On Nov. 17, 2010, the European Commission adopted a "Communication 'Energy infrastructure priorities for 2020 and beyond—A Blueprint for an integrated European energy network.'" In the document, the commission defines EU "priority corridors" for the transportation of electricity, gas, and oil (OGJ Online, Nov. 18, 2010).
A background document released at the same time—"Commission Staff Working Paper: On Refining and the Supply of Petroleum Products in the EU"—presents an overview and analysis of problems facing European refiners.
This is the second of three articles that present the elements of that working paper. The first article (OGJ, Jan. 3, 2001, p. 90) examined demand issues as they have and will affect European refining. This second article presents the working paper's views on supply issues and the economic viability of the European refining industry. The final article (OGJ, Mar. 7, 2011) will present the effects of future demand developments on European refining by 2030.
Production declines, variations
North Sea crude production (from Norway, UK, Denmark) fell to 4.3 million b/d from 6.4 million b/d 2000-08. Over the same period, supplies to Europe of heavier, more-sour (more sulfurous) crudes from Russia and Africa were growing. The result was an increase in the proportion of heavy and sulfurous crudes coming into EU refineries, as well as a higher dependence on oil imports from third-party countries that represented 80% of EU crude refinery intake in 2008 against 75% in 2000.
The impact on the EU refining industry of lighter crude being replaced by heavier crude varied according to region, with Northwest European refineries being especially affected. Nearly 100% of the crude refinery intake in Ireland and Denmark originates from the North Sea, followed by the UK (80%), Sweden (57%), Germany (27%), France (21%), Finland (17%), the Netherlands, and Belgium (14%).
Conversely, in Central Europe, refineries are often located on the Druzhba pipeline, and most of their intake is Urals crude. In the Mediterranean area, the larger proportion is Arabian Gulf, which is again heavier than Urals crude with similar API but higher sulfur content, followed by Urals crude.
Falling production of North Sea crude in an environment of growing demand for lighter distillates represents a major concern for NWE refiners. Lighter crude oils such as North Sea crude produce a higher share of more valuable light products that can be recovered with simple distillation, while heavier crude oils produce a greater share of lower valued products (such as fuel oil) with simple distillation and therefore require additional processing to produce higher value products.
North Sea crudes have an additional attractive property: low sulfur. Higher sulfur crudes are naturally less valuable in an environment of lower sulfur fuel specifications, as in the EU. In addition, the impurities in heavy, high-sulfur crudes, such as nitrogen and metal, generally increase as the crude becomes heavier and further increase the processing severity required to convert heavy crudes to light products.
The quality of crude oil thus dictates the level of processing and reprocessing needed to achieve the optimal mix of product output, with a trend towards heavier and more sulfurous crudes leading to a more complex and costlier refining process, such as via use of deep conversion or desulfurization units, also leading to higher CO2 emissions.
In the future, it isn't clear how Europe will be affected by the changing global crude diet. In the short term, according to the International Energy Agency, the average crude density may slightly lighten with a marginal decrease in the sulfur content until 2014 mainly due to the impact of growing condensate volumes produced by member states of the Organization of Petroleum Exporting Countries. Lighter supplies from Russia, Africa, and the Middle East will likely increase, according to the IEA, partly offset by expected Canadian crude mix, where new production from heavy oil sands is mostly sour.
In the longer run, NWE crude intake from the Urals, Caspian, and Middle East will gradually come to represent growing proportions. This trend may become a key problem for refiners in that region, pushing them towards investments to adapt their plants in order to refine the changing flow of crude.
Impact of biofuels
In the EU in the next 20 years, it is likely that much or all of the growth in motor-fuel supply, which represents the largest use of processed crude oil, will be in biofuels. A key driver of the supply of biofuels in the EU will be the organization's Renewable Energy Directive. This sets a 10% target for use of renewable energy in transportation by 2020, the majority of which will likely be contributed from biofuels, which must meet certain specific sustainability criteria.
