By: John Auers and John Mayes
In this last of our “round the world” examination of refinery capacity developments, we move on to a couple of adjacent regions with drastically different but somewhat interdependent dynamics. Specifically, we will discuss the environment in Western Europe and the Former Soviet Union (FSU). FSU, which is dominated by the Russian Federation, bears a similarity to the Middle East in that the region’s refiners are feedstock advantaged (due to the regional surplus of crude), primarily government controlled and major exporters of refined products, primarily to Western Europe. They have also added capacity over the last decade and have fairly extensive plans for more investment in the downstream sector. And just like in the Middle East, those plans are being negatively impacted by low oil prices, which have reduced the amount of money available for refinery projects. The situation in Western Europe, on the other hand, is vastly different and instead of potential expansion the question is how much capacity will be shut down. With feedstock disadvantages, high costs, declining domestic demand and uncompetitive configured refineries, almost 2 million BPD of capacity has been rationalized over the last decade. Although the drop in crude prices and a rebound in demand has led to a bit of a “European Spring” over the last couple of years, the underlying negative fundamentals remain in place and more shut downs are likely. But as with developments in the other regions of the world, what happens with refinery capacity growth (or decline) in the FSU and Europe could be significantly influenced by “wild card” events and the success or failure of individual projects or refinery rationalization decisions. In today’s blog we will discuss some of the more prominent of these as we once again look at how product supply/demand balances could be impacted “With or Without You (Them).”
“My Body Bruised, She’s Got Me With Nothing to Win and Nothing to Lose” – Europe/More Rationalization Ahead
Recent years have not been kind to the refining industry in Europe. After peaking in 2006 at over 17 million BPD, refining capacity in Europe has declined to less than 15.2 million BPD currently, a decrease of about 1.9 million BPD. There are numerous reasons for the sharp contraction. Declining product demand in Europe is probably the single greatest cause but increasing environmental requirements, high labor costs, and relatively low levels of refining complexities are also contributing factors. 
Italy suffered the greatest reduction in refining capacity in the region with a decline of over 600 MBPD in the last decade. This decline represented almost a quarter of Italian refining capacity. Significant declines were also experienced in France (almost 600 MBPD), the UK (about 500 MBPD), Germany (over 350 MBPD), and Romania (about 150 MBPD). Not all countries suffered declines however, with Spain seeing the greatest increase at 185 MBPD.
While the rate of refinery closures has ebbed in the last year, refinery construction is also very modest. The only project to add crude processing capacity is the construction of the new SOCAR refinery in Izmir, Turkey. This facility will have a crude capacity of 183 MBPD. While not adding processing capacity, ExxonMobil is upgrading its Antwerp, Belgium refinery with the addition of coking and hydrocracking units. The cost of the Antwerp expansion is around $1.1 billion.
Adding to Europe’s refining woes is the prospect of a future which may be as bleak as it’s past. The dominant event which will drive European refining margins is likely to be the shift to low sulfur bunker fuel in 2020. These new regulations being progressed by the International Maritime Organization (IMO) will reduce the sulfur level in bunker fuel from the current level of 3.5% to only 0.5% in January of 2020. Because most crudes cannot produce a fuel oil with this low of a sulfur level, it is likely that most of the new low sulfur bunker fuel will be produced through the blending of very low sulfur distillates. Up to two million BPD of higher sulfur fuel oil will be backed out of the bunker pool in 2020. The prospects of placing this product into alternate dispositions appear bleak.
While distillate prices are expected to rise in this new environment, high sulfur fuel oil prices are likely to be sharply lower. This in turn will pressure refining margins in fuel oil refineries. Because most refineries in the U.S. are coking/asphalt refineries, they will generally be benefited by the new regulations. Refineries owned by national oil companies will likely be somewhat immune to the margin effects because of political reasons. Fuel oil refineries operated in free market areas will be the most negatively impacted and these are concentrated in a few Pacific Rim countries (Japan, South Korea, Australia, etc.) and Europe.
