European Refining--Part I, Historical Perspective and Assessment

How European refining became a zombie sector

Introduction

Europe’s refining industry has been under stress for an astonishing four decades. Today, the European product market is awash in product from Russia, the US, and the Middle East, and the refining sector is characterised by overcapacity, underutilization, thin margins, and shifting ownership. In a series of three articles, Opportune LLP (“Opportune”), a leading international energy consulting firm, explores the complex dynamics of the European market and the long-term outlook for the refining industry in Europe.  In this first article of the series, Opportune analyses the forces affecting the current European market, and how it got to where it is now. The second article will focus on M&A in a European context, including what is for sale, if there are any buyers, and whether there are opportunities. The third article will investigate alternatives to M&A and the rise of asset-backed trading models.

The European refining sector has been unprofitable or marginally profitable for decades with only a few exceptions that include the so-called “golden age” of refining between 2004 and 2008. Global trends, such as a surplus in primary distillation capacity and declining oil demand, started developing in the 1970s and have been persistent issues ever since. This led international oil companies ("IOC") to abandon their original integrated model and slowly decrease exposure to underperforming downstream operations.

Capacity cuts, plant shutdowns, and conversions to storage facilities have historically played a minor role in equilibrating the market lagging behind the contraction in oil demand. In the last few years, the rationalization process has accelerated, largely because of the financial crisis, with c. 2.4 million bpd of capacity retired. This reduction is too little, too late, and significant additional capacity should close to address the market imbalances.

Opportune believes that structural constraints in terms of strong labour unions, stringent environmental laws, insulated inland markets, and prohibitive shutdown costs will inhibit mass-market closures. Expect the European Union and regional governments to intervene by providing financial incentives to convert refining plants and support a reindustrialization process of sites unrelated to the oil and gas sector.

However, we consider there is still potential for the refining sector in Europe for companies with the vision to integrate trading, logistics, and processing; especially those that serve local and regional markets, exploit market distortions, seek operational excellence, and can be creative in using refinery assets. But first, how did we come to this point? Click below to read the full article...

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