Will It Drive Out The Big Integrated Oil Companies From The Refining Sector? Publication Date: November 2009 GlobalData. This brief is a licensed product and is not to be photocopied Page 1
Will It Drive Out The Big Integrated Oil Companies From The Refining Sector? The global refining industry is witnessing a slump following the global economic downturn after a high return period in the past few years. Uncertain product demand due to the global economic downturn, decreasing refinery margins and a surplus refining capacity are having a combined negative effect on the profitability of refining operations. Due to this, major integrated oil companies with significant refining operations have seen a decline in their revenues from the previous year. These trends will continue to cast a shadow of uncertainty over the future of refinery margins thereby compelling integrated companies to divest their non-profitable assets to fund other businesses. Economic Downturn And Uncertain Global Product Demand Has Had A Negative Effect On The Downstream Sector The global refining industry witnessed a major change in market dynamics in 2008. The refining industry during the period from 2003 to mid 2008 has changed from a low return industry to a high return industry. The surge in petroleum product demand in this period, especially in developing nations, lack of refining capacity and relatively high crude oil prices were the reasons for its turnaround. The trend continued through the first half of 2008 but the economic slowdown has severely impacted the refining sector since then. The global annual petroleum product demand declined by 2.5% in 2008 compared to that in 2007 and this was the first annual petroleum product demand decline in several years. The trend continued in the first two quarters of 2009. The US petroleum product demand decreased to 18.75 million barrel per day (bpd) in the first two quarters of 2009, the lowest level in this decade. In 2008, the US petroleum product demand decreased by 5.8% from 2007 at 19.5 million bpd. China s petroleum product demand in 2008 was 6.8 million bpd, a decline of 1.4% from 2007 level. The decreased demand of petroleum products and low refinery margins forced many companies to cut throughput rates in their refineries or temporarily shut down the refineries. This has also prompted many companies to postpone or cancel their refinery investment plans. Changing petroleum product demand pattern in favor of diesel has also created uncertainties about the future balance of gasoline and diesel. The gasoline demand, particularly in the US, which consumes around 40% of the world s gasoline, is on a decline, though it has shown some improvement since the second quarter of 2009. The regulations favoring ethanol blending across the globe are also negatively affecting gasoline demand. As a result, refineries in the US are facing the biggest challenge as they are configured to produce more gasoline than middle distillates. So far, the refining structure has worked in balance with the European refineries exporting excess gasoline, and the US exporting excess middle distillates to Europe and Asia. However, changing product demand dynamics has left the global refining industry with excess gasoline production capacity and shortage of diesel production capacity. On the other hand, demand for fuel oil has seen a decreasing trend in recent years. Fuel oil is now considered as GlobalData. This brief is a licensed product and is not to be photocopied Page 2
an unwanted refinery product mainly due to the declining consumption of fuel oil which is being increasingly replaced by natural gas in power plants. Decreasing demand has affected the lower fuel oil spread which remains negative. The refiners are trying to decrease the production of fuel oil to enhance their profitability. Optimizing the product slate for the future demand pattern is going to be a big challenge for the global refining industry. Surplus Refining Capacity And Decreasing Refining Margins Fuelling The Down Cycle In The Refining Sector Global refinery utilization has increased over the years. Global refinery utilization was 82% in 2002 and increased gradually to reach 86% in 2007. Currently, the global refinery utilization is around 85%. Economic slowdown and decreased petroleum product demand has affected refinery throughputs, especially in North America. In October 2008, the monthly refinery throughput declined to 80% in the US, the lowest level in a decade. Thereafter refinery utilization in the US improved to 86% in the third quarter of 2009. In Africa, refinery utilization decreased from 81% in 2007 to 77% in 2008. The new refinery projects coming online and stagnant petroleum product demand in major consuming nations will see some drop in refinery utilization rates globally. Figure 1 shows the increase in the global refinery capacity and the fall in refinery utilization from 2000 to 2008. GlobalData. This brief is a licensed product and is not to be photocopied Page 3
Figure 1: Global Refining Capacity And Refinery Utilization from 2000-08 4500 86.6 86.3 87.0 4400 85.9 85.9 86.0 4300 84.3 84.8 85.0 Refining Capacity (Million Tonnes) 4200 4100 4000 83.5 83.3 82.0 84.0 83.0 82.0 81.0 Refinery Utilization (%) 3900 80.0 3800 2000 2001 2002 2003 2004 2005 2006 2007 2008 Year 79.0 Source: GlobalData/BP Low refining margins during the years 1990-2002 led to closure of several refineries. The refineries which ceased to operate during this period were simple units with limited secondary processing. However, the consolidation during this period led to efficient running of larger refineries. The efficiency, in turn, led to increase in global refining capacity, better utilization rates, profits, and a wave of consolidation. The 1.05% annual increase in refinery capacity during consolidation strengthened refinery margins during the period 2000-08. Increased margins were driven by global oil demand, particularly in India and China and gasoline demand in the US. Environmental regulations in the US such as the introduction of new low sulfur specifications and phasing out of MTBE (Methyl Tertiary Butyl Ether) increased the prices thereby improving the refinery margins during the period 2004-07. In Asia, the demand for refined product was low between 1999 and 2002 and as a result the refining margin was below break-even during this period. This led to a shutdown of refineries in the Philippines and Japan. However, 2003 was a turning point. With economic recovery in the Asia Pacific, refining margins grew proportionally. Most Asian cities witnessed the introduction of cleaner fuel standards and larger refineries developed in the Singapore hub. GlobalData. This brief is a licensed product and is not to be photocopied Page 4
