A continuing refining headache

Reliance's Jamnagar refinery

Jamnagar

“The upstream has always been the more glamorous part of the industry,” write Barclays Capital analysts today, “as it generated economic rents, rents which were further protected by OPEC policy, and which also generated most of the past and the present leaders of the major international oil companies.”

By contrast, crude oil refining, as well as being less glamorous, has the drawbacks of being seen as a value destroyer and subject to vagaries of high exit costs, protectionism and ‘perverse responses to price incentives’.

But it has one thing in common with more bouyant upstream world: trends in non-OECD countries are increasing influencing the OECD refining market.

Refining has been a major drag on the profits of integrated oil companies in the past year, and stand-alone refiners have also been doing it tough.

But BarCap analysts Costanza Jacazio and Amrita Sen believe it still has further to go – and that the western refining industry is not helping itself by letting political pressure temper the imperative to simply close down more refineries (as witnessed in Total’s Dunkirk battle, for example).

They note interest from big Asian companies such as Reliance, Essar and PetroChina in European refineries, but argue that selling refineries is not the answer to industry’s overcapacity:

In our view, refinery closures, not sales, will be required to bring the refining sector back into better balance. From such a view point, government efforts to prevent the system from rebalancing itself will add to the refiners’ woes by keeping margins lower for longer.

Meanwhile Asian countries – at least, South Korea and Japan – are not immune either, and Japan is thought to have perhaps the biggest challenge of all OECD economies, with the country’s petroleum association predicting total product demand will have fallen 16.7 per cent in the five years to 2013.

BarCap’s analysts add that proximity to China and its growing refinery capacity makes matters worse for Japanese refining; China, as we noted last week, is increasing its product export capacity.

In fact this theme is one that is affecting all OECD refining: the industry’s efforts to shut down or delay new capacity will help, they write, but it faces another challenge:

However, overall economics will continue to depend on capacity additions in non-OECD emerging markets relative to these shut downs, the tussle between which has been won by the former so far.

The outcome? Refining will continue to perform poorly “for some time to come”, they write.

Related links:

Shell’s refining headache (FT Alphaville)
BP’s unsurprising refining surprise (FT Alphaville)
Valero points to difficulties in US energy sector (FT Energy Source)

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