French refiners face shakeout with soaring costs, downturn

Sept. 20, 1993
Ste. Nationale Elf Aquitaine refinery at Grandpuits, France, is one of three the French state oil company owns in France. Photo by G. Houlbreque, courtesy of Elf. [43,688 bytes] French Refiners' Unleaded Project Outlays* [385,565 bytes] French Refining Capacities, 12-31-92 [451,483 bytes] Western Europe Refiners' Desulfurization Requirements [547,184 bytes] Massive environmental outlays and a changing products market are spawning a shakeout in France's refining industry.
Massive environmental outlays and a changing products market are spawning a shakeout in France's refining industry.

The shakeout was perhaps inevitable, given lingering surplus refining capacity and weak products demand growth in Europe. But the scramble to meet changing products specifications under new environmental and market demands has speeded the process. Accommodating new environmental mandates and their corresponding new product specs alone will cost French refiners about 44 billion francs ($7.7 billion) this decade.

Thus far, only 6-7 billion francs ($1-1.2 billion) has been spent to complete the introduction of unleaded gasoline (OGJ, Nov, 18, 1991, p. 23). Still to come are outlays to reduce sulfur in diesel and residual fuel oil (OGJ, Dec. 2, 1991, p. 21).

Poor results

Last year France's seven refiners posted the lowest refining margins in a decade, booking combined after tax operating losses of 872 million francs ($152.6 million).

That compares with a combined profit of 5.6 billion frances in 1991.

Their average gross margins on Brent crude hovered at about 95 francs/metric ton ($2.28/bbl), below the 100 franc/ton breakeven point and a steep drop from 180 francs/ton in 1991. French marketing margins in 1992 were the lowest in Europe, despite the decline in service stations to 20,200 in 1992 from 22,900 in 1991.

That's not unusual for a long suffering French downstream sector. During 1982-92, French refiners registered combined losses of 22 billion francs.

France's refining industry is beset by problems specific to its own market beyond reduced margins, which is what all refiners in Europe face. Accordingly, each of the six major integrated companies operating in France-Total, Ste. Nationale Elf Aquitaine, Shell France, Esso SAF, BP France, and Mobil Oil Francaise-has devised an individual strategy for a return to profits. A seventh refinery, Cie. Rhenane de Raffinage (CRR), is owned by four of the majors.

A critical concern for France's petroleum industry is whether the continuing hemorrhage in financial results will undermine refiners' ability to make the required environmental investments. Conversely, refiners also worry whether their already strapped operations can survive spending billions of francs in added outlays that offer no financial return.

Signs of shakeout: Shell

Shell and BP each took dramatic steps at midyear toward restructuring their French refining operations in early examples of the shakeout.

Shell France last May disclosed cuts of 600-700 jobs in its refining/marketing division work force of 3,200 and that it is seeking partners for its refineries and chemical units. That came on top of job cuts totaling 450 at Shell Chemie, the company's chemical unit.

The restructuring comes on the heels of 2 consecutive years of losses totaling 3 billion francs for Shell France. In first quarter 1993, Shell France posted a loss of 390 million francs, compared with a loss of 238 million francs in first quarter 1992. In addition, Shell France had accumulated debt totaling 6.5 billion francs by yearend 1992.

Shell's parent answered speculation over Shell's possible withdrawal from France by earmarking 2 billion francs in capital spending for the French unit, declaring France to be a key market. Yet Shell's commitment to France comes with an equal commitment to restore profits. Shell France Pres. Peter Hadfield said the job cuts will be voluntary and accompany partnerships in the company's three refineries and marketing rationalization.

One approach such refining partnerships could entail would be to form a new company to manage operations of the refineries with partners within the Royal Dutch/Shell Group in Europe or elsewhere. Parent Royal Dutch/Shell undertook such an approach by creating a new company to manage, beginning in 1994, the group's U.K., German, Dutch, and French tankers.

Similar alliances are being considered for Shell's chemical operations in France. Negotiations are under way between Shell and Italy's Montecatini involving Shell Chemie assets. Hadfield said that venture could include the new Notre Dame de Gravenchon polyethylene unit owned jointly with Exxon Chemical Co. in northern France and the Berre steam cracker on the French Riviera.

Signs of a shakeout: BP

British Petroleum Co. plc in mid-June launched a takeover bid through BP Europe Ltd. for the 14% of BP France's stock it does not own at a price of 120 francs/share, or about 700 million francs.