In addition to the transition to low sulfur bunker fuel, European are also facing other pressures. Russia has almost completed a $30 billion upgrade of its refining system. Historically Russian refineries produced large volumes of fuel oil, FCCU feed and other unfinished products, most of which went to Europe or the U.S. at reduced prices. The Russian upgrades will have two negative effects on European refiners by removing attractively priced feedstocks and increasing gasoline and distillate competition. European refiners will also see heightened competition from U.S. and Middle East refiners. European product exports to Latin America have been almost eliminated as U.S. exports to the region have expanded. Similar pressures are now being felt in Africa. Large new export refineries in the Middle East will also challenge European refiners in a variety of markets.
“On a Bed of Nails She Makes Me Wait” – FSU/Russian Modernization and Expansion Slowed by Low Prices and Sanctions
In contrast to Western Europe, the countries to the east, which comprise the FSU, have seen an increase of about 700 MBPD of refining capacity over the last decade. Essentially all the growth has come in the Russian Federation (about 900 MBPD) with the troubled Ukraine suffering a similar fate as Western Europe, with almost 200 MBPD of capacity idled. As with most aspects of the FSU, the Russia’s refining industry dominates the region, making up about 80% of the regions 8 million BPD of capacity, and behind only the U.S. and China in that category.
As noted in our opening paragraph, Russian expansion (and to a much lesser extent smaller expansions and plans in the Central Asian “Stans”) have been incentivized by growing crude production and resulting feedstock cost advantages. Product demand growth has also been generally healthier than in Western Europe, although that growth has stagnated in recent years. With the entire economy and especially the petroleum industry under significant government control, governmental policies, particularly in regards to taxes, domestic prices, and investment plans have played a major part in the growth of the Russian downstream segment.
While the Russian refining industry is large in terms of capacity, it is very limited in its downstream upgrading capabilities. This results in the production of significant quantities of fuel oil and unfinished intermediates, which make up the bulk of Russian product exports. In an effort to increase the complexity of Russian refineries and the production of higher valued products, the Russian Government has, over the last several years, taken a number of steps to encourage the upgrading and modernization of the downstream industry. The most comprehensive of these steps was the adoption of a system wide program in 2011 to construct over 120 upgrading units (FCCU’s, hydrocrackers, reformers, alkylation units, cokers, HDS units, etc.) by a target date of 2020. The Ministry of Energy was tasked to implement this program and there was some early progress, with almost 30 new upgrading units completed by the end of 2015. The results of this progress could be seen in a fairly dramatic decrease in the exports of unfinished oils (fuel oil blendstocks, FCCU feed, ATB, etc.), with U.S. imports of these streams dropping by almost 100 MBPD from 2013 to 2015-16.
The bulk of the new upgrades were to come in the 2017 to 2020 timeframe. In TM&C’s most recent issue of the World Refinery Construction Outlook (WRCO), we have over 1 million BPD of potential upgrading capacity additions (almost half for FCCU and hydrocracking) included in our comprehensive list. However, the precipitous drop in oil prices, along with the negative impacts from the sanctions the E.U. and U.S. have implemented as a result of the Ukrainian aggression, have led to a significant slowdown in the upgrading plans. Financing from Western sources is drying up, as is the ability to procure equipment and technical services. Our current “probable list” includes less than 450 MBPD of upgrading additions expected to be completed by 2020, and several projects included in that total are on our “watch list” to be downgraded to “unlikely by 2020” status.
While refining construction activity is slowing in Russia, it might be picking up a bit in the Central Asian republics. This area is also endowed with strong crude resources, but the downstream segment is pretty limited. However, with crude production picking up and investment not impacted by sanctions, the downstream is perking up as well. Kazahkstan is the big player here and two reasonably large ($1 to 2 billion) refinery upgrades by the national oil company, KMG, are slated to come on line in the next two years. KMG is also looking at building a grassroots, 120 MBPD refinery in the Mangistau region and a new refinery in neighboring Tajikistan is also a possibility in coming years.
TM&C has recently completed and published its 2nd edition of the WRCO. Some of the key findings in this study were summarized in our February 7th blog (Planes, Trains and Automobiles, and Now Also Ships). 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 and potential rationalizations is provided. If you would like more information on this or our other products, or for any specific consulting engagements with which we may be able to assist, please go to our website and send us an email or give us a call.