It does not have the glamour of wildcatting in distant frontiers, nor the customer visibility of petrol stations, but oil refining is a critical part of the industry. It turns the gloopy black crude oil into the carefully tailored products, from petrol, diesel and jet fuel, to lubricants and feedstocks. A key part of Middle Eastern investment plans, refining is entering a more complex and pressured decade.
Instead of exporting raw materials, refining has traditionally been seen as a way for oil producers to ‘add value’ to their product. Refining margins also tend to outperform when oil prices drop. More recently, Middle Eastern states, notably Saudi Arabia, the UAE and Kuwait, have sought to guarantee offtake by investing in mega-refineries in their key emerging Asian markets, China, India, Vietnam, Indonesia, Malaysia and others. And they have added petrochemical complexes to generate higher-value and more sophisticated outputs.
Still, refining faces three major challenges. First is overcapacity. World oil demand is expected to rise about 1-1.1 million barrels per day during this year, and 1.3 million bpd in 2020. But a wave of new refineries will increase capacity by 1.8 million bpd and more than 2.2 million bpd respectively. By 2021 it will be a little slower (and some of the planned 2020 refineries may slip into the year after), but 2022 is another strong year with 1.8 million bpd expected.
This gain comes mostly from giant new refineries in China, the Middle East and one big plant in Nigeria built by tycoon Aliko Dangote. Adnoc plans to create the world’s largest refining and petrochemical complex at Ruwais, adding a new 600,000 bpd refinery around 2024. Kuwait is upgrading two refineries to produce cleaner fuels, and building a third giant greenfield facility, while Oman is constructing a big refinery with Kuwaiti investment at its south-eastern port of Duqm. There are smaller projects in the UAE at Enoc’s Jebel Ali refinery and Brooge’s Fujairah oil storage terminal. Iran and Iraq also have a range of refining projects of varying sizes and realism.
If refining capacity is in surplus, some will have to run below maximum rates, and even shut down. This is most likely in Europe and Japan, where both oil demand and production have been dropping for years, energy costs and wages are high and imported crude more costly. However, closing refineries is difficult – they have serious environmental legacies, local politicians tend to resist large layoffs of workers, and governments prefer self-sufficiency in refining to assure a secure supply of fuels.
Meanwhile, plants in the Middle East, developing Asia and North America are more competitive, being large and modern and having easy access to feedstock. Surplus Chinese products are exported to Asian neighbours, but they want to retain their own refineries to avoid dependence on Beijing.
The second challenge is the possible peak in demand for oil. Improved vehicle efficiency, tighter environmental standards, a slowing Chinese economy, replacement of oil by natural gas, and the rise of electric vehicles, can combine to drive oil consumption into permanent and inexorable decline. When this will happen is a matter of debate, with estimates ranging anywhere from the mid-2020s to the mid-2040s or beyond. But for refinery investments predicated on a payback of more than a decade, and decades more of useful life after that, the prospect is worrying.
The situation is worse than it sounds, because a growing share of final oil demand is not derived from crude oil. It comes from natural gas liquids, a by-product of gas production that is booming particularly in the US; from biofuels made from crops and plant waste; and from synthetic fuels derived from coal in China. So the peak of refining runs will come before a peak in overall oil consumption.
To cope with this prospect, new refineries are typically integrated with petrochemicals production. This brings cost-saving synergies, and adds value and diversity of outputs. While road fuel demand is expected to go into decline in the foreseeable future, demand for petrochemicals – producing plastics, rubber, paint, glue, fibres and a host of other products – is anticipated to keep rising. In developing countries, it grows faster than the economy.
Petrochemicals are therefore seen as a hedge against “peak demand”. New Chinese plants are usually designed for a high output of petrochemicals. Saudi Aramco plans a $20 billion (Dh73bn), 400,000 bpd plant at Yanbu to turn crude oil directly into chemicals without going through a refining step, though this may be rethought following its acquisition of compatriot Saudi Arabia Basic Industries Corporation.
The third concern for refiners is tightening environmental standards. On January 1, 2020, new regulations reducing the allowable amount of sulphur in shipping fuel go into force. This is bad news for simple refineries with a high output of sulphurous fuel oil. It will be favourable, though, for complex plants that can desulphurise crude.
In the longer term, measures will be taken intended to clean up the oceans, which may dampen petrochemical growth. There will be more emphasis on recycling and using biomaterials as inputs. And refineries’ greenhouse gas emissions will come into focus as climate change policies tighten. Refiners will have to keep improving energy efficiency, incorporate renewable energy, and install systems to capture their carbon dioxide.
Building refining capacity at home and abroad is a key part of most Middle Eastern states’ energy strategies. As the industry’s challenges grow, they will have to be disciplined, innovative and highly efficient to make a success of these investments.
Robin M. Mills is CEO of Qamar Energy, and author of The Myth of the Oil Crisis