Shell Global Solutions - Business News - Bright Future

BUSINESS NEWS
Bright future
Today’s refiners prepare to meet tomorrow’s challenges
R
efiners are facing more challenges
today than ever before, with demands
being made by many stakeholders.
Customers continue to want performance
and fuel economy and are increasingly
concerned about their role in contributing
to greenhouse gas emissions. Governments
are also concerned about emissions and,
at the same time, are interested in energy
security and supporting local agriculture,
all of which are contributing to a drive for
increasing market penetration of biofuels.
Shareholders, although attracted to
investing in the industry because of current
high margins, are concerned about cost
inflation and the sustainability of returns
over the medium-to-long term.
The recent improved margins come as
a relief in an industry that has, in the last
few years, undergone a long period of low
investment. But it is important for refiners
to understand the drivers for refining
margins in order to prepare for the future.
Colin Crooks, Supply Envelope Manager
for Central Eastern Europe, Mediterranean
and the CIS, Shell Polska SP, describes
the background to today’s situation and
identifies four primary drivers. The first
is growth in the demand for oil products.
“In the late 1990s and the early part of this
decade, there was a period of unusually
low demand growth. In 2003, and more
dramatically in 2004, we saw a return to
high levels of demand growth,” says Crooks.
“When the demand for oil products is
high, refineries are run at near-maximum
operating rates, and this is the second
driver,” he adds. “When this happens,
the simple distillation barrel, or the
hydroskimming barrel, becomes profitable
or at least break-even. That lifts the whole
refinery margin curve, and the other morecomplex
barrels generate a lot more money.”
The third driver is the length in global
fuel oil supplies. During the late 1990s,
there was a steady decrease in the demand
for fuel oil, as fuel oil was replaced by
natural gas in the energy mix. Between
2003 and 2005, the increased production
of gasoline and diesel resulted in a surplus
of fuel oil as a by-product. With no
demand for the extra fuel oil, it now goes to
the power sector for electricity generation
and attracts a relatively low value, priced
equivalent to the natural gas it displaces.
“High crude oil prices are the fourth
driver – a result of the failure of non-
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OPEC supply to meet expectations year
on year, and the need for OPEC to supply
the balance,” says Crooks. Spare capacity
in OPEC during 2003–2005 dropped
significantly, which helped to support prices
owing to a supply risk premium. Another
influence in the crude oil price was the
need for non-OPEC countries to invest in
incremental exploration and production.
The investment community led up the
future price of oil because they identified the
need for a higher price to justify investment
in, for example, deep-sea drilling and
producing oil from difficult environments.
The low fuel oil prices combined with
high crude oil prices translated into high
upgrading margins for those refineries able
to convert fuel oil into lighter products.
Looking to the future, energy demand
is set to continue to increase globally,
especially in Asia. Growing demand and
high margins are driving investment. “We
are seeing the largest wave of conversion
capacity growth since the 1970s,” says
Crooks. “Increased conversion capacity
consumes fuel oil. The price of fuel oil
could rise and potentially squeeze margins.
There is a risk of distillation capacity
overbuild putting some pressure on margins
in the future.”
However, two of the counterbalancing
forces to this are the escalating costs
of projects and the limitations in the
physical capacity of the engineering and
construction sector to build new projects.
Therefore, not all the capacity that is being
planned will come on-stream and that
might support margins.
Crooks points to the imbalance of
demand and supply around the world and
the trade flows that serve to rebalance the
surpluses and deficits: “In Europe, there is
a surplus of gasoline and an undersupply
of diesel. As the Middle East increases its
refining capacity, it will extend exports to
the West as well as its traditional markets
in the East. There will be an opportunity
for Russia and the CIS countries, as they
continue to invest in product quality
capabilities, to export diesel to Europe.
“The biggest challenge is in the Atlantic
Basin. Europe’s gasoline surplus has
traditionally found a home in the USA.
However, the import requirements of the
USA could decrease as the country increases
its refining capacity and substitutes gasoline
with ethanol. The imbalance here will be
difficult to solve, even with the trade flows,”
notes Crooks.
Biofuels are an increasingly important
part of the fuels mix; Europe is unable
to produce enough to meet legislative
requirements, and there will be a need for
imports. Replacing gasoline with biofuels
will mean a decrease in the demand for
gasoline, further contributing to the surplus
in Europe.
Another stress on refiners is that they
need to keep investing in product-quality
specifications, for example, the sulphur
specifications for gasoline and diesel, which
requires capital investment but does not
add value. This puts stress on cash flow and
the ability to invest in growth projects.
“The industry has always been cyclical,
and there is no reason to suppose the future
will be any different. The high margins
that we have enjoyed recently will start to
decline, and we will end up going through
another period of tight margins in the
PRESENTING: Colin Crooks at Shell Global Solutions’
Regional Symposium, which was held this year in Italy.
industry. When that happens, refiners will
need to be ready,” he affirms.
Shell is responding by focusing on
operational excellence, process safety, asset
integrity, reliability, availability and project
excellence – executing projects properly and
achieving flawless start-up.
“A key factor is maintaining cost
discipline. There is a tendency, when
margins are good, to take the focus off
costs. By keeping strict control of their
operating costs, when the situation does
change in the future, refiners with the best
cost structure will be in a good position,”
concludes Crooks.
Another way of staying ahead of the
game is to take advantage of technology
and innovation. The Shell group places
considerable emphasis on innovation, for
example, pioneering technology such as
gas-to-liquids and coal gasification. One
thing is certain: refiners cannot relax in
their search for improvement. However
hard companies work to be at the top of the
range, it requires continuous improvement
to stay there.
• Contact: Mark Junner
Email: mark.junner@shell.com
Issue 3, 2007 www.shell.com/globalsolutions
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