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Covid-19 compounds European refiners’ challenges

The demand impact from widespread lockdowns causes an immediate demand headache. But longer-term structural obstacles remain

“The prospects for European gasoline look particularly grim at the moment.” So says Chris Judge, vice-president, crude and oil products at price reporting agency Argus Media and an analyst of European refined products markets for well over 20 years.

Or, rather said. As, to put into context the scale of both the short and longer-term challenges facing the European refining sector, Judge uttered these words in late February, before the extent of the impact of the Covid-19 pandemic on European and global products demand was clear.

These short-term challenges are daunting enough in themselves. The grounding of the majority of the world’s planes and strict lockdowns on people’s mobility bite hard into transport fuel demand.

Shutdown risks

Requirements for jet fuel have fallen dramatically. Consultancy Energy Aspects warns that refineries in Spain and the Netherlands are at particular risk of being forced to cut jet fuel output. “The financial pressures from [the pandemic] event will perhaps accelerate the rationalisation of capacity in Europe,” says Robert Campbell, the firm’s head of oil products research.

“My own judgment is that the energy transition will proceed at, if anything, a stronger pace in Europe” Beck, AspenTech

Not every refinery throughput is hit as hard as jet and middle distillates. There will be a more muted impact for refiners that produce a lot of marine fuel, according to Eugene Lindell, a senior consultant at research firm JBC Energy.

“From the [marine fuel] refiners’ side, we do not see any production issues as the low sulphur fuel oil crack is expected to be higher than the gasoline crack meaning that refiners will have an incentive to supply this fuel first,” says Lindell. “One complicating issue is that the low outright crude price automatically creates a narrower price spread between clean and dirty fuel. This is bad news for ship owners that invested in scrubbers, as it lengthens the payback period.”

Transition slowdown?

A key question for European refiners over the medium to longer-term is whether the strain on public finances that the response to Covid-19 will have caused encourages European states and institutions to slow down or even abandon costly initiatives to decarbonise their energy systems.

Relaxing certain rules could have a modest impact on the opex of refineries. But by far the most significant impact would be a move away from the trend of electrification in the transport sector, as that is the existential problem facing the European refining sector.    

Ron Beck, industry director of oil and gas at AspenTech, a US software provider for process industries, sees the potential for a row-back, but is unconvinced. “My own judgment is that the energy transition will proceed at, if anything, a stronger pace in Europe,” he says. “But the opposite is possible if economies and personal economic situations are stressed over an extended period of time.”

125pc – increase in US ethanol imports to Europe

And Campbell shares the scepticism. Decarbonisation is “a long-term policy that has been adopted by the EU and refiners will have to comply”, he concludes. However, Europe will have to be aware that continuing down the path may create winners and losers. “Any financial distress for more independent firms—rather than the refineries controlled by the largest oil companies—will perhaps hasten closures.”

But not all non-vertically integrated refiners will suffer equally, illustrating the diverse nature of the actors on the sector. For example, Greece’s Hellenic Petroleum, which has an upstream production arm far smaller than its main refining business, is well placed to weather the current storms as its “high complexity index and high storage capacity allow for flexibility”, according to investment research firm Edison.

Current and future challenges

Echoing Judge’s point on refiners’ travails even before Covid-19, Hellenic registered in the last quarter of 2019 its lowest system benchmark margins since the third quarter of 2013. And Edison has reduced its forecast of Hellenic’s 2020 Ebitda by 26pc to reflect the new reality.

On the other hand, it still expects the refiner to be “significantly” free cash flow (FCF) generative, with FCF of €437mn in 2020 and of €413mn in 2021. This will allow Hellenic “to de-leverage and [to] fund opportunities to maximise margins through the optimisation of existing installed capacity as macro conditions evolve”, Edison says.

Two of the firm’s three refineries—Aspropyrgos and Εlefsina—are complex, integrated and provide significant flexibility of feedstocks and throughput. While the third, in Thessaloniki, is much smaller and simpler, it still benefits from housing the firm’s petrochemicals units, which have material Greek and Mediterranean sales and complement Hellenic’s refining system.

In Edison’s view, the assets also benefit from their Greek location. They are significantly closer to Middle Eastern crude feedstock than most of their peers not just in northwest Europe but even further west in the Mediterranean.

Hellenic intends to improve the performance of conversion units and the energy efficiency of its refineries, Edison notes, and explore opportunities for operational optimisation through a digital transformation programme.

But the firm cannot change what is the reality for all European refiners—they are upgrading old facilities where, elsewhere in the world, modern greenfield plants have been built. The Aspropyrgos facility has benefitted from several upgrades: in 1986 (residue conversion project, FCC, mild hydrocracker, vis-breaker and CCR units); in 1999 (capacity increase); and in 2004 (upgrade of conversion units). From 2014, gas rather than fuel oil has supplied heat and power, reducing costs and increasing flexibility.

Edison describes Aspropyrgos as “one of the most modern refineries in Europe”. But it was still first built in 1958. China and the Middle East have refineries that are younger by 50 years or more.

Structural problem

As well as age, Europe’s refinery sector faces a challenge in that it has structural oversupply of gasoline and diesel—a consequence of the huge improvements in vehicle efficiency over the last few decades. And its sink markets for these products are getting increasingly competitive.

Traditionally, European gasoline and diesel have found a ready home in west Africa and Latin America. But, on gasoline, US Gulf Coast refiners are competing strongly in these markets, says Argus’ Judge. The US competitors have the advantage of cheaper feedstock and, in the case of Latin America, geography.

Nor are gasoline markets further afield any more promising. The huge increase in Middle Eastern refining capacity means that Europe’s refiners “can forget about” that region as a source of demand. China’s refined product surplus means the same is true for southeast Asia.

“My contention is that either the gasoline market is going to fall apart in Europe, or these decarbonisation targets are not going to be met” Judge, Argus Media

On diesel, increased capacity in the Middle East and upgraded capacity in Russia are boosting supply, leading to a market that looks “longer and longer”, says Judge.

There are only a few bright spots. One is that, because of an improving but still not fully functioning US products pipeline network, as well as the market distortion created by the Jones Act on US coastal shipping, Europe’s “traditional arbitrage” to the US northeast should remain open, says Judge.  And the introduction of IMO 2020 could see a material volume of low-sulphur vacuum gasoil (VGO) going into blending for low-sulphur fuel oil (LSFO) marine fuels, rather than being cracked to go into the gasoline pool, which could be supportive.

But other bearish drivers are also strengthening. In October, the Netherlands moved to E10 gasoline—that is, where 10pc of the fuel is made up by biofuels, rather than the 5pc of E5. With Belgium having already moved, this means the ARA products hub, Europe’s largest and most important, is now an entirely E10 gasoline market, says Judge.

And he notes that US ethanol imports into Europe jumped by 125pc year-on-year in 2019. Biodiesel mandates mean the gasoline story is repeating in the diesel market.

Longer-term, though, the electrification of Europe’s road transport poses the biggest threat to gasoline, diesel and the continent’s refiners. “Something has got to give,” says Judge of targets such as the UK’s plan to ban all new sales of gasoline, diesel and hybrid vehicles by 2035. This is five years earlier than a previous 2040 date, while EVs have a current UK market share of 2pc and huge challenges on infrastructure such as charging remain unsolved.

“My contention is that either the gasoline market is going to fall apart in Europe, or these decarbonisation targets are not going to be met,” Judge contends.

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