Led by strong margins in the late 2000s, rapid increase in domestic demand and high population growth rates, governments in the region have invested heavily in building new refineries, upgrading existing ones and adding extra processing capacity.
Energy consultancy Apicorp (The Arab Petroleum Investment Corporation), estimates that by 2020, the GCC will add an extra 830,000 barrels per day (bpd) of new capacity, while its refineries will be able to process heavier crudes and produce high-grade, high-quality refined products to be supplied to markets in the region or exported abroad.
But since the fall of oil – crude prices hit a fresh seven-year low in December – refining margins have been shrinking dramatically. This, combined with persistent slowdown in demand from China – the GCC’s main fuel-export market – as well as rising competition abroad, rings several alarm bells for GCC refiners.
“Refiners continue to invest in complex refining capacity despite highly volatile margins and generally lowlight heavy differentials. [However], market conditions have generally not justified this level of investment,” Tom Janssens and Tim Fitzgibbon, senior analysts at McKinsey & Company said in a recent report entitled ‘The Conundrum of New Complex Refining Investments’.
According to data outlined in the report, planned investment in complex capacity, including coking, cracking and hydrocracking, is projected to continue at an annual rate of 2.9%. This is almost twice the rate of investment in new refining distillation capacity, indicating an overall increase in global refining complexity.
Most of this increased complexity has come from green field refinery investments in the Middle East, Asia and Latin America, the report notes.
Saudi Arabia’s refineries Yasref and Satorp, together with the newly expanded Ruwais refinery in the UAE, have added approximately 1.2mn barrels per day of new refined capacity in the last three years alone. In Saudi Arabia, Yasref and Satorp have had a substantial impact on the Kingdom’s trade balance. From 2012 to June 2015, gross exports of gasoline and diesel more than tripled, growing from 44,000 bpd to 173,000 bpd and 98,000pbd to 308,000 bpd respectively.
Refining capacity in the GCC is expected to grow further, with ambitious new projects due to come on stream as early as next year.
These include the UAE’s 200,000 bpd Fujairah refinery, which has 2016 as its target completion date and is expected to come online around the same time.
The rest of the additions will come from Saudi Aramco’s gigantic Jazan refinery due to be completed in 2018, followed by Ras Laffan 2 in Qatar, expected to be fully operational by Q3, 2016 and Oman’s flagship Sohar refinery, which after expansion will be able to process more than 200,000 bpd.
It remains to be seen how Kuwait’s much-delayed Al Zour refinery project will develop, but so far, the government has shown full commitment by awarding over $13bn worth of contracts to construction firms.
The refinery is slated to be the Middle East’s largest refining complex and once completed will have a capacity of 615,000bpd, raising Kuwait’s total refining capacity to 1.4mn bpd.
Bahrain is also due to add a modest but not insignificant 100,000 bpd to its Sitra Refinery, whose current capacity stands at 260,000 bpd. However, there is a lot of uncertainty over when the expansion would be completed.
Likely to come online in the early 2020s is Oman’s 230,000 bpd Duqm refinery, a joint venture between Oman Oil Company and Abu Dhabi’s International Petroleum Investment Company (IPIC).
All these new refineries, and most of the existing ones for that matter, will be configured mainly to produce diesel to meet the anticipated increase in diesel demand from Asia, particularly from China. However, Apicorp notes, China’s recent economic rebalancing – away from manufacturing towards consumer goods and services – has caused diesel demand in the country, related to heavy industries and transport of goods, to flat-line.
As a result, China has turned from a net importer of diesel into a net exporter, with exports averaging 76,000 bpd in 2014 and hitting 166,000 bpd in July 2015, Apicorp says.
Rising competition from the US and India are further squeezing margins for refiners in the region, with one producing record volumes of distillates in 2015 and the other ramping up output of refined petroleum products. Meanwhile, demand for gasoline in China continues to grow as personal transportation needs increase.
Although refiners in the GCC would be prepared to meet some of the demand, historically the region has been a modest exporter of gasoline and exports are not expected to exceed 100,000 bpd by 2020, according to estimates by Apicorp.
Diesel exports, on the other hand, would increase sharply from 310,000 bpd in 2015 up to 895,000 bpd in 2020.
This may cause the least efficient, older refineries in the Middle East to close, Apicorp warns, adding that factors other than profitability would have to be considered.
Already, Kuwait has announced plans to shut down its 200,000 bpd Shuaiba refinery – the oldest in the country – by April 2017.
The closure will take place ahead of its clean fuels project which is expected to start operations by mid-2018, a KNPC spokesman said at a news conference in November.
He added that work on Kuwait’s Clean Fuels Project is almost 37% complete. The upgrade project is an expansion of Kuwait’s two largest refineries and will produce higher-value products such as diesel and kerosene mainly slated for export.
While some remain sceptical over the immediate return on investment from expensive expansion projects at refineries, Janssens and Fitzgibbon suggest producers may be taking a long-term view instead.
“For a player with a large portfolio and multi-decade time horizon, it can make good strategic sense to continue investing in capacity that is structurally advantaged over the full margin cycle, even during the low periods.
“Similarly, a player with a lower cost of capital may still invest with limited short term returns,” the analysts said.
Furthermore, the experts argue, such decision could be motivated by strategic rather than pure economic view.
“For refiners in markets under threat of capacity rationalisation, investment can be critical to avoid being the most likely candidate for shutdown.
“Coupled with a view that the long-term prospects for a market are much brighter than the present, this could be enough of a rationale to support investment sooner than margins alone would support,” the pair said, adding that strategic investments in refinery upgrades could also be driven by a desire to eliminate competition from rival refiners.
“A big conversion investment by one refiner may encourage refiners in the same geography to exit as their position has deteriorated,” the two said.
In either case, it will be the new refineries in the Middle East that survive in the competitive landscape – the key questions being whether they would achieve a positive return, Apicorp says.
“This will depend on a number of factors; some are specific to the company (namely, their efficiency in implementing the projects and their operational efficiency); some are country-specific (reforming energy prices); while others are sector-specific (the size and complexity of global refining capacity and changing demand patterns). In this current environment, where many governments will be forced to seek private sources of finance to fund many of the planned projects, they have to show that these projects are adding real value and are not solely driven by the increasing pressure to meet ever-increasing demand.”
