Opportunity Issue 95

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OIL AND GAS Refining 2021: who will be in the game? To keep up with change, refineries will have to restructure, strategically reposition their assets, or leave the market. With one in five oil refineries expected to cease operations over the next five years, choosing the right operating model and level of integration will be crucial for survival and sustained profitability. These stark prospects are among the findings of a recent Kearney study of the global refining market. In North America and Western Europe, the current trend of refinery closings is expected to continue, with one in five refining assets being squeezed out of the market over the next five years. Meanwhile, the boom in demand in Asia and the Middle East will lead to substantial changes in capacity and partnership structures. The conventional wisdom of vertical integration as the ideal and sustainable model for refiners is being challenged. Choosing the right operating model and the required level of integration across the value chain – for each asset and each region – will be crucial for improving margins and sustaining profitability in a volatile market. For assets that are not financially viable, regardless of their model, a decision about whether to exit will need to be made early on to prevent financial losses later in the decade. VALUE DRIVERS IN REFINING In the face of such rapid regional and global change, refiners need to re-examine what creates value in their industry to ensure they capture the most value from their asset portfolios. The value an asset generates depends on factors related to input, output and the asset itself. Value related to input factors includes crude fungibility, trading and hedging, energy imports and blending components. Output value relates to the choice of product and market sectors, for example, lubricants, petrochemicals, specialities (aviation and marine), or fuel and energy (domestic or industrial). Asset value relates to scale and technology, the fiscal and regulatory (regime) environment, supply chain management and slate flexibility. The value derived from each barrel of oil consumed varies from day to day and over the long term, as does the risk to that value. Risk factors relate to supply and demand fluctuations and arbitrage, price and time exposure, volatility and availability, political and regulatory instability and uncertainty, and interdependencies along the value chain. In such a complex and changing environment, refiners must be confident that they are participating in the market most productively – ensuring that a refinery asset has both the right flexibility and the ability to capture multiple marketing options. OPERATING MODELS FOR REFINERS — A DIVERSE PALETTE Four principal operating models are currently in play in the industry, with no single model dominating. The picture is evolving constantly, as companies adopt models they feel are best suited to the times. The operating models can be defined briefly as follows: • Upstream integration. A single source of crude oil accounts for more than 50% of the upstream integrated refiner’s supply; the crude source can be either equity crude or a long-term contractual arrangement. ___ __ Adapting to local or regional conditions, while making the most of global synergies, is the name of the game. 12 | www.opportunityonline.co.za
Refinery value drivers OIL AND GAS Input Crude fungibility • Local or regional balances • Pipeline or imports by ship • Multiple asset optimisation Trading and hedging • Feedstock • Products • Currency Energy imports • Electricity • Steam Blending components • Gasoline • Biofuel • Gas to liquids Source: A.T. Kearney analysis Asset-related Output Scale and technology • World-scale or sub-scale • Distillation and conversion • Technology Fuel and energy • Merchant only versus retail • Export versus local sales Fiscal and regulatory regime • Tax • Regulation • Environment Specialties • Specialist markets (marine, aviation, asphalt) with dedicate assets • Brand equity Supply chain management • Location • Logistics infrastructure • Working capital optimisation Petrochemicals • Which value chain •Joint venture or sole ownership • Export versus local sales State flexibility • Dedication of technology • Ability to change baskets • Operational flexibility Lubricants • Base oil plant • Blending plant and storage www.kearney.com • Merchant refiner. Lacking both upstream and downstream integration, the merchant refiner has the flexibility to react quickly to both crude and downstream supply opportunities and to adjust operations or integrate into a larger logistics hub. • Downstream integration. Dedicated marketing channels take more than 50% of the downstream integrated refiner’s production. These trades are secured either through equity or long-term contracts. • Vertical integration. Fulfilling the requirements for upstream and downstream integrated refiners at the same time, the vertically integrated refiner can capture value by making the most of advantages across the value chain. MAXIMISING VALUE: DIFFERENT STRATEGIES FOR DIFFERENT REGIONS In such a diverse landscape, there is no one-size-fitsall approach to business. Adapting to local or regional conditions, while making the most of global synergies, is the name of the game. The only given in this shifting landscape is that refining excellence is imperative in all input, output and asset-related dimensions. Eastern European and Russian refiners are investing in technologies and scale to overcome the limitations of their dated structures and to pursue asset excellence. However, infrastructure and output issues around the still-underinvested and not yet upgraded refining technology landscape are hindering integration with the local market and are favouring fuels export instead. Asia Pacific has the highest activity in terms of numbers of refineries opened and closed, even as small, polluting and less efficient refineries are being closed and world-scale state-of-the-art facilities are coming online. In this highly attractive market, international oil majors are becoming much more involved in joint ventures to build petrochemical plants, attracted by relatively high economic growth in many countries. THE ONLY CERTAINTY: A REQUIREMENT FOR EXCELLENCE We expect further significant upscaling in global refining, which will result in divestment and closure of lagging assets in North America and Western Europe. The changing global supply-and-demand situation will push Middle East refiners to intensify their partnering with Asia Pacific players. Meanwhile, more refineries in Asia Pacific – especially China and India – will integrate with petrochemical plants, as a combined build-or-buy reverse integration. Changes in crude availability and discounts will affect refining capacity and profitability of some players in the region. Companies can respond to these changes by choosing among different operating models and methods of value-chain integration. Each model has its strengths and weaknesses; for instance, the pure merchantrefining model ranges from vulnerable to high volatility in absolute oil price. For new investors, integration with a competitively positioned upstream player or a secure downstream business will be important. Deep integration of refining with petrochemicals can add value but comes with its complexity and economic factors.. The only given in this shifting landscape is that refining excellence is imperative in all input, output, and asset-related dimensions. The market gives no-one a free ride, and it has become more important than ever to manage risk exposure. ___ __ The value derived from each barrel of oil consumed varies from day to day and over the long term, as does the risk to that value. www.opportunityonline.co.za | 13
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