The offer was upped from an earlier bid of 80 francs/share.

BP France Pres. Raymond Bloch said the parent's efforts to fully acquire its French subsidiary did not mean a restructuring campaign is in the offing. However, the takeover bid sparked a flurry of speculation about BP's future in the country.

BP's French unit posted an operating loss of 322 million francs in 1992 and expect comparably grim results this year. As with BP's other European affiliates, BP France has been technically integrated under the BP Europe umbrella in Brussels but not legally incorporated within that structure. Bloch recently disclosed his early retirement at age 55, to occur Oct. 1, and his replacement by current General Manager Paul Castellan, also 55, who will merge the jobs of president and general manager. That disclosure fueled more speculation about the diminishing importance of what used to be one of BP's major affiliates.

BP disputes any connection between the takeover bid and Bloch's imminent departure, but Bloch said, "The evolution of BP France the last few years no longer warrants keeping a president and a general manager." Analysts took that to mean the gradual Europeanization of BP France under Bloch's guidance.

It's unlikely BP will shut down or sell its Lavera refinery in southern France. The plant is BP's only refinery in southern Europe. However, full ownership of BP France will give the parent needed flexibility to form a partnership or joint venture in France with another company.

French refiners' problems

France's refineries are comparable technically with their European competitors, noted Olivier Appert, director of the hydrocarbon directorate at France's Ministry of Industry.

However, French refineries designed to produce mainly gasoline now must cope with a market in which diesel fuel demand growth of about 6-7%/year far outpaces demand growth for gasoline. At the same time, demand for heavy fuel oil is depressed because of the French govemment's strong bias toward nuclear power plants, which now supply 75% of the nation's electrical power.

France is the biggest consumer of diesel fuel in Europe, It currently uses about 400,000 b/d of diesel, compared with 350,000 b/d of leaded and unleaded gasoline. French refiners can meet almost all of the domestic demand for gasoline but only 80% of the domestic demand for diesel. That situation is aggravated by tax breaks and diesel use initiatives promoted by French automakers Peugeot and Renault.

Because demand for heavy fuel oil is stagnating, French refiners cannot compensate for the increasing diesel demand through using more of the middle of the barrel.

With that split on products trends, strong demand for diesel makes it more costly for refiners to implement European Economic Community directives on sulfur content. Accordingly, an added tax of 28 centimes/I. on petroleum products to help trim the French government budget deficit will only slightly narrow the gap between prices of diesel and premium gasoline. France's tax rate on premium gasoline of about 79% of the pump price, recently up from 77.7%, is the EC's highest.

Surplus capacity

Industry officials blame lingering overcapacity in Europe for the refining margin squeeze.

Total Refining & Marketing Pres. Jean-Claude Vettier estimates surplus capacity at 500,000-600,000 b/d.

"Out of the 115 refineries in western Europe, 30-40 posted negative earnings before tax under last year's conditions," he said. "Faced with huge mandatory investments the next few years, it is clear that some refineries will be unable to meet these costs and will have to go out of business. To restore the balance in Europe, it would only need for 10 refineries to drop out."

His view was shared by a veteran oil industry analyst who sees membership in Europia, the European petroleum association, halved the next few years. The most likely dropouts will be regional niche companies, he noted, those established to serve local markets and lack the critical size and financial base needed to survive.

Europeanization?

France's refiners do not consider themselves "regional" companies.

Five are affiliates of large international majors, and the two French companies are majors in their own right. The two French majors' refining strategies can be equated with those pursued in Europe by parents of French affiliates. Conversely, those affiliates are developing domestic strategies that are increasingly being drawn into their parents' European group strategies. At this stage, however, the Europeanization process varies according to company and is restricted, even in the most advanced cases, to product coordination and exchanges, pooling procurement services and equipment purchases, and other ways of achieving economies of scale.

"Oil companies in France," Vettier said, "are much less European than chemical companies. Coming from a chemical group, I was surprised to see how even the international affiliates in France had maintained their national reflexes. Oil companies in France are nationals first and European only marginally."

European environmental constraints and common product specifications will do far more to Europeanize the refining industry than any company strategy, he contends.

Technical problems

Meanwhile, French refiners face technical problems specific to the domestic market.

A key problem is not so much excess capacity as it is the increasing maladjustment of French refineries to the country's special market conditions, especially with conversion units designed around optimum gasoline production.

