Will the Producing Countries Rebuild Oil Refineries?
Saadallah Fathi Al-Hayat - 25/02/06//
Oil prices have significantly soared during the past two years, thus alarming most analysts in the producing and consuming countries alike. In 2003 for instance, the West Texas oil price reached on average $31.07 a barrel, while OPEC crude basket stood at an average $28.2 a barrel. In 2004, their prices spiraled even further, hitting $41.49 and 36 a barrel respectively. In 2005 too, they hovered above unprecedented levels, with the barrel price often exceeding $70 and 60 respectively and the average ranging throughout the year between $60 and 50 a barrel.
Though complicated, the oil market has ascribed this spike to the severely growing demand, especially in China and India, which coincided with the slowdown in supplies outside OPEC; the deteriorating geopolitical conditions in some producing countries; and finally, the shrinking reserve productive capacity margin in OPEC countries. Nonetheless, in addition to the aforementioned factors, oil refineries have been brought into focus since mid-2004 every time the oil market was addressed. As if we have, all of a sudden, discovered that the refining capacity cannot, qualitatively and quantitatively speaking, satisfy the growing oil market.
Early 2005, the refining capacity reached, as revealed the Oil and Gas Magazine, 82.4 million b/d in 647 refineries. At the same time, the conversion capacity, i.e. the refineries capacity to transform the undesirable heavy products into marketable light ones, amounted to 27.5 million b/d, equivalent to 33% of the refining capacity. As the demand for oil hovered in 2005 around 83.5 million b/d, these refineries have, as expected, operated at high and unparalleled capacities during the past two decades. As proof, the utilization rate currently equals 90% or even more in the United States compared with 60 to 70% in the late 80s. In addition, the oil market seems sensitive to all the developments in refineries, even if remedies to return them to service have been swiftly taken. Besides, the climate factors, especially hurricanes Katrina and Rita and the damages they wrecked to refineries, have disrupted the refining capacity and, with it, the oil market stability.
Most importantly, we must always bear in mind the reasons behind the huge surplus capacity in the United States and Europe, in turn induced by the huge investments in the 60s and 70s. In the same vein, we must remember the huge transformations and divisions in the oil industry as to extraction and processing, which have kept the refineries profitability extremely low until recently. Unfortunately, these two factors have, along with the shrinking demand early 80s, curtailed the investment incentives in oil refineries, shutting down most facilities, mainly the small and technically un-advanced ones. Then many environmental legislations were enacted, mainly the 1990 US Clean Air Act and its amendments and other similar bills in Europe, Japan, and even some developing countries. Hence, the refineries were obliged to funnel investments to such activities so as to meet the new requirements and keep functioning. Accordingly, the refining capacity slightly increased, between 2000 and 2005, to 1.1%, while the demand for oil soared by 8.3%. Meanwhile, the conversion capacity climbed by 9.8% compared with 12.5% for the hydrogenating capacity.
Now as the reserve refining capacity has apparently diminished, the future demand for oil is expected to prompt many regions in the world to boost their refining and conversion capacities. Even more, the conversion capacity may outstrip or at least equal the refining capacity, as the markets of heavy products, like fuel oil, are increasingly shrinking. For instance, the demand for fuel oil annually dropped by 1.4% between 1980 and 2004 with the emergence of other energy sources. By contrast, during the same period, the demand for gasoline and distillates annually mounted by 1.9 and 2.2% respectively. Likewise, the share of the light products in demand rose from 64% early 80s to 80% now - a phenomenon likely to persist in the foreseeable future. As far as hydrogenation is concerned, it must reach record levels in the new refineries, especially that different regions in the world embrace the international trend to reduce sulfur content in the said products.
On the other hand, the International Energy Agency (IEA) expects, in its World Energy Outlook 2005, the demand for oil to amount to 120 million b/d in 2030. It even projects the global refining capacity to swell from 82.9 million b/d in 2005 to 121.3 in 2030. Such 38.4-million-barrel-per-day increase means that 150 refineries are to built worldwide, with a 250-thousand-barrel-per-day capacity each, i.e. at a rate of six such refineries every year. But if we take into account the improvements, additions, and alternatives the current refineries need, then the task appears arduous. Hence, we cannot but question the capacity of engineering and construction companies to take up this challenge.
