financial backing, face significant regulatory obstacles or simply represent a very broad concept rather than a well-defined construction venture. In many parts of the world, announcements of new projects are more of a political “want to” rather than an actual project with realistic economics.
At TM&C, we use multiple criteria to assess the likelihood of construction for each of these 236 Announced projects. In order to sort out the winners and losers, we have established a Probability Index with a scale of one to five. A one would represent a project with the lowest likelihood of completion, while a five would be the highest. Projects with a five are generally those well into construction. The criteria which set the Probability Index for each project are the funding capabilities of the principals, the level of detail in the announcements, the historical track record of the principals in completion of other projects, regional crude and product balances, and perceived environmental and strategic obstacles. The amount of crude-capacity additions for each ranking is shown in Figure 1.
Projects with a ranking of three or higher (in our Probable list) are deemed likely to be constructed and are included in our biannual C&RPO, which will be released in early August. As shown in the above figure, only half of the crude-capacity additions are ranked as three or higher.
Summing Up the Current Forecast
Of the total of 236 projects on our Announced list, our we have determined, based on the criteria outlined above, that 118 of these projects are likely to be completed by 2022 and are included in our Probable list. Of these, 23 are grassroots refineries, with the rest involving expansions or modifications to existing refineries. Total crude-capacity additions for these Probable projects total about 8.3 million BPD. With a utilization rate of 90%, this would increase global crude runs by 7.5 million BPD, which is somewhat above our forecast global demand increase. When taking into account the growth in alternate fuels, this excess capacity growth is between 1.0 and 1.5 MMBPD. We would expected this imbalance to lead to the closure of some uncompetitive plants, with the 2020 IMO regulations playing a key part in determining which plants will fall in that category.
As with the Announced list, the bulk of the Probable projects are to be constructed in Asia Pacific. The region has 33% of the new projects, but these comprise 50% of the additional global crude-processing capacity. The Middle East has fewer projects, but they are generally also fairly large. The average project in the Middle East will add over 120 MBPD of capacity, while the average Asia Pacific project will add about 105 MPBD. The average project in the U.S. will add only 12 MBPD (220 MBPD in total for the 12 Probable projects). Figure 2 is a regional comparison for the two construction lists.
Expected Future Drivers
So far, very few projects are included in either our Announced or Probable lists which are targeted to respond to the IMO LS Bunker Fuel regulations mentioned earlier in our blog. This is in large part to the fact that the 2020 implementation date was only finalized in late 2016, with much of the industry expecting a postponement. Uncertainty related to where the investment will be made – shipboard or at the refinery level – has and will also continue to slow project development. However, we can expect, because of the very strong economic drivers (higher diesel prices/lower fuel oil prices/larger heavy versus light discount) resulting from these regulations, that more new projects incentivized by those drivers will eventually be conceived and announced over the coming years. Most of these projects will be focused on resid destruction, primarily in regions currently producing higher volumes of heavy fuels, such as Asia and Europe. As we noted earlier, refinery rationalizations will also result, leading to opportunities for competing facilities. Other developments, including those related to changes in the regulatory, economic, product demand and crude market environments will also result in new project announcements and refinery shutdowns. In all cases, refiners and their financiers, will be cautious with investment decisions, keeping in mind worries about an eventual peak in petroleum demand. We feel this will be an important factor which will keep “overbuilding” from becoming a serious issue, especially in an environment where we believe “peak demand” fears are somewhat overhyped.
The next editions of our C&RPO and WRCO (which are issued semi-annually) are expected to be released in early August. The WRCO includes our comprehensive (Announced) refinery project listing, instead of just the most probable projects which we include in the C&RPO. In the WRCO, each project we track is listed by region and ranked based on its probability of success. In addition, a detailed discussion of the regional factors and trends that are affecting refinery construction projects is provided. If you would like more information on either of these or any other of our products, or for any specific consulting engagements we may be able to assist with, please go to our website, send us an email or give us a call.