Business is booming for oil refiners but they are also facing a dilemma

From my somewhat snooty viewpoint of a career begun in the glamorous “upstream” business of finding and extracting oil and gas, refining has long seemed necessary but unappealing. The process of turning crude oil into usable products has been plagued by low profitability and overcapacity. Now, things have dramatically turned around, but for how long? Oil and gas production reaps the reward of prices, currently about $112 a barrel, minus costs and taxes. It takes place wherever the geology and politics permit, from deserts to tundras to 3,000-metre oceanic depths. The downstream, by contrast, is a margin business. Profits are derived from the spread between the input cost of crude oil and the prices of outputs — petrol, diesel, jet fuel, cooking gas, heavy fuel oil, asphalt for roads, lubricants, feedstocks for plastics, and others. Global refining margins — the gross profit for processing one barrel of crude — typically hover between $2 and $5. Sometimes they go negative. Sophisticated refineries, with greater flexibility, are able to process lower-quality crudes, or produce more high-valued products, can do better. Out of this, the refiner has to pay for fuel, electricity, labour, maintenance, the capital cost of the facility and a host of other expenses. Refineries need constant investment to meet tightening safety and environmental standards and a changing demand mix. They often carry heavy liabilities: unionised workforces and pensions and pollution legacies from less stringent eras. In Europe, they have to cope with soaring natural gas and carbon prices. On the cusp of the coronavirus pandemic, things looked grim for refiners. Almost 10 million barrels a day of new capacity was due to come online by 2025, mostly in India, China and the Gulf. But demand for refining was close to a peak — because of rising fuel efficiency, biofuels, electric vehicles and petroleum liquids derived from natural gas, required minimal processing. Among global refining mainstays, oil demand in Europe has been in decline since 2006; in Japan, since 1996. Governments resist closures, though, firstly because of the loss of jobs, and secondly because of worries about the security of supply of importing refined fuels. The Australian government has offered subsidies to keep its last two remaining refineries running. In some developing countries, politicians demand the construction of refineries even with a poor commercial rationale to dole out patronage, win prestige, develop the local economy or reduce imports. Not surprisingly, major integrated oil companies such as Shell, BP and TotalEnergies — that combine oil and gas production, refining and fuel retail — have been selling or closing refineries, or converting them to biofuels processing or storage terminals. Since the onset of the pandemic, which temporarily crushed transport fuel consumption, about 3 million barrels per day of worldwide refining capacity has been shut down. As demand rebounded, the remaining plants are struggling to produce what is required. Diesel, the key commercial fuel, is in short supply. Refiners can reconfigure to yield more diesel and less jet fuel, but now air travel is rebounding. Trying to produce both reduces the output of petrol. The Opec+ production restrictions, sanctions on Iran and Venezuela, and some loss of output from Russia, crimp the availability of diesel-rich, medium-gravity crude oils. Very light US feedstock is less suited to current consumer demand. Russia typically exports more than 1 million barrels a day of oil products to Europe; now that is reduced by buyer unwillingness and sanctions. Its Ministry of Economic Development expects a 20 per cent drop in shipments this year. And a vital supplier of the Asian market, China, has cut its refineries’ export quotas by more than half to cut pollution and rationalise the industry. Diesel stocks in Europe, US and the key trade centre of Singapore have drained to multi-year lows. So, refining margins have soared above $30 a barrel on a global basis and $50 in some locations. Even though crude prices are, historically speaking, not that high, the squeeze on refined products is driving end-user prices to records, for example in the UAE, equivalent to $176 a barrel for diesel. This contributes to inflation, fuel shortages and global economic worries. The Middle East, though, is now benefitting from its expanded refining capacity. Huge new plants have economies of scale, are sophisticated to maximise the output of high-value products, match the latest European environmental fuel specifications, and often realise synergies by integration with petrochemical units. They serve still fast-growing markets in the Gulf and South Asia. Four new mega-facilities totalling almost 1.4 million barrels per day are on their way. Jazan, in south-western Saudi Arabia, began operations last year and is now commissioning its diesel production. Kuwait’s Al Zour should start up soon, Iraq’s Karbala in the autumn and Oman’s Duqm early next year. Adnoc is completing its “crude flexibility project”, allowing the Ruwais refinery to run different types of feedstock, including imports if preferable. But in October, it decided to cancel a new refinery at the site that would have been ready in 2026, finding it economically unattractive. Dubai’s Enoc raised the capacity of its Jebel Ali plant in 2020, and Abu Dhabi, Fujairah, Egypt, Iran, Iraq and Bahrain have implemented various other expansions and upgrades. A giant new refinery in Nigeria, built by Aliko Dangote, Africa’s richest person, is expected to begin processing in the third quarter of this year, finally easing the crude-rich nation’s paradoxical dependence on imported fuels. The value of such plants in today’s market is shown by Saudi Aramco’s first-quarter results: upstream profit improved 75 per cent on higher crude prices and production. But downstream, including refining, gained 130 per cent. The company has bought a stake in Poland’s second-largest refinery and agreed to develop a new complex in China. Refiners today are enjoying the best of times. But the imminent new capacity and a potential economic slump should ease current fuel shortages, and then climate action and battery vehicles loom. So they face a dilemma: keep investing, or cash in now on what might be refining’s last golden age. Robin Mills is chief executive of Qamar Energy, and author of The Myth of the Oil Crisis

Business is booming for oil refiners but they are also facing a dilemma

Global refining margins – the gross profit for processing one barrel of crude – typically hover between $2 and $5