European downstream developments

Alan Gelder, Wood Mackenzie, UK, explains why the European downstream sector needs to adapt; doing nothing is not an option.

The global pandemic has provided the European downstream sector with a glimpse into the future and clearly demonstrated that doing nothing is not an option for securing long-term survival. The pandemic, through various government lockdown measures, has shown a potential future of lower demand for transport fuels. This was a world in which the commercial viability of large swathes of European refi ning capacity was challenged, as Wood Mackenzie’s Refi nery Evaluation Model indicates that only a handful of sites were cash positive in 2020 (so had a positive net cash margin [NCM]). Figure 1 also compares the 2019 NCM profi le, where almost 70% of sites were cash positive. A cash positive position is key for sustained commercial success as it provides funds for future investment and returns to investors.

Demand growth will not suffice

Since the end of March 2021, global oil demand has recovered strongly from the nadir of April 2020 when it had collapsed by around 20 million bpd compared to the previous year. 2Q21 global oil demand is already 13 million bpd higher than 2Q20 levels. Wood Mackenzie projects oil demand to reach about pre-pandemic levels on a global basis towards the end of 2022. This is surely supportive for European refi ning?

The return of global oil demand to above pre-pandemic levels is necessary but insuffi cient for European refi ning’s commercial success for reasons of both demand and supply. Wood Mackenzie’s outlook of European demand is still 600 000 bpd below 2019 levels by the end of 2022, arising from a slow regional economic recovery and the gathering pace of energy transition, in which Europe is a leader.

On the supply side, very few refi ning projects under active development pre-pandemic were cancelled. Project completion has been slower than originally anticipated and the commissioning of mechanically complete facilities has been delayed given the poor refi ning margin environment. Even before the pandemic, new sources of supply were expected to outpace demand growth. The loss of three years of global demand growth hence poses a serious challenge to refi ners as global utilisation is not anticipated to recover back to pre-pandemic levels during this decade unless refi neries close. European refi nery utilisation is particularly challenged as the new capacity additions are more competitive. As a region, it therefore struggles to export its growing surplus of gasoline (Figure 2).

Low utilisation and low refi ning margins are synonymous, so the commercial viability of the European refi ning industry is challenged for much of the current decade. The risk of rationalisation of competitively weak sites and poor margins for standalone fuels

Figure 1. European 2020 preliminary net cash margin.

Figure 2. Global and European refinery utilisation profile.

Figure 3. Competitive strength of integrated refinery petrochemical sites. refi neries is high. Cost reduction, effi ciency improvements and improved optimisation remain critical to success, but these actions alone may not guarantee the survival of all European sites. Adaption will be key.

Every refi nery is unique, so there is a wide disparity of net cash margins across a region such as Europe. There were many sites in 2019 that enjoyed attractive net cash margins, but about one third of sites were cash negative for that period. Figure 3 shows the 2019 European NCM profi le, with the fi rst and second quartiles dominated by integrated refi nery petrochemical sites, with the weakest assets (in the fourth quartile) being predominately standalone fuels refi neries. Any adaption strategies need to refl ect the source of a site’s current competitive position and how these factors evolve in future.

Working in tandem with energy transition

As the world recovers from the COVID-19 pandemic, climate change is increasingly at the forefront of government policies. Energy transition is gathering pace. The associated electrifi cation of the passenger car fl eet will slow the pace of global gasoline demand growth and drive it into decline. Meanwhile, the versatility and durability of petrochemicals ensures sustained demand growth, particularly in the developing world.

The fi rst energy transition mega-trend relevant to refi ners is a switch in demand away from gasoline to petrochemical feedstocks, so promoting the adoption of refi nery – petrochemical integration, particularly for new facilities in Asia and the Middle East. In addition to diversifying the product slate, highly integrated refi nery – petrochemical sites can capture higher value from economies of scale for investment, operational cost synergies and fl exibility to shift yields to maximise overall site margins. There are risks to petrochemical demand growth as societies focus on the environmental challenges of plastic waste, so the growth for petrochemical feedstocks will be tempered by the increase in mechanical and chemical recycling rates. The mega trend will challenge the competitive position of many refi ning sites that currently enjoy advantaged ex-refi nery gate pricing by virtue of their inland location. As local demand for refi ned products fall, any net defi cit position becomes a net surplus unless supply is cut. The pricing consequences of such a shift can be dramatic, as it will prompt the rationalisation of inland sites, to the benefi t of coastal locations.

The second energy transition mega trend is decarbonisation. This can be in a direct form in the reduction of carbon intensity of the fuels made available to consumers by increasing the contribution from biofuels or the chemical

Figure 4. European NCM uplift from petrochemicals against petrochemical yield, 2019.