"As it stands, France's refining industry has no intrinsic technical handicap," Appert said. "In any other country, it would be fairly well adapted. "

In terms of conversion rate or refinery size, he believes France is average in Europe. But with its production base increasingly at odds with market demands, Appert worries that, in the long run, excess supplies of gasoline could permanently jeopardize refinery profits. In addition, the big share diesel commands in France's motor fuels mix will make application of the EC's reduced sulfur content directive more costly. French refiners also must cope with other handicaps specific to France that further depress margins. At the top of the list is open access to France's products market, Vettier noted.

"Anyone can buy oil products and flood the French market," he said. "There are too many importers. France is a wide open field, not like Germany or Britain ... France is a net importer of middle distillates, and surprisingly, of gasoline."

Another handicap Vettier lists is oil industry salaries, higher in France than elsewhere in Europe. Taking 100 as an index, salaries break out as 115 in France, 110 in Germany, 92 in the Benelux countries, and 78 in Britain. Port fees and local industrial taxes are also more costly than in other European nations.

Such adverse industry conditions are compounded by the battles oil company service stations must wage against chain hypermarkets that sell motor fuel at discounted prices. Hypermarkets account for about 40% of a market that is experiencing a prolonged economic slump and shows little sign of picking up near term.

Refineries at risk

So it follows that French industry analysts consider inevitable in the mid to long term a narrowing of the refining field in France.

In support of this view, they point out that French refining capacity has almost been halved since 1980's level of 3.2 million b/d. Analysts point to Mobil as the most likely candidate for full withdrawal from France, because last year it pulled out of southern France to concentrate its service stations in the northern region around its Notre Dame de Gravenchon refinery.

Also considered at risk by the same analysts is Esso's Fos refinery on the French Riveria and Shell's Petit Couronne refinery in Normandy, northern France. However, when asked directly about these prospects, the companies involved dispute the analyses.

"No oil company withdraws from France," insisted one company official. "It is a strategic market, like Germany and Britain."

Companies seem to be taking the prospect of huge mandatory outlays in their stride. As one analyst explained, "Companies tend to overreact to new regulations because they haven't found the most cost effective way of dealing with them. In the next stage, they find ways of doing it cheaply and convert the mandatory into something profitable."

This view can be seen in the way each company is dealing with the situation. Strategies focus on one or two niche products, confining business, whenever possible, to a geographic region surrounding a refinery along U.S. lines, and seeking a partner to share the cost of running a refinery.

This is in addition to a number of cost cutting measures from work force reductions to logistical concerns. It has become increasingly important for products to reach market at the least possible cost.

For example, Mobil Oil Francaise has sought to embrace most of these moves in its new regional strategy while it maintains a role as Mobil's top producer worldwide of lube oils, produced at the Notre Dame de Gravenchon refinery. The refinery, an official pointed out, is well integrated with Mobil Europe.

Shell France strategy

Shell France is in the early stages of a strategy built around its commitment to the Royal Dutch/Shell Group to restore profits, said Jean-Claude Dupuy, Shell France vice-president for supply and refining.

The company also must grapple with a domestic capacity overhang. Shell's French refining capacity totals more than 310,000 b/d, compared with its domestic supply needs of only 200,000 b/d.

The parent is no longer willing to shore up its money-losing affiliate, making it vital for Shell France to find partners for its refineries. One approach has been made to Total. The suggestion was that Total share Shell's Berre unit in Southeast France instead of rebuilding the neighboring La Mede refinery, damaged in an explosion early this year. Nothing came of the offer, said Dupuy, because Total preferred to rebuild Le Mede using an insurance settlement to do so.

Shell France operates CRR's Reichstett refinery in partnership with Total, BP, and Mobil. It has a 65% stake in what is France's only refinery in the northeast corner of the country, which Dupuy described as a niche market because it also supplies the German market.

While the Berre refinery is part of a substantial petrochemical complex, the Petit-Couronne unit in Normandy is less upgraded and has no petrochemical base. But, Dupuy pointed out, it is being specialized in production of lube oils and bitumen.

That Shell France intends to hang on to its three refineries is demonstrated by the 100 million francs being spent on each to debottleneck and revamp them, install hydrodesulfurization units, and add reactors, catalysts, and piping. By October, the new sulfur recovery unit at Petit-Couronne will be on stream at a cost of 170 million francs, a project designed to reduce sulfur dioxide emissions.