Between 2005 and 2008, all these developments led to a very short golden era for the global refining industry. This was soon followed by a global decline in petroleum product demand and refining capacity expansion plans in the Middle East and Asian countries leading to overcapacity which, in turn, resulted in lower refinery margins. With the decrease in crude oil price, the refinery margins plunged to very low levels in the third quarter of 2008. Though refinery margins started to recover from the start of 2009, volatile crude oil prices and petroleum product demand patterns will continue to cast a shadow of uncertainty over the future of refinery margins. Figure 2 shows the refinery margins from November 2007 to October 2009. Figure 2: Refinery Margins In $ Per Barrel from November 2007 October 2009 30.0 25.0 20.0 15.0 10.0 5.0 0.0 Nov-07 Dec-07 Jan-08 Feb-08 Refinery Margin ($ per barrel) Mar-08 Apr-08 May-08 Jun-08 Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-09 Jun-09 Jul-09 Aug-09 Sep-09 Oct-09 NWE -Cracking (3-1-2) Singapore -Hydrocracking (4-1-2-1) USGC -Cracking (3-2-1) Source: GlobalData GlobalData. This brief is a licensed product and is not to be photocopied Page 5
Major Integrated Companies Have Seen Their Refining Earnings Fall Since The Economic Downturn Uncertainty in both commodity and capital markets have forced many companies to postpone their projects. The prices of crude oil and petroleum products have dropped drastically from the peak of 2008 affecting the profitability of refineries. The meltdown in the financial sector has made it difficult to raise finance for the capital intensive refinery projects. The economic downturn and the ensuing decrease in the global demand have decreased the revenues from the refining operations of major companies. The US refiners are the most affected in this downturn due to the decrease in demand of gasoline especially in the US market. The earnings from refining operations of the super major integrated oil companies have fallen considerably in the third quarter of 2009. The figure below shows the third quarter year-on-year earnings from the refining businesses of the five super major integrated oil companies. Figure 3 compares the downstream earnings of super major integrated oil companies in Q3 2008 and Q3 2009. GlobalData. This brief is a licensed product and is not to be photocopied Page 6
Figure 3: Downstream Earnings Of Super Major Integrated Oil Companies in USD, Q3 2008 and Q3 2009 3500 3000 2500 Earnings ($ million) 2000 1500 1000 500 0 BP ConocoPhillips ExxonMobil Shell Chevron Q3 2008 Q3 2009 Source: GlobalData/Company Annual reports ExxonMobil Corporation which had a refining capacity of about 280 million tons in 2008 saw their earnings fall from $3,013 million in Q3 2008 to $325 million in Q3 2009. BP, which had a refining capacity of about 155 million tons in 2008, has reported a loss of $229 million on a replacement-cost basis before interest and tax from US refining and marketing operations in Q3 2009 as compared to a profit of $338 million in Q3 2008. Also, the company s revenues from non-us refining and marketing operations have reduced from $1,634 million in Q3 2008 to $1,145 million in Q3 2008. Similarly, the other super major integrated oil companies, Shell, Chevron and ConocoPhillips have seen lower earnings levels in 2009 as compared to 2008. GlobalData. This brief is a licensed product and is not to be photocopied Page 7
Fall In Downstream Earnings And An Upward Trend In Crude Oil Prices Will Prompt The Major Integrated Companies To Plan To Divest Their Downstream Assets The golden era of the refining sector seems to be coming to an end with the economic downturn and an uncertain outlook for the product demand. The decline in the product demand has resulted in decreased refining margins and reduced earnings for the companies from their downstream businesses. Also, the financial crisis has constrained the capital availability which is visible in the reduction in the capital expenditure plans of oil and gas companies. In this scenario, companies are following a prudent strategy for new investments and to survive in the downturn. Consequently, companies with tight cash flows might divest their non-core or non-profitable businesses to obtain funds for the operations and other more profitable investments. Companies such as ConocoPhillips which inherently have an inorganic growth strategy might plan to divest their nonprofitable businesses. Additionally, the recent upward trend of the crude oil price after hitting a low in the second half of 2008 is providing an incentive for super major oil companies to invest in the upstream sector. The high crude oil price and a sustained price level in the short to medium term will prompt companies to invest more in the upstream sector. Consequently, the refining sector which historically has low margins will be the perfect target to divest. Adding credence to this is the recent news about some major integrated companies planning to divest their refining businesses. According to sources, BP has shortlisted 22 US properties for divestment in the midstream asset review. Oil major Shell also has plans to divest about 15 percent of their global refining assets in the next few years. Shell and Essar Group, an Indian industrial conglomerate, are in talks on the sale of two refineries in Germany and one refinery in UK owned by Shell. ConocoPhillips is also under plans to sell $10 billion assets from energy exploration, refining and marketing businesses over the next two years. Apart from the super majors, other companies with significant refining businesses plan to shut down operations in some of their refineries due to surplus supply and low refining margins. Sunoco was expected to idle its 150,000 bpd Eagle Point refinery at Westville due to the recessionary economy, weak demand and increased refining capacity. Therefore, changing crude oil prices and uncertain petroleum product demand patterns will continue to cast a shadow of uncertainty over the future of refinery margins thereby compelling integrated companies to divest their non-profitable assets to fund other businesses. GlobalData. This brief is a licensed product and is not to be photocopied Page 8