The risks of refining capacity and environmental policies

The majority of people, especially in the West, think nothing of Opec ministers meetings except that they are for fixing production and raising prices.

While this view is obviously biased, it is true that the level of Opec production has been the main concern of the organisation for many years now. It is the only instrument left in the hands of the organisation to impact the oil market.

However, there were two important points in the press release of the last meeting of Opec ministers in Isfahan that were not related to the production level and that went largely unnoticed.

These two points relate to the state of the refining industry and environmental policies and in the opinion of Opec and many others have a large impact on the evolution of the price level particularly since the beginning of 2004.

In fact the two points are largely related as we shall later.

With respect to the refining industry the Opec press release said that "shortage of effective refining capacity especially conversion capacity is expected to persist" and that has caused a dislocation between crude oil and product prices in the market.

In fact light product prices have appreciated much more than crude oil's, which meant that while the market may be well supplied with crude it is not so with products as the refineries are unable to turn all the crude supplied to marketable products.

By the end of 2004, the Oil and Gas Journal reported that there are 674 refineries around the world with a total crude distillation capacity of 82.4 million bpd and that is very close to crude demand and meaning that there is really no cushion or spare capacity.

The conversion capacity or the capacity of the refineries to turn unwanted heavy products into light marketable products is reported to be 27.5 million bpd or about 33 per cent of distillation capacity. This is very low compared to what is technically possible.

To cut the story short, there is an obvious need to build new distillation and conversion capacity in many areas of the world and conversion may have to take precedence over new distillation capacity.

Similarly, The IEA in its March 2005 Oil Market Report is saying that global refining capacity is a factor in the 2004 price rise and is saying that the "refining capacity expansion is a critical issue" and that "oil consumption (has) caught up with installed capacity."

The refineries are very expensive and the profit margin is so low.

The United States for instance needs many large scale and sophisticated refineries and if it wants these plants to be built somewhere else there should be some guarantees to use their products and to generate an agreed profit margin.

If it wants the plants to be built in the United States itself, then it should facilitate that for the investors whether Americans or otherwise.

The second point in the Opec press release is related to environmental policies and it is "calling on consuming governments to align their environmental with their energy policies."

In 2004, product specifications have become stricter in the United States followed by Europe in 2005 and even in India and China though to a lesser extent.

It is generally felt that these changes while necessary are too rapid and that refiners are not given sufficient time to invest in capacity and modifications to meet them.

In Asia (excluding the Arab countries) for instance, the conversion capacity is just over 5 million bpd or about 23 per cent of distillation capacity and coupled with a shortage of desulphurisation capacity makes it difficult to meet these specifications without undue reliance on light sweet crude oils causing differentials between heavy and light crude to double or more from their traditional levels.

High consumption states in the United States have banned the use of MTBE in gasoline and thereby causing shortages and higher prices in the market.

No wonder then that as long ago as October 2004; the Opec Oil Market Monthly report said that "the shortage of refining capacity in the USA and the limited conversion and upgrading facilities in Asia will remain major upside risks for the market."

The refinery utilisation rates have increased to very high levels of well above 90 per cent at times and while this is good economically it is less so from the security point of view.

The writer is the former head of the Energy Studies Department at the Opec Secretariat and is currently working as an adviser