Dupuy also noted Shell France has a big market in bunker oil and exports or uses in its refineries the heavy fuel oil it produces. He acknowledged, however, that the EC's lower sulfur content specifications looming for heavy fuel oil could kill that market.

"There is no way of justifying a deep conversion unit with margins expected to remain low for a long while," he said. "But we are considering no closures. We use conversion capacity to the maximum. Any one closure of conversion capacity will lose money.

"We manage to break even but not generate the sort of money we need. Hence the job cuts, selective investments, cost cutting measures, and the focus on improved logistics. Hence also the need for a good, solid partner."

Shell France works closely with the parent group in Europe, notably its research division, Dupuy noted.

"The great question is: Should one speak of Europeanization in terms of country coordination or in terms of product synergies?"

The company has cross-processing agreements with other companies in countries close to its refineries: Agip SPA in Italy and Petrofina in Belgium.

Esso's focus

Esso's SAF's Port Jerome refinery in Normandy, northern France, is working at full capacity and is part of a large petrochemical complex.

Moreover, it is at Port Jerome where parent Exxon has its sole white oils production unit. The refinery is the world's top producer of white oils. Port Jerome also has significant asphalt production and provides 20% of France's jet fuel market and a sizable share of the domestic marine fuels market.

Esso has placed on stream a 350 million franc, 4,000 b/d alkylation unit at Port Jerome. Esso opted for alkylation over isomerization because it boosts octane without increasing gasoline production as much, a concern in the slumping French market. Further, the sulfuric acid process based alky unit is fed butane from Exxon Chemical's steam cracker at Port Jerome.

The Fos refinery in southern France, struggling with competition from other Mediterranean refineries, is working at only 50-65% of capacity.

"We use it as a swing producer to balance our supply and demand needs," an Esso official said. He does not see Fos at particular risk but notes Esso is the leading refiner in Europe with 10 refineries.

There are many directives under discussion in the EC, and depending upon what emerges, parent Exxon might be led to make a number of strategic decisions involving either revamps or shutdowns.

Although less sophisticated than the Port Jerome refinery, the Fos plant produces asphalt as well as gasoline and diesel. Exxon has a deep conversion unit in Rotterdam that relies on maintaining feedstock and product supply arrangements with other Exxon refineries in Europe.

In France, Esso has an edge over affiliates of other multinationals in that it has a relatively profitable upstream sector. Esso REP is France's leading oil producer. Over the years, the upstream has served to balance the downstream in the latter's less profitable periods.

BP France prospects

Oil industry analysts in France have mixed feelings about BP France.

The recent purchase by BP Europe of the remaining 14% of BP France it does not own has given rise to a number of rumors, including possible withdrawal.

One analyst described the Lavera plant as a "high quality refinery," with the country's only hydrocracker. However, another analyst claimed BP France is becoming "increasingly marginal" in France for that reason. The Lavera refinery's reliance on its hydrocracker will leave it taking the full brunt of the mandatory environment investments for reduced sulfur content of diesel, in addition to being short on gasoline, he pointed out.

Bloch and Castellan took pains to explain that full ownership by BP Europe of the French affiliate is a necessary step in the parent's strategy of knitting all its European affiliates into a single structure with centralized decision making.

"Full ownership will provide greater flexibility to seize all immediate opportunities," said Castellan, without elaborating. It could be a joint venture or alliance or some other form of partnership but would in no way change the parent's or BP France's strategy, he said.

The Lavera refinery, Castellan stressed, is the group's only refinery in the Mediterranean, and considerable investments have been made at the plant the last few years. The octane program is complete with installation of an isomerization unit, and future requirements will be less costly-including the diesel sulfur specs, which "would be dealt with in its own good time."

In a joint venture with Elf, BP France also is investing 300 million francs in its Dunkirk refinery, which produces only lube oils, to boost production capacity to 6,400 b/d from 5,000 b/d. The next major investment, a conversion unit, won't be a consideration for another 5-6 years, Bloch said. If it gets a green light, that project could be built either as a full scale unit or in phases within a group project.

Although projects to implement productivity gains at Lavera are not complete, BP France's refinery compares favorably in terms of operating costs with other BP refineries in Europe, Castellan said.

"If we were in any other country in Europe," he said, "our 400 million franc loss of last year would have been a 250 million franc profit. We lack that extra 20 centimes/I. on premium gasoline because of stiff competition in the French market."