The increasing use of biofuels will affect EU refiners in terms of a reduced need for supply of conventional fossil transport fuels. In the case of biodiesel, it has the potential to reduce the growing pressure on the need for diesel.
On the other hand, increasing the share of such biogasoline blendstocks as ethanol in the European gasoline pool could further reduce the market for refinery gasoline. This would be problematic to refiners, given that there is already an excess of gasoline-producing refinery capacity in Europe, as noted earlier.
Marine fuel restrictions
The future marine sulfur-fuel specification requirements mentioned above are likely to pose difficulties to the industry in supplying resulting demand. While supplying 1% sulfur fuel should pose no significant problems for refiners–blends can simply be modified to redistribute the higher sulfur components—the real challenge will be the changes to 0.1% sulfur content and 0.5%, respectively, for emission control areas (ECAs) and the rest of the world, as these will likely require the conversion of bunker fuels to diesel. This will require investment in desulfurization or conversion capacities.
Current technology cannot achieve reductions in sulfur content of residues to 0.1% unless a very-low-sulfur feed is used. Even if it were possible, it is questionable whether refiners would not rather prefer to focus instead on converting residual fuel to other lighter, more valuable fuels, and decide to stop supplying the bunker market altogether.
Production of additional gas oil, however, whether for the marine sector or in order to meet current EU demand, poses an additional problem for EU refiners, as it implies further cracking or breaking up of the heavier remaining products. Complex refineries are more energy intensive and emit more CO2 than simple refineries. Every additional cracking process and every additional desulfurization step need energy and thus increase CO2 emissions. Increasing gas oil production in the context of ever tighter sulfur specifications will therefore lead to an increase in CO2 emissions by EU refining.1
EU refiners, which will be required either to purchase permits to emit CO2 or to improve the CO2 emission efficiency of its plants,2 will therefore have to pay more for the CO2 emissions from (more complex) refineries producing products the EU requires (i.e., middle distillates). For the same reason, careful consideration of the impact on refineries needs to be given when designing implementation measures to reduce fuel life-cycle greenhouse gas emissions, contained in the EU's fuel-quality directive (OGJ, June 15, 2009, p. 44).
This leaves the EU with the dilemma of, on the one hand, relying more heavily on imports of petroleum products into the EU or, on the other hand, hoping that EU refiners will produce more of the required products, even if (all else being equal) it means emitting more CO2 and therefore having to pay for it.
The future price of carbon in the EU's Emissions Trading Scheme is therefore a crucial issue to the industry and to the EU, as the higher it is, the more the risk that it exceeds the freight costs that an importer of such refined products as diesel would incur from shipping the product from abroad, with no overall benefit in terms of CO2 emissions.
According to the refining industry, it would have to buy about 25% of its allowances to maintain activity that, inclusive of the additional costs of CO2 in purchased electricity, should cost the sector more than €1 billion/year, based on a price of €30/tonne.3
EU refining profitability
Falling demand for petroleum products at a time of stable levels of capacity have in turn sharply affected refining margins. The impact of the recent crisis on refining margins has been particularly harsh, as Fig. 1 shows, with both simple (hydroskimming) and complex (cracking) margins hitting 15-year lows in 2009.
Views diverge on when, in the future, the sector will experience recovery in margins and to what extent. While acknowledging a recovery in margins at the start of 2010 due to a drawdown in oil product inventories and recovering demand, the IEA in January 2010 predicted that construction of refineries globally over the previous 2 years and a massive contraction in oil consumption during the recession have led to a global glut of capacity. It thus maintains a bearish short-term outlook for the global industry.4
Looking further ahead, the combination of the prospect of increasing demand for middle distillates—including widespread global dieselization (as mentioned previously)—with consequent increases in low-sulfur fuel/middle distillates5 prices as well as rising crude prices6 lend support for a recovery in complex margins in the coming years in the EU7.
