Only a year ago refiners worldwide were enjoying record margins and talking of a ‘golden age’ of refining. Capacity utilisation in the main consuming regions had risen to record highs while demand continued to outstrip the ability of refineries to supply products. Now the golden age seems to be over. Margins are falling once more and US gasoline crack spreads are depressed by high inventories, excess supply and weak demand. Yet crude prices are still rising, driven in large part by shortages of products in the middle distillate range — jet kerosine, diesel fuel and heating gasoil. These key products are currently trading at record premiums to crude, giving a clear signal to both refiners and consumers that demand is outstripping supply.
Negative hydroskimming margins are putting a ceiling on how much crude oil refiners are prepared to process. While the majority of refineries now have some upgrading, there is not enough capacity to convert all the fuel oil coming out of distillation columns. Although global distillation capacity is rising, new upgrading capacity is not keeping pace with this increase and, as a result of this, global utilisation has fallen over the last two years from a peak of 86.6% in 2005, indicating that refiners are reluctant to use hyroskimming capacity. Data for the world’s largest refining countries1 show that capacity utilisation is falling. Even ignoring the peak in utilisation during 2005-2006, which was due to the shutdown of US Gulf coast capacity in the 12 months following Hurricanes Katrina and Rita, capacity utilisation in these countries has fallen to 88% this year from over 90% in 2004-2006 (see Figure 4).
The refining system therefore has spare capacity — but it is not the right sort of capacity. To make matters worse, any extra crude that might be released on to the market is likely to be heavy Saudi Arabian crude — which is the wrong sort of crude oil. Thus, at the margin, the industry can only produce a yield of around 70% fuel oil and 20% middle distillates — not an economically attractive option for refiners at current crude prices. There is no 'quick fix' for the industry's problems. Since 2003, global oil demand has risen by 6 mbpd while refining capacity has increased by just 4.3 mbpd and refinery throughputs by 5 mbpd, according to BP.
A recent spate of investment in Asia has boosted refining capacity by over 2 mbpd in the last two years, but lower utilisation rates have limited the amount of extra oil products supplied to the market. More new refineries are planned in Asia, which is still short of oil products, and in the Middle East, where producers want to cash in on future export markets for high quality products in Europe and the Far East, but few of these will be on stream within the next two years. Construction costs in the oil industry are soaring and shortages of materials and skilled labour are extending construction times, adding further to costs.
Analysis of refinery output data from the largest refining areas - US, EU 16, China, Japan, India, South Korea, Russia, Brazil, Argentina - illustrates the problems faced by refiners in attempting to match output to a rapidly changing demand slate. Since 2003, fuel oil yields in these 24 countries have fallen by just 0.5% to 8.5% of crude input, while middle distillate yields have risen by 0.8% to 32.4%. However, fuel oil production in volume terms has continued to rise as higher refinery throughputs have offset the effect of lower yields. Last year, fuel oil output was 5.64 mbpd, 250,000 bpd higher than in 2003. Middle distillate output rose by 2.4 mbpd over the same period, but even this was not enough to meet the steep increase in demand.
North America and Asia-Pacific remain the regions with the largest product deficits, because refining capacity is still unable to meet local demand. In 2007, net imports in both regions were over 1.5 mbpd (see Figure 5). North America is mainly short of gasoline — the US imports just over 1 mbpd and Mexico 0.3 mbpd — while Asia-Pacific is mainly short of petrochemical feedstocks — i.e., naphtha and LPG. OECD Europe, for its part, faces a growing shortage of middle distillates, most of which is met by exports from refineries in the FSU. The Middle East, North Africa and South America are net product exporters, but while total product deficits appear to be matched by surpluses from exporting regions, shortages still arise because refineries in the exporting regions cannot provide the right mix or the right grades of products to meet the importing regions’ precise needs.
Around 6 mbpd of new refining capacity is planned over the next four years. The bulk of this is in Asia, mainly in China and India, where 4 mbpd of extra distillation capacity could be on stream by 2012. Middle Eastern countries’ plans for expansion, however, appear to be moving further into the future. Cost escalation and lengthening construction times are delaying many of the projects originally planned to be operating by 2010. With the cost of a grass-roots refinery now put at between $6bn and $12bn, the private sector is increasingly reluctant to take on the risk of downstream investment. Stateowned companies, whose objective is to meet local demand rather than make a long-term return, are increasingly the main downstream investors.