Total's strategy

Total's strategy takes a different tack from foreign majors' affiliates in France, focusing on expansion of refining operations outside France and realigning them to reflect fading borders.

Total has set up a management team to oversee all its European operations, The company has an 8% share of the U.K. market, concentrated in the southern U.K. through its Lindsay refinery, which Vettier described as "increasingly well balanced in its market."

Through the Flessinger refinery in Netherlands it has 5% of the Benelux market and exports to Germany, while through the Reichstett refinery it has 4-5% of the Rhine region market.

"We function in Europe and in France on a regional basis," Vettier said. "But the system has its limits for it is countered by product exchanges. Total is very strict about keeping to its own product standards."

Vettier claims Total has a fully integrated refining/marketing system in France. "We produce and sell within a fully integrated circuit," he said, "although we are short in southern France and long in our Flanders and Normandy refineries in the north.

"This is why we were so keen to rebuild La Mede. We examined with all refiners in the area how some kind of long term industrial arrangement could be worked out to replace La Mede. We came to the conclusion that, considering our needs in the area and the nature of our integrated system, we needed to rebuild La Mede. The FCC cracker should be back in working order in mid-1994, while the alkylation unit is due on stream this September."

Vettier said Total is strategically better situated than most other oil companies in France because of its refining layout. There are isomerization and alkylation units in all Total refineries. Each is capable of producing middle distillates with a 0.15 wt % sulfur content because of desulfurization investments already carried out. Lower sulfur content specs for diesel could be met at little extra cost, he said, pointing out that Total has a strong position in the diesel market, especially with truck driving Total charge card owners. Vettier claims Total's product specs can't be matched by any other oil company in France because of its refineries' configuration of isomerization units, aromatics extraction units, the high performance desulfurization units, and addition of oxygenates to gasoline. Total exports its bottom of the barrel products and tries to keep its imports to a minimum. Even at that, Vettier believes that with currently poor prospects for profitability, the refining business in France is not generating enough cash to meet future mandatory environmental costs. Still, Vettier has not given up a proposal to build a deep conversion unit.

"We are discussing with Saudi Arabia a partnership under which we would be assured of steady supplies of sweet crude from Saudi Arabia to feed a deep conversion unit in which the Saudis would have a stake. Thus the economic risks of such a venture would be reduced."

Elf's approach

Unlike Total, Elf does not aim for a fully integrated refinery/marketing network in France.

Instead, Elf skims production of its three refineries for 60% of its needs, focusing on production of high grade gasoline.

"We are net product importers, especially of middle distillates," explained Alain Guillon, director of Elf's refining/marketing unit. "It is not profitable to produce middle distillates in France for a number of reasons. So we are less affected by environmental costs."

"We have developed our refining business on the American model, with marketing regions around our refineries: Donges in Brittany in the west of France, Grandpuits near Paris, and Feyzin near Lyon in eastern France.

"In addition, we have acquired a number of independent networks since 1990 to increase our market shares and balance production and sales of gasoline."

Elf built up its refining business in Europe in 1990-93 through what Guillon calls "and imaginative allianace and acquisition policy that involved focusing on core sectors." Thus Elf pulled out of the U.S. and various nonstrategic businesses in France to develop its refining base in Europe.

Through purchase of Amoco Corp.'s interests in Britain, including a 70% interest in the Milford Haven refinery, and later acquisition of the Heron network, Elf now accounts for 5% of the U.K. market, notably 8-10% of Southwest England.

Through its gradual acquisition of 30.4% of Spain's Cia. Espanola de Petroleos SA, Elf accounts for 25% of the Spanish market, including 25% interests in the Algesiras, Santa Cruz de Tenerife, and Huelva refineries.

Through an alliance with Germany's Thyssen, it entered the East German privatization fray and acquired the Leuna and Zeiss refineries, soon to become a single new grassroots refinery at Leuna.

Elf also acquired the Minol network of service stations in Germany. That gives it 30% of the East German market and 8% of the total market in Germany, which Guillon describes as a launching pad for downstream expansion in eastern Europe.

"We now have 70% of our refining/marketing business in France and 30% in each of three other countries, with economies of scale achieved either nationally or regionally. Our aim, within the next 10 years, is a 70-70 ratio without reducing our position in France. "

He added that in view of the forthcoming "investment war" for refineries in Europe, Elf is open to other alliances. Elf's pending privatization won't affect its current downstream strategy, Guillon said, noting, "After all, we already have 300,000 public shareholders.

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