Global competition
Asia and the Middle East have been building new, larger, more cost effective and generally more complex refining units in recent years, so that the regions are becoming key players in global refining markets.
In spite of the crisis, Asia and the Middle East added 1.6 million b/d of new crude distillation capacity in 2009 and at least a further 600,000 b/d in 2010. In terms of expected refining projects in the next 5 years, the two regions combined will add nearly three quarters of all additional capacity in the world.
Given how close the region is to Europe, expectations are that the Middle East will likely become a key provider of refined products, especially of middle distillates, to Europe. European imports of kerosine and jet fuels already originate mainly from that region. It is planning some 1.7 million b/d of additional capacity, which is expected to come on stream by or around 2015. New projects include several large export-focused refineries that are being cofinanced by European-based oil majors such as Shell and Total.
For some, the idea of even importing refined products from places as far from Europe as Asia is not far-fetched, with the view that operators of large refineries there could prove able to deliver products to the EU at prices competitive with home production.8 While this may be true, the extra freight and logistical costs of importing from such distant places could mean that the price of end products will rise, to the disadvantage of end users. Admittedly, freight and logistical costs could also decline in the future, should the size of vessels employed to import refined products increase.
In practice, Asian oil firms are already eyeing the EU market. India's Essar has been expanding its home refinery at Vadinar with the aim to export to Europe (OGJ, Dec. 27, 2010, p. 19), and in late 2010 it was negotiating with Shell to acquire three of its European refineries (Stanlow in the UK and Heide and Hamburg-Harburg in Germany) with the intention to close them and turn them into import terminals.
PetroChina has also been in talks with Ineos over an investment in its Grangemouth refinery in Scotland. In addition, state subsidies are supporting some refineries in such countries, with the example of Chinese refiners that have been running record high throughputs in 2009 due in part to guaranteed margins. For instance, Sinopec, a state-controlled refiner, is subsidizing its refineries to export products, thereby encouraging them to maintain high throughputs.9
The industry believes that with limited domestic demand for high-quality fuels, Indian and Middle Eastern refiners will seek to use the EU market as a temporary outlet for excess production until local markets grow sufficiently to absorb production. It warns that over time, the combination of domestic market growth and tightening product specifications could then see such players refocus on their domestic markets, with consequences for a more import-dependent Europe.10
Upgrade investments
As mentioned previously, a growing trade gap is avoidable should EU refiners decide to invest heavily in upgrading existing capacities to make them more complex and thus able to skew the production mix towards more diesel and less gasoline.
According to the industry, in order to fill a gap in demand of 30 million tonnes/year of gas oil and jet fuel (in 2008, EU net imports of gas oil/diesel and kerosine/jet fuel amounted to 36.7 million tonnes), EU refiners would need to build about 20 large hydrocrackers at a cost of more than €8.5 billion.11
As was already highlighted, an additional 15 million tpy of low-sulfur gas oil/diesel is likely from marine sulfur fuel restrictions being lowered to 0.1% from 1% by 2015. Producing an additional 15 million tpy of gas oil would require investment of about €4.5 billion, representing 10 upgrading projects, according to the industry.12 This would come on top of the 20 projects cited previously.
Taking also into account the further costs that would need to be incurred to meet the proposed MARPOL global specification changes to 0.5% sulfur content globally from 3.5% currently by 2020,13 additional costs associated with the full changes in sulfur-fuel specifications could run into as much as €23 billion by 2020 in the EU.14
According to industry, capital expenditure associated with previously announced projects to be built in the EU within the next 6-8 years was on the order of €34 billion. In a context of low refining margins, however, many of these projects may not be implemented and the latest estimate is that only some €14 billion of investments might be spent improving European refining in the next 6 to 8 years, again depending on economic conditions. Historically, European refiners have invested an average of around €5 billion/year over the past 20 years in desulfurization capacity of distillates and gasoline, upgrading of production facilities and processes, and installation of emission abatement equipment and energy savings.15
Good and stable economic conditions—ensuring high and stable margins—are important for investment in new refining and conversion capacity to occur, as several years can come to pass between the decision to build a refinery and start of production. Yet, as has been said, although margins are trending up again, they are still low and there is some uncertainty as to how they will develop.
