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Middle East expansion further clouds global refining picture

Challenges to refiners are myriad. Another boost in Mid-East Gulf capacity brings more complexity

Refining has always held the potential to be a challenging aspect of the oil industry. But the Covid-19 crisis has put the sector firmly in the spotlight, accelerating some existing trends and ushering in new ones.

Global oil demand is expected to fall by 8.5mn bl/d this year. Product balances have been upended; peak oil demand anxieties have sharpened; investments have been curtailed and balance sheets have been weakened. And some integrated oil majors have accelerated portfolio adjustments to prepare for the ­energy ­transition.

To make matters worse, net refining capacity additions in the Middle East show no sign of slowing. The region is expected to add just under 2mn bl/d of new capacity in the next five years. What will be the implications?

Woes everywhere

Since 2015, global refinery utilisation rates have hovered around 82pc on a yearly basis. But in 2020 rates have dipped to historic lows, hitting around 64pc in the second quarter.

Europe’s refiners have already weathered many storms: overcapacity following the 2008 financial crisis; a shifting marginal barrel driven by US light oil growth; and a more stringent regulatory environment that includes EU vehicle fuel efficiency standards and the International Maritime Organization’s 2020 sulphur cap.

European refiners with stronger balance sheets and more complex configurations will be further incentivised to explore investments in biofuels

In the short-term, the continent’s refiners face mature domestic product markets and threats to existing sink markets—such as in Nigeria and Latin America in the Atlantic Basin from revitalised US Gulf Coast competitors, and in the Mediterranean and the Gulf from the Middle Eastern capacity boom. Longer-term threats have also loomed in the background: the electrification of transport and automotive manufacturers’ ambitious targets for electric vehicles, as well as growing policy pressures for decarbonisation more generally.

Overcapacity was already a challenge for Europe’s refining industry. Over the past 10 years, around 2mn bl/d of capacity has been closed, and the threat of further rationalisation was already looming before Covid-19. But the pandemic has been a great accelerator: oil demand fell in Q2 by almost 3.3mn bl/d year-on-year. Refiners with simpler configurations and high operating costs will come under particular pressure.

Looking across the barrel, gasoline demand has picked up from its April lows—from a global year-on-year demand drop of c.5.8mn bl/d in Q2 to 1.9mn bl/d in Q3. But product stocks remain elevated and crack spreads (the price difference between a refined product and its input costs) remain under pressure.

In the US, this year’s driving season has been atypical. Gasoline imports into the East Coast Padd1 region are down by almost 29mn bl on a year-on-year basis. In Asia, while Chinese gasoline demand has rebounded sharply, fears over additional Covid-19 case spikes continue to dog other regional demand hotspots such as Vietnam, Japan, Indonesia and Australia. A reflection of this uncertainty and demand weakness has been Singapore gasoline margins, which turned negative earlier in the year.

To make matters worse, Opec+ cuts—which have made medium-sour crude more expensive—and higher-than-expected Middle East official selling prices (OSPs) have also weighed on margins by boosting feedstock costs. On the other hand, Asian refiners with greater flexibility in crude slates have been spoilt for choice in the current trading cycle— with popular grades trading in the spot market at healthy discounts to OSPs.

China has been an important balancer in terms of mopping up marginal barrels of crude—with imports at a record 13mn bl/d in July. But refinery utilisation rates have fallen recently, as crude congestion and midstream bottlenecks bite. The higher refinery runs have meant clean product exports have also been higher year-on-year, leaving the Asian market awash with gasoline.

While this has contributed to gasoline’s recovery still having some way to go, greater consumer reluctance to use public transport should support the fuel’s recovery into 2021.

No bet on jet

More concerning for oil demand is jet fuel. Commercial flights are down by 90pc, marking the aviation industry as among the pandemic’s biggest losers. With the International Air Transport Association now forecasting that flight numbers will not recover until at least 2024, jet fuel demand is unlikely to reach 2019 levels until at least 2025.

90pc – Fall in commercial flights

The asymmetry in the downturns in gasoline and jet has also played out in the Middle East. In Saudi Arabia alone, gasoline demand fell by almost 50pc in April but jet demand disappeared almost entirely in the same month. While jet has shown some improvement since then—supported by more internal flights—the much lower numbers seen for this year’s Hajj pilgrimage season serve to highlight the long road ahead for aviation ­fuel’s ­recovery.

Likewise, while Kuwait has announced a resumption of flights from August, it will be a phased approach, as in other aviation hubs such as Qatar. In the UAE, the aviation sector is set to lose almost $7bn in passenger revenue as activity is restricted to mostly cargo movements.

And these revisions to Middle East jet fuel balances are taking place as the region expects to add c.2mn bl/d of net product length by the mid-2020s.

Saudi Aramco, for example, expects to launch its much awaited 400,000bl/d Jazan refinery in early 2021. Completion of Aramco’s $2.5bn Ras Tanura clean fuels project—which will produce low-sulphur diesel—is expected at the same time.

New capacity

In Kuwait, national oil refiner KNPC’s clean fuels project—which will integrate the Mina al-Ahmadi and Mina Abdullah refineries into a single integrated project—is underway. And Oman’s Duqm refinery is expected to come online in 2023.

Much of this new capacity was expected to be partially absorbed by rising demand. But, with product balances now being revised, the region is set to have significant overcapacity, leaving refiners with difficult decisions to make.

Middle Eastern refiners’ decision-making this year may offer an indication of what to expect. Alongside run cuts, refiners have pushed growing volumes of jet into the gasoil/diesel pool.

But, if Middle East refiners decide to continue to juggle slates to minimise jet output, any increased diesel exports will also have to contend with an Asian market also looking for destinations to place middle distillates, as China’s diesel/gasoil demand growth slows over the next ­decade.

The revision to Middle East product balances and net capacity additions in both the Middle East and Asia will likely spur four main outcomes. Firstly, with global refining capacity now expected to grow at more than double the rate of expected oil demand growth, further European refinery closures may be expected over the coming years.

Secondly, European refiners with stronger balance sheets and more complex configurations will be further incentivised to explore investments in biofuels, either by converting weaker assets or via integration plays. Finland’s Neste is a good example of this evolution: the firm has expanded investment in pre-treatment facilities and is expected to lead in the biodiesel market.

Thirdly, while Covid-19 has impacted fuels, it has had much less of an impact on plastics—although this sector has its own longer-term environmental challenges. The attraction of integrating refining operations with petrochemicals will certainly not have decreased: the existing strategies of key players such as Aramco in pushing further into petchems will continue, even if some less-scalable petchems businesses will remain vulnerable to portfolio streamlining (as with BP).

Finally, a pre-existing assumption before the pandemic was that NOCs, including those in the Gulf, with long crude positions but shorter refining positions, would be key candidates to acquire distressed downstream assets—particularly as European IOCs divest and reposition their portfolios. But, with Covid-19 having weakened balance sheets across the entire industry, it remains to be seen if this will hold. 

Ahmed Mehdi is an independent petroleum consultant

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