Crude prices are continuing to fall slowly and producers are alarmed as to how low it can go. Theoretically, this trend should not much affect refinery economics, where the perception is that product prices could follow crude prices proportionately and thus keep refinery profit margins the same.

But this works only in a perfect world where all other things remain the same… and we all know they don’t. Therefore, while Brent crude oil prices have lost 17 per cent from their average in June, gasoline prices in Rotterdam lost 19 per cent, and refinery margins were maintained only by reducing refinery utilization rates to about 77 per cent.

Falling demand in Europe is forcing not only reduced refinery utilisation rates but total closure of some refineries as well. According to the International Energy Agency (IEA), 17 refineries representing about 16 per cent of Europe’s capacity were closed in the past six years.

Yet Bloomberg is cited in the industry journal Hydrocarbon Processing magazine of October 1, quoting Antoine Halff, the head of IEA’s oil industry and markets division, as, “Traders are increasingly taking control of failing refineries in Europe, betting they can make profit from plants that lose money for conventional oil companies.”

These are acquired for “almost no fee” and may be operated in such a way as to increase utilisation rates when the margins are good and reduce the rate otherwise. Traders may use a flexible working force reduced to the bare minimum in contrast to conventional oil companies and their high overheads and normally higher utilisation rates.

Vitol and Gunvor are among the traders involved in this new trend, where Vitol is owner of the Cressier refinery in Switzerland and Gunvor bought two refineries in Ingolstadt and Antwerp. In contrast, Total is to reduce its refining capacity to cope with the fall in demand and Eni has been negotiating since July to shut “as much as half of its refining capacity”.

The situation for refiners in the US is better and utilisation rates are much higher at 92 per cent since the US has not built new refinery or surplus capacity for many decades now. In Asia where oil demand is still healthy, many countries are building modern and large refineries. Worldwide surplus will become a reality once we consider the Middle East’s refinery construction as well.

In a column last December, I had said that “ refinery distillation capacity [in the Middle East] may grow from just over 8 mbd now to about 15.5 mbd in the years to 2020” while “domestic consumption of refinery products is expected to rise from about 6.6 mbd in 2011 to about 7.5 mbd in 2020”.

Surplus capacity

Therefore, the large capacity expansion must be destined for the export markets, which are getting smaller either because of shrinking demand or because of the expansion of refineries in these markets. For this reason, I said, “This is another reason for [Middle East] countries to rethink and restructure some of their projects as surplus capacity may pressure margins further and reduce refinery utilisation.”

In this environment, Saudi Arabia commissioned two world-scale refineries of 400,000 barrels a day each in less than a year, one in Jubail in a joint venture with Total of France and the other in Yanbu in a joint venture with Sinopec of China. But the good thing is that both refineries are very sophisticated with high products specification for the intended export markets, though Saudi refiners, like all others, may struggle for better profit margins and higher utilisation rates.

The same will apply to the expansion in Ruwais and the upcoming one in Kuwait. These countries may need to review and utilize all avenues of reducing cost and improving efficiency to aid their chances of making profits and recover investments.

The use of the heavier grades of oil as feedstock may also help to improve margins provided that product specification are maintained at the highest level demanded by the market or driven by environmental consideration. I may say here that the UAE, Saudi Arabia, Bahrain and Kuwait have either completed their clean products programmes, or have them under construction or in the planning stage.

One last word, since the situation is not so clear, the producing countries should also review their foreign refinery investment programmes. These joint ventures refineries with consuming countries are good in locking future crude oil sales, but they do compete with domestic refineries built for export.

If oil demand growth does not improve, we are likely to see further pressure on the refining industry here and worldwide.