The transport sector currently accounts for a dominant proportion of the global crude oil consumption with refining throughputs spiking during peak driving seasons. As penetration rates for electric and hybrid vehicles are still at modest levels, that dominance is set to endure for some time to come, albeit in decreasing proportions.
Oil and gas companies have recently seen challenges in the downstream Refining and Marketing (R&M) subsector; but these challenges are different for developed and developing countries.
Total OECD petroleum consumption peaked at about the year 2005 and has been declining since. Figure 1 shows that while OECD consumption increased by about 20% between 1990 and its inflexion year of 2005, that for non-OECD increased by more than 60% from 1990 through 2010.
Weak motor fuel demand and the consequent decline in refining throughputs (Figure 2) have combined with costly regulatory requirements particularly in the United States to bring about poor refining returns. In the United States for example, figures recently released by the Energy Information Administration show that for the week ended September 23 2011, gasoline demand was 419,000 barrels per day (bpd) less than year-ago levels while the four-week average for gasoline demand was 2.4 million bpd less than the corresponding 2010 period. According to the released figures, both Gulf Coast and Atlantic Coast refinery runs saw declines.
Unforeseen circumstances earlier this year also added to poor refining throughputs. For example, European refineries, which take about 80% of Libya’s light sweet crude production, saw significant decline in runs when unrest knocked off that country’s output. In addition, the Sendai earthquake in Japan still keeps about 500,000 bpd of refining capacity offline.
Faced with increasing difficulty to reserves replacement, resource nationalism as well as the aforementioned challenges, many Integrated Oil Companies (IOCs) embarked on various restructuring processes aimed at improving their profitability.
For ConocoPhillips, — which, among the oil majors had the highest share price gains year-on-year for 2010 — assets divestment was the principal restructuring tool. It was therefore no surprise that downstream R&M assets formed a significant proportion of that divestment. The oil major recently broke up into two companies with R&M operations comprising one of them. It is also in the process of selling off refining assets such as the 185,000 barrel-per-day refinery in Trainer, Pa. in the United States. Total and Shell among others have also been involved in R&M divestment.
It would however be incorrect to assume that R&M operations are loss-making ventures (Figure 3). Falling demand for refining products has meant that the most efficient refiners are the most viable. Niche-focused independent oil and gas companies have proved much more efficient in their respective niches than unwieldy IOCs. For example, independent Exploration and Production (E&P) as well as R&M companies recorded overwhelmingly higher share price gains year-on-year in 2010 than IOCs. The potential alliance between resource-rich National Oil Companies (NOCs) and these niche-focused independents may well add to the viability concerns of IOCs.
An upside to the break-up of integrated companies into smaller independents is that the sum of the market valuation of the smaller units has in many cases exceeded that of the original company. This may lend credence to the position that niche-focused companies boast higher operational efficiencies.
For developing economies, where demand is largely subsidy-driven, the challenges are somewhat different. Countries such as Saudi Arabia, India, Pakistan, Venezuela, Iran, China and Nigeria among many others have emplaced various forms of petroleum product subsidies. While such subsidy regimes provide for caps in domestic product prices, they often do not allow for adequate refining margins and have on massive scales, entrenched corrupt financial practices as well as natural resources wastage. With such operational climate, many IOCs have either spurned R&M investments or spun them off completely.
In India, due to the large subsidy burden, the government has mandated a series of increases — albeit gradual — in the prices for refined petroleum products.
In Saudi Arabia where crude oil is used for much of its domestic power generation, subsidies often bring electricity prices as unsustainably low as US$0.015 to US$0.04 per kilowatt. The country’s oil consumption increased by 75% over the last 10 years and is set to top an estimated 5.6% increase this year, against the estimated global average of about 1.4%. The head of Saudi Aramco had earlier this year, warned that by the year 2028, more than 8 million barrels of oil equivalent per day would be internally consumed if the trend is sustained; and that would impose severe restrictions on export proportions, probably impacting global supply.
Nigeria is often considered emblematic of the oil resource curse. In Nigeria, gasoline prices have been fixed for the past few years at about US$0.42 per liter across the country, irrespective of international crude oil prices or transportation costs. A refining company in that country would therefore face very bleak profitability prospects if it were required to purchase crude oil feedstock at the highly volatile international prices. Of the 18 refining licences issued more than 7 years ago, none has received a final investment decision; and that, in a country which imports most of its refined product consumption.
For most of those licences, there were no proper provisions for supply of feedstock or evacuation and distribution of product. Security issues as well as poor regulatory regimes compounded the case.
As Nigeria’s oil and gas production is now predominantly offshore, floating refining operations would stand the country in much better stead. They would provide proximity and ease of access to feedstock as well as better security against sabotage or terror threats.
The issue of caps on some product prices would still have to be addressed. A one-step (total) revocation of subsidies would probably throw up much greater and unsavory challenges for leadership and country. However, since the R&M or downstream sector creates far more jobs than the upstream counterpart, part of current product subsidies may be used initially to guarantee refining margins as a first step in the total subsidy revocation exercise. That would spur investment and with positive, multi-sector knock-on effects.
Such guarantees are not novel. Capital expenditure (Capex) is critical for sustained oil and gas production. When global crude oil prices were at capex-crippling lows, the Nigerian government entered into contracts which guaranteed investors a certain margin on each barrel of oil produced. Even with the contracts’ inherent flaws, the result was that while global upstream activities were at a lull, operators in Nigeria paved the way for the subsequent, timely increases in the country’s oil and gas reserves.
For Nigeria, the burden of petroleum product subsidy is already unbearable. According to the country’s Petroleum Product Pricing Regulatory Agency, PPPRA, about US$13 billion was expended to subsidize refined petroleum products between January 2006 and June 2010. In comparison, about US$6.4 billion was provided for capital expenditure in the country’s 2011 budget.
One single element of data in Nigeria’s refining statistics, tells all the story: over the past ten years, the country’s refineries have averaged an abysmal aggregate capacity utilization of less than 30%. The values are 10.90% and 21.53% for 2009 and 2010 respectively according to the Nigerian National Petroleum Corporation, NNPC. There has been either a lack of adequate feedstock supply, or a lack of technical maintenance. Without provisions for adequate refining margins and supply of feedstock, the country would be hard-pressed to find worthy investors for that subsector.
As seen in Figure 2, non-OECD refining throughputs have been on the increase (30% between 2000 and 2010), driven principally by the Asia-Pacific region where economic growth over the next few years is expected to be strong. Singapore refining margins are also expected to see significant upticks through the next few quarters.