COLUMN-Grangemouth's reprieve leaves other UK refineries vulnerable: Kemp

Reuters

By John Kemp

LONDON, Oct 28 (Reuters) - "Grangemouth now has a greatfuture," its operator Ineos said on Friday, a remarkableturnaround from a week earlier, when the company describedScotland's sole refinery as financially distressed.

But Grangemouth's reprieve will still leave all seven ofBritain's oil refineries under intense pressure in the comingyears.

One or two will probably close in the next few years,according to a report prepared for the UK Petroleum IndustryAssociation (UKPIA) by consultants Purvin & Gertz.

The remaining group will require 1.5 billion to 2.0 billionpounds ($3.2 billion) worth of investment to cope with changingfuel demand and up to 5.5 billion to meet more stringentenvironmental regulations.

AGAINST THE TIDE

"Existing UK refineries were either constructed or expandedin the 1960s with further major additions of distillation andcatalytic cracking capacity in the 1970s and 1980s," accordingto Purvin & Gertz.

The problem is that the refineries were built to producegasoline. But domestic gasoline consumption has peaked. Instead,demand for diesel and jet fuel is growing rapidly.

Gasoline consumption reached a maximum of 24 million tonnesper year in the mid 1990s, declining to just 15 million tonnesin 2010. By contrast, diesel usage has surged from 12 milliontonnes in the mid 1990s to 22 million tonnes in 2010. And jetfuel consumption has risen from under 8 million tonnes to morethan 12 million.

"The UK industry configuration remains more suitable forsupplying the UK demand profile of the 1990s rather than for2012," Purvin & Gertz wrote.

There is little chance of major new investment: "A wholerefinery site requires a very large area, typically more than200 hectares for a mid-sized refinery. Given land and planningpermission, it would cost around 4-5 billion pounds to constructone today, therefore these vital assets are unlikely to bereplaced."

Instead Britain has become a major trader of refinedproducts. In 2011, Britain's refineries exported over 5 milliontonnes of gasoline and 4 million tonnes of fuel oil, while thecountry imported 5 million tonnes of diesel and 6 million tonnesof jet fuel.

Overall, Britain was able to cover 83 percent of itsrequirements from domestic refineries in 2011. But while thecountry had a 37 percent surplus of gasoline above its domesticconsumption, it relied on imports for 29 percent of its dieseland 45 percent of its jet fuel.

REGULATION COSTS

Purvin & Gertz were particularly critical about the impactthat new regulations, mainly focused on protecting theenvironment, would have on refiners' survival.

To comply, UK refiners will need to make some 5.5 billionpounds in capital expenditure between 2013 and 2030, none ofwhich will be profitable.

Of the total, 4.6 billion pounds would have zero return(costs would be passed through to the consumer but with noaddition to profitability) and 900 million would actually have anegative return (costs could not even be passed through).

"No industry would bear such an investment burden for noreturn," Purvin & Gertz wrote in a report entitled "The role andfuture of the UK refining sector in the supply of petroleumproducts and its value to the UK economy" published in May.

"When faced with such a large mandatory capital expenditurerequirement that provides no return on investment, a number ofUK refiners could be forced to close UK refineries as they maynot have access to adequate finance," Purvin & Gertz observed.

"Those refiners fortunate to have access to adequate financewould still be likely to conclude that operating in the UK wouldnot provide an adequate return on investment compared to otherregions and voluntarily decide to close UK and Europeanoperations," the consultants added.

UKPIA is lobbying the government to cut the costs of newregulations, which may colour the dire warnings in itsconsultants' report.

But Purvin & Gertz is one of the world's leading refiningexperts. The report provides the most comprehensive overview ofthe state of Britain's plants, and the picture it paints is nothealthy.

INTO THE FIRE

Britain's refineries have an average capacity of just210,000 barrels per day and Nelson Complexity Index of around9.0. Nelson complexity is a measure of the sophistication of arefinery -- its ability to produce a higher share of premiumproducts from lower quality crude by processing and upgradingthem. The European Nelson average is around 7.6.

Britain's refineries are bigger and more complex than theEuropean average but quite small and unsophisticated incomparison with the giant refineries on the U.S. Gulf Coast andin Asia, which industry sources say have Nelson Complexities indouble figures.

UK refiners make a long-term average cash margin around $2.6per barrel, according to Purvin & Gertz. Once turnaround anddepreciation charges of roughly 86 cents per barrel arededucted, the operating margin is $1.84 per barrel, which isthin.

Purvin & Gertz nonetheless labels them "core refineries":not hugely profitable but ones the consultants expect to survivein the long-term and will still be needed to keep European andglobal markets adequately supplied.

But the industry is commercially fragile. Purvin & Gertzconclude the discounted return on capital could be as low as 2-3percent.

Purvin & Gertz doubt whether the financing can be found toinvest 5.5 billion pounds in environmental upgrades to meet along list of UK, EU and global regulatory requirements, as wellas 1.5-2.0 billion in commercial upgrades, over the next twodecades, when profitability is so poor.

Among other items, refiners must invest heavily to meet newlow-sulphur standards for marine bunker fuel (MARPOL Annex VI),increased compulsory stockholding obligations (CSO), and newsafety standards for tank farms.

REFINERIES AT RISK

European refining needs further rationalisation. Based ontheir throughput and complexity, Purvin & Gertz argue Britain'srefineries could all survive. Most of the European refineriesthat have closed so far have been smaller and less complex thanBritain's remaining seven units.

Provided UK refineries are not subject to greater environmental and regulatory requirements than theircounterparts in Europe and the rest of the world, they might allsurvive.

But given the intensifying regulatory pressures within theEU, Purvin & Gertz thinks at least one and perhaps two willclose.

Closures would worsen the country's dependence on importeddiesel and jet fuel. But by eliminating the gasoline surplus,they would raise domestic gasoline prices and strengthen thefinancial position of those refineries which remain.

REGIONAL RIVALS

Britain's distribution system for refined products isstrongly regionalised.

Southern England, which is home to only one refinery atFawley but hosts major aviation hubs at Heathrow, Gatwick andStansted, has a severe shortage of all products.

Scotland, where Grangemouth is located, has surplus gasolineand jet fuel but is short of heating oil and diesel.

By contrast, the Central England and Wales region, whichcontains the country's other five refineries -- at Milford Havenand Pembroke in Wales, Stanlow in Cheshire, and Lindsey andSouth Killinghome in Lincolnshire -- has a surplus of allproducts except diesel.

Purvin & Gertz compared UK refineries with their Europeancounterparts, both those that remain open and those that havealready closed.

In terms of size and complexity, the most marginal refineryBritain is Milford Haven because of its small capacity (just130,000 barrrels per day) and lower-than-average Nelsoncomplexity (just 7.0).

Grangemouth (210,000 barrels per day, 7.8 complexity) andPembroke (210,000 barrels per day, 9.2 complexity) are the nextmost at risk. But both are much larger than the refineries thathave closed so far, so their economies of scale give some degreeof protection.

Fawley, which is the largest (246,000 bpd) and mostsophisticated refinery (11.6) is the least endangered. It isalso the sole source of supply in the region which is alreadyshort of the supply of all products, especially diesel and jet.

Grangemouth too is the sole source of supply in its region,Scotland. So if a refinery must shut, it is most likely to beone of the five in the Central England and Wales region, whichhas the most excess capacity and a surplus of gasoline, jet andheating oil.

Grangemouth's workforce has reason to be relieved after thecompany agreed to keep it open, but the outlook for the sectorremains fragile.

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