May 06, 2020

Global Refining - Adjusting to Challenging Times Ahead

Stratas Advisors

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The refining industry has been accustomed to good times. But now, it faces overcapacity and enters a challenging phase that is going to be tough compared to 2015-2016 being a benign and profitable period. With a slump in refining profits, refiners face difficult times ahead post COVID-19. The most pressing issues are how to manage huge excess in refining capacity and operate profitably in the longer term. The industry needs to consider the longer term, when demand recovers, to deal with transport fuel surpluses.

 

The refining sectors face numerous individual challenges unique to each region. In North America, the refineries, which benefit from lower oil prices are not immune from the crisis of this scale. The shale oil producers and independent downstream companies are likely to bear the first brunt of this new market environment. Investment projects are likely to be reevaluated literally forcing companies to undertake significant cuts in new refinery upgrading projects. In Europe, refining industry urgently needs to consolidate to counter demand shock in the short and longer terms. European refineries will need to find alternatives to maintain exports to less affected regions including Africa and Latin America.

 

In Asia, relentless refining capacity additions, most of which are export-oriented, had led to significant overcapacity, albeit much of this new capacity comes online are linked to petrochemicals for domestic consumption. There are still a long list of new projects in the pipeline in China, which are at risk of being delayed indefinitely or cancelled. Chinese government is expected to delay the approval of new grassroots refinery investments as the industry struggles to cope with excess capacity. The situation in Japan is similar to that in Europe, where more commercially-oriented refiners are already moving to rationalize their refining operations. India’s export-oriented refineries including Reliance and Nayara Energy need to rapidly develop alternatives in face of lower oil demand in their traditional markets in Europe, Asia and the US.

 

Africa and Latin America are both dependent on imports and need to decide how to further develop their refining sectors. Both regions however have the option of expanding refining industry given lack of refining capacities. However, refinery investment projects could face significant delays as lower crude oil prices constraining financial position of oil companies relying on revenues from crude oil exports.


The path forward is less clear, though mergers and alliances will play a role. Pressures to consolidate the industry will increase as options to export products are being closed off by the deteriorating economic outlook. Strategic alliances that come with crude supplies and/or product export outlets could help refiners in Europe, US and Japan prolong their refinery life. To summarize, challenging and interesting times lie ahead. A key question is how to manage new capacity coming online precisely when global demand is suffering and demand in key mature markets in western hemisphere is in decline. The first round of pressure will be felt as the refineries ramp up crude throughputs and place a significant quantity of refined products in the international market towards the end of 2020.


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