In this regard, the IEA estimates the investments needed to this end at $460 billion, 30% of which represent the forecasted share of conversion capacities.
In addition, such huge investment may be driven by many important factors, such as the constraints and obligatory improvements to the oil products, let alone the expected deteriorating quality of the heavier and less acidic crude oil to be internationally refined. Yet, this ambitious program can be easily self-financed if the refining margin sustains the same recent levels instead of falling to the low level of the past two decades. In fact, the 2004 refining margin equaled $8 a barrel then it significantly mounted to higher levels, especially in the aftermath of Hurricanes Katrina and Rita in the South of the United States. Theoretically speaking, estimates are apparently encouraging based on the current data. The refining capacity too is expected to remain reasonable. Yet, nothing guarantees that this will really take place. The time may have come indeed to seriously ponder on this issue and on the means to ensure that the refining industry, this important link between oil production and consumption, will be more profitable to investors. With no doubt, there is no magic potion to help us attain this goal. But as we all know, restricting investment and failing to expand the refining capacity are the worst means to preserve the refining margin in a market that relies, first and foremost, on stability and the consumers and producers trust.
In its aforementioned report, the IEA has also confirmed that in the industrialized countries where the demand for oil increases the most, it is impossible to build new refineries. Indeed, the last new refinery in the United States was built almost 30 years ago. Even more, just one refinery with a 150-thousand-barrrel-per-day capacity is under construction now in Arizona though the permit to this end was issued in 1999. Naturally, the US imports of oil products rose from 1.6 million b/d in 1995 to more than 3 million now. As the same situation prevails in the European countries and Japan, the expected expansions in the industrialized countries will be confined to some additions to the current refineries.
On the other hand, the refineries built near the consumption markets are generally deemed economical thanks to the low transportation cost and the spared practical problems. Nonetheless, the industrialized countries still abstain from building new refineries, which means that such refineries may focus once again on the crude oil production sources and that the producing countries will become more influential in the international market. But at present, the signs in this direction remain weak, even if OPEC has stated in its November 2005 monthly report that its member states are either building or designing an approximate 4-million-barrel-per-day refining capacity now. If these projects are indeed mapped out, then OPEC's refining capacity will be boosted to 13 million b/d - perhaps more in the next years. In this regard, the IEA expects the MENA refining capacity to increase by at least 8 million b/d by 2030. In truth, these figures are not so encouraging in our opinion. For, as we all know, there are many currently built or designed refineries with a capacity of 450 thousand b/d in Iraq, 600 thousand in Kuwait, 400 thousand in Saudi Arabia, 150 thousand in Qatar, 300 thousand in U.A.E., 115 thousand in Amman, 150 thousand both in Syria and Egypt, and 300 thousand b/d in Algeria.
In parallel, the producing countries must expand their refining capacity if they are to heed processing, generate new job opportunities, and meet the local, regional, and international demand. Equally important are the government desire, the easily issued construction permits, and the chosen locations. Likewise, the currently attractive refining margin, the skyrocketing oil receipts in general, and the reduced costs in these countries compared with the industrialized countries all incite governments to expand their refining industry. Besides, such step may open new horizons and breed technological breakthroughs covering many industries and activities. But when the producing countries bear the burden of investment, many risks will arise. In fact, investing in refineries is costly and seeks, along with the needed investment, to boost the capacity to produce crude oil and gas and generate electricity. Therefore, such investment may be made at the expense of the social and economic sectors. Yet, mystery still engulfs the most important and dangerous refining margin. Hence, an investment model must appear for this industry to reap at least reasonable profits.
In short, now more than ever, the world is seriously examining the need to facilitate and expand the refining industry. So, the oil-producing countries must seize the momentous opportunity to enhance and expand their current refineries and build new ones. But at the same time, they must balance risks and opportunities, while avoiding the harmful competition and irrational expansion, which may narrow the refining capacity.
* Mr. Saadallah Fathi is a consultant, a former expert at the Iraqi Oil Ministry, and the Former Head of Energy Studies Department at "OPEC" Secretariat.
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