Even if prospects were more positive, however, there would be no guarantee that EU refining would make the necessary investments to meet the shortfall in supply of middle distillates. Tightening fuel specifications as well as the demand focus on diesel are not new phenomena in Europe; yet the industry has been slow to adapt. This is because until now, there has been a market for the excess gasoline produced by EU refiners, so that the industry could opt not to carry out all of the investments required for more hydrocracking units to produce more middle distillates and deep conversion units such as cokers and residue cracking installations to produce low-sulfur marine fuel.16
Also, while European refiners have been faced with dramatic reductions in demand for fuel oil since the 1980s, at the same time the rapid development in North Sea crude production, along with increasing demand for bunker fuel, allowed especially coast-based northwestern EU refiners to avoid fuel oil conversion investments.
Last but not least, while EU refiners have suffered on several occasions from economic downturns and oil shocks, there have always been prospects of recovery and continued growth in demand, which eventually did take place. In this instance, future EU demand prospects are bleak, especially if put in the context of growth prospects in other regions of the globe such as Asia Pacific and the Middle East.
While there is considerable need for further investments by EU refiners, therefore, and in the case of falling gasoline exports, a real incentive for the EU industry to invest, there are many developments that—taken together—make such investments unlikely, not least the growing costs of refining in the EU, the falling supply of North Sea crude, and uncertain prospects in terms of refining margins.
Impact of restructuring
Overall, known planned and actual divestments and shutdowns in EU refining capacities since the start of the crisis in 2008 extend to 18 out of 104 refineries in the EU, representing some 134 million tpy (2.7 million b/d) of crude capacity, equivalent to 17% of total EU refining capacity (Fig. 2). At publication of this report in late 2010, only two of these units had been sold, others had been for sale for some time but found no buyers, and others have yet to be shut down for extended maintenance until market conditions recover.
The most vulnerable types of units are either small to medium-size or gasoline-oriented refineries, which are less adapted to current demand patterns. The industry, however, warns that restructuring of gasoline capacity could also affect diesel production if, instead of divesting only of gasoline units such as fluid catalytic converters or catalytic reformers, EU refiners opt to shut down entire refineries altogether.17
Assets that have been put up for sale since the crisis and still await buyers amount to close to 900,000 b/d. It is expected that at least another 400,000 b/d of capacity is likely to be formally put up for sale in the foreseeable future as a result of the crisis. In addition, refining capacity that is known to have been temporarily shut down as a result of the crisis amounts to some 900,000 b/d. These units could either be restarted or eventually also be put up for sale, depending on market conditions.
Note that no complete shutdowns have been announced by EU refiners. Since the beginning of the crisis, uneconomic assets that have not been put up for sale have generally been subject to extended maintenance or temporary shutdowns, while assets that have been formally shut down are in fact being converted to depots or storage (equivalent to 258,000 b/d at yearend 2010).
Opinions abound on the amount of capacity that needs to be shut down in the EU. These range from 640,000 b/d to 2 million b/d, equivalent to 4-15% of total EU capacity, with the view that such decreases are necessary for a return to acceptable margins and in order to prevent further increases in the volumes of gasoline supplies.
If 2009 utilization rates of 79% (calculated as a proportion of product consumption to total capacity) for countries that comprise the Organization for Economic Cooperation and Development (OECD) Europe provide a good guide of the likely long-run utilization rate for the EU industry, then it could be argued that there is 21% excess capacity. This exceeds the total capacity of the 18 refineries in question.