Figure 5. US and European ethylene cost of production profile, 2019.

fuels refi ning; the NCM uplift grows as the yield of chemicals increases. This is an extract of Wood Mackenzie’s new site-specifi c benchmarking data available within its REM-Chemicals research. As shown in Figure 4, it is important to understand the roles of different petrochemicals within the overall site economics and the context for the different contributions between sites. Given the cyclical nature of the petrochemical sector, these contributions will, no doubt, vary over time. As shown in Figure 4, petrochemical integration clearly has benefi ts for overall site economics. The converse also applies in that refi nery integration has clear benefi ts for the competitive position of petrochemical production. Figure 5 shows the cost of production profi le for ethane crackers in Europe and the US. It shows the traditional profi le of the new ethane-based steam crackers in the US Gulf Coast (USGC) being the most competitive, with the European liquids-based steam crackers being the least. However, extending the analysis of co-product credits to include the refi ned products from integrated sites can transform the competitive position along a petrochemical value chain. The additional co-product credits from the refi nery re-locate the European site into one of the lowest cost producers within its peer group. For reference, the cost of ethylene production from the new Hengli facility (one of the world-scale second generation integrated sites recently commissioned in China) has also been included. Had it been fully operational in 2019, its ethylene cost of production would have been negative – a truly competitive position. Low costs of production along specifi c value chains ensure high utilisation at integrated sites despite margin weakness in any single petrochemical value chain. Wood Mackenzie considers it vital for the downstream sector to understand the economics of integrated sites to establish the dynamics of competitor behaviour in recycling of plastic waste. There is also the focus on emissions both refi ning and petrochemicals. reduction from the refi ning sector, which involves effi ciency This disparity in overall site competitiveness arising from improvements and the potential switch away from methane petrochemical integration will remain in Europe, as it is steam reforming towards more sustainable forms of hydrogen expected to be one of the energy transition’s global leaders. generation. These are signifi cant investments, for which returns Standalone fuel refi neries face signifi cant commercial pressure, may be poor as the technologies to decarbonise hydrogen so European refi ners need to consider a strategic framework to production (CCS or electrolysis) are not yet mature. Whilst it is secure their long-term survival. critical to explore the role these technologies could play; it is key to allocate these activities to the sites that are sustainable Strategic framework for European sites far beyond the investment payback period. This is to ensure The attributes of the ‘last site standing’ in the European refi ning learnings can be captured and deployed effectively at locations and petrochemical landscape that are commercially viable yet that will remain in commercial operation over the long-term. compatible with Europe’s net-zero aspirations are: Large, coastal, highly integrated refinery/petrochemical Chemical integration drives complexes that are globally competitive. competitive advantage during the Operating in a highly efficient, low carbon manner. energy transition An integral part of the circular economy (through In a world of globalised commodity markets in crude oil, adoption of second-generation biofuels and chemical refi ned products and bulk petrochemicals, a strong competitive recycling of petrochemicals) and integral to the local position is essential for high asset utilisation, positive cash community (via waste heat distribution to local fl ows and long-term sustainability. Petrochemicals add value to communities and other industries).

Figure 6. Indicative European downstream decision tree (source: Wood Mackenzie).

Located in an industrial cluster that enables economies of scale on CCS, low carbon hydrogen and waste collection/management.

Given the uncertainty of the pace of the energy transition, agility will be a key attribute for any strategic framework that looks at the options available to individual refi neries. Refi ners will need to carefully monitor developments and opportunities for their transformation. This includes the policies and transformations in other sectors that will introduce new entrants into their traditional markets (as refi ned products compete with electricity and other sources as the energy for mobility).

Not all the current refi ning sites will survive the energy transition. Even for those that are currently well placed, adaption is still required. The indicative decision tree (Figure 6) is a simplifi cation of the options involved, with ‘no regrets’ moves focusing on effi ciency improvements and margin capture through digitalisation and cost excellence, as well as benchmarking against key regional and global competitors to establish the current position of a site and the attributes of those that are already in fi rst quartile.

Conclusion

It is critical to understand what future success looks like in refi ning, petrochemicals, and emissions when mapping out any major investment to sustain the operating life of an existing asset. Even in a rapid energy transition, the role of refi ning as a ‘conversion industry’ remains, but there will be less conversion of crude oil due to the greater role of alternative feedstocks.

Doing nothing in the face of the energy transition acknowledges that a site will ultimately close. For some, that could be the best decision, but one to be consciously made as part of business diversifi cation. For those that aim to survive and thrive, they must invest and adapt to become one of the ‘last sites standing.’

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