Main Drivers & Outlook of the Refining Industry
The refining market reached a turning point early in 2004, when the substantial increase in demand for finished products, principally diesel and gasoline, used up the excess refining capacity that had been created in the previous decades.
The system is now largely balanced between demand for products and availability of refining capacity. The refining sector has thus become the bottleneck in the system as a whole, putting substantial pressure on refining margins*.
Forecasts for future refining margins are also positive. In fact, increases in refining capacity in the next few years will struggle to keep up with rising demand for finished, which is strongly driven by rapid growth, especially in emerging markets such as China, India and the Middle East. In the medium term, therefore, the system is expected to maintain a substantial equilibrium, even if different trends are expected for the two main products: middle distillates demand is projected to grow very strongly and new refinery additions will only manage to balance it operating at maximum utilization; gasoline demand growth, although robust will be more than balanced by new production capacity, leading to a lower average utilization of gasoline oriented facilities.
As a general concept, it is also important to stress the exponential rise in the cost of building and/or expanding oil refineries (due to competition for engineering and construction services and for raw material supplies, both within the sector and in with the other sector like oil extraction), which is a major hindrance to expansion of refining capacity.
Furthermore, strong growth in oil products is helped by a lack of substitutes able to compete in either technical or economic terms. While production of biofuels (mainly biodiesel in Europe) is increasing relatively rapidly, it will only be able to meet a small fraction of total demand, due to uncertain availability and the cost of the raw materials used to produce it, as well as its reliance on tax incentives.
The same applies to other sources, such as GTL (gas to liquid process, or conversion of natural gas into gasoil). Here the problem lies with construction costs, which can only be seen as economical in a market context of long-term crude prices remaining stable at very high levels.
Increasingly stringent environmental specifications could favour the sector further.
Environmental specifications for oil products have become more restrictive in recent years. This process concerns all the main markets. China, India and many other countries in Asia, Latin America and North Africa plan to introduce ‘clean’ motor fuels, taking their lead from the US, Europe and Japan.
The key factor here is levels of sulphur, which is one of the biggest polluters. In Europe, the current maximum content permitted for gasoline and diesel is 50 parts per million (ppm), but this will drop to 10 ppm from 2009. A limit on sulphur content of 10 ppm is already enforced in Japan and in various northern European countries, and is regarded as the optimum standard achievable with the technologies currently available. Emerging markets are some years behind the industrialised countries, but the route they have embarked on is irreversible.
The introduction of ‘clean’ motor fuels will contribute to slower growth in refining capacity, since compliance with new standards requires a substantial investment. This will only increase the need for engineering and construction services, for which demand is already particularly strong, thus further driving up the aforementioned costs.
Useful links:
www.bp.com
www.doe.gov
www.oilmarketreport.org
www.unionepetrolifera.it
* Refining margin is the difference between the value of the oil products generated by a refinery (such as gasoline, gasoil, etc.) and the cost of the crude oil used in the refining process to produce them.