It is not known how many employees these "vulnerable" refineries represent, and estimates are imperfect, as indicators such as capacity, utilization, and complexity cannot by themselves provide an accurate guide. In addition, while the number of direct employees is known for some refineries, there are several additional indirect employments that depend on a refinery for their livelihood, whether as subcontractors working on site or as providers of products and services either to the refinery or to employees of the refinery. The number of dependent indirect employments as a multiple of direct employments for a refinery can be on the order of three to five, according to representatives of the industry.
Thus, while the industry itself employs directly only 100,000 people in the EU, it can be considered that as much as 400,000-600,000 jobs directly depend on EU refining. This figure excludes the further 600,000 jobs in logistics and marketing.
The gradual disappearance of refining activity in the EU would also have consequences for the industries for which a local refining presence is important. The EU petrochemical sector, which employs 778,000, is perhaps the best example of such an industry.
There are 58 steam crackers in the EU, 53 of which were operating at yearend 2010, while 77% of the feedstock of those 53 operating crackers comes from refineries. Of the 58 steam crackers in existence, 41 are directly integrated refinery steam crackers.
According to the petrochemical industry, having refinery and interdependent industry on the same site brings a number of synergies not only in terms of the supply of energy but also of support services and product exchanges. More than 5.3 million tonnes of products from crackers are sent back to refineries, equivalent to 12.5% of total refinery transfers to steam crackers. This includes hydrogen, which is produced in excess by the crackers and of which refineries are normally short and which is used by refineries in hydrocrackers to upgrade heavier fractions into lighter products, such as diesel, naphtha, and kerosine. It also includes butanes and gasoline.
The relationship is therefore mutually beneficial, although integrating refineries and steam crackers is not the strategy employed by all the oil majors; and, while Total as well as ExxonMobil are highly integrated (upwards of 74%), BP and Shell have relatively lower levels of integration (24% and 39%, respectively).
The degree of integration with the petrochemicals industry is also only one of several factors that will influence how vulnerable a refinery is to being closed down. Other key aspects will likely include how clean and efficient (in terms of CO2 emissions and pollutants) is the refinery and its flexibility and fit in terms of meeting market demand. The cost of access to crude oil is another factor.
Preparing for 'decarbonization'
For beyond the next 20 years, up to and as far as 2050, the key challenge for EU refiners on the basis of current EU ambitions for the environment and climate change is less one of partial restructuring and adaptation or upgrading of refining capacity and more one of a radical departure from oil as the main transport fuel or as a key source of energy.
Energy and transportation are the targets of the vision to a move towards a low-carbon, resource-efficient, and climate-resilient economy by 2050, and as an energy-intensive industry supplying mainly fossil-based fuels to the transport sector, EU refining will be concerned by developments to implement such a vision.
Transportation in particular has been the sector most resistant to efforts to reduce CO2 emissions due to its strong dependence on fossil-energy sources. Currently, the sector is responsible for about a quarter of EU CO2 emissions and also contributes greatly to reduced air quality and related health problems, particularly in urban areas. While energy and transport efficiency as well as effective transport demand management can all contribute to reducing emissions, the ultimate solution to nearly full decarbonization of transport is the substitution of CO2-free alternative fuels for transport for fossil sources.
Such a vision is guided less by idealistic ambition than practical as well as moral imperatives:
• Oil, the main energy source for transport overall, supplying nearly 100% of road transport fuels, is expected, with present knowledge, to reach depletion by 2050. Substitution of oil therefore needs to start as soon as possible and increase rapidly to compensate for declining oil production, expected to reach its peak within this decade.
Climate protection and security of energy supply objectives would therefore both benefit from building up CO2-free and largely oil-free energy supply to transport with a time horizon of 2050.18
• By 2030, the global automobile fleet is predicted to grow to 1.6 billion vehicles from 800 million and to 2.5 billion by 2050. This will be accompanied by an increasing scarcity and cost of energy resources. These trends will have to be addressed by a step change in technology to ensure the sustainability of mobility in the long term.19
As the EU progressively decarbonizes the transport sector, it is inevitable the sector must directly consume less fossil energy, since it is unlikely ever to be viable to capture CO2 emissions on vehicles. While the oil industry does not foresee the end of oil as a major energy source by 2050, a number of its companies have already made significant investments to move away from dependence on oil and offer examples of how some of the actors present in the EU refining market are looking at the longer term.
References
1. 2009 estimates of the costs of changes in marine sulfur fuel specifications by Purvin & Gertz for the European Commission are for 7 million tpy of extra CO2 emissions by 2015 (due to changes to 0.1% sulfur content), representing an increase of 5% vs. baseline CO2 emissions of 142 million tonnes in 2015. Including the change to 0.5% globally, total increases in CO2 emissions by 2020 could reach 11.8 million tpy.
2. As the EU refining industry is included in the EU Emissions Trading Scheme (ETS). Note that the EU refinery industry has been recognized as being at risk of carbon leakage, on the grounds that crude oil and derived products are moved around the world in a very open market in which there is complete exposure to worldwide competition, which will allow the industry to obtain free permits for the first 2 years of the third phase of the ETS (2013-14). Free allowances will in principle be allocated based on product-specific benchmarks for each relevant product.
The starting point for the benchmarks is the average of the 10% most efficient installations, in terms of greenhouse gases, in a sector or subsector in the EC in 2007-08. The use of such benchmarks is to ensure that the allocation takes place in a manner that gives incentives for reductions in greenhouse gas emissions and energy efficiency efficient techniques. Furthermore, given that the benchmarks will be stringent, only the most efficient installations will have any chance of receiving all of their needed allowances for free.
3. It is worth noting, however, that the carbon price in the ETS has been trading at prices much less than €30/tonne, a combination of the crisis, higher-than-expected energy prices, and the build-up of considerable buffer of unused freely allocated allowances, which can be carried over into Phase 3 (2013-20) of the ETS. The ETS carbon price in the PRIMES Reference scenario in 2030 is €19/tonne of CO2, much lower than the PRIMES Baseline (€39) due to the achievement of the renewables targets and additional efficiency measures, which decrease electricity demand and emissions.
4. Oil Market Report, January 2010.
5. According to Purvin & Gertz, tightening sulfur marine fuel sulfur specifications would lead to increases in the prices of bunker fuels of between 30% and 75% in the ECAs by 2015.
6. Hydrocracking margins tend to be highest when crude prices are high and there is a wide price difference between light and heavy crudes, as hydrocrackers can take lowest-cost heavy crude and sell products into a high-price market.
7. As part of its work evaluating the impact of biofuels on the EU refining industry for the European Commission, Wood Mackenzie projected NWE Urals cracking margins (more relevant going forward than Brent cracking margins) to reach $3.45/bbl in 2010 compared with $2.62/bbl in 2009 and $4.62/bbl in 2008. According to the consultancy, margins should continue to rise slowly, reaching levels of $5.13/bbl in real (2010) terms by 2015.
8. "Downstream Depression," Petroleum Economist, April 2010 (www.petroleum-economist.com).
9. Oil Market Report, Mar. 12, 2010.
10. "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
11. "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
12. "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
13. Which would require an additional 100 hydrocracking projects globally in the next decade at a cost of €46 billion; "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
14. Source: estimates by Purvin & Gertz for the European Commission, 2009.
15. "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
16. One alternative approach to dealing with increasing demand for diesel and falling demand for gasoline would be to implement changes to the catalytic-cracking process (rather than develop hydrocrackers), so that these units could process heavy residues into diesel. One example of a specialist heavy residue catalytic cracking is a unit at Shell's Pervis, Netherlands, refinery.
17. "White Paper on EU Refining," Europia, May 2010 (www.europia20years.eu).
18. Report of the European Commission Expert Group on Future Transport Fuels, forthcoming, January 2011.
19. Communication on a European strategy on clean and energy efficient vehicles: eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=COM:2010:0186:FIN:EN:PDF.
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