Refining and Fuels, The Fundamentals of Change
Speaker: Iain Conn
Speech date: 05 March 2012
Title: Refining & Marketing chief executive
Speech date: 05 March 2012
Title: Refining & Marketing chief executive
Good afternoon ladies and gentlemen. I would like to start by thanking IHS CERA for the opportunity to address you today.
For the next ten to fifteen minutes, I would like to focus on the changing world of hydrocarbons and what the implications are for the fuels business, with a major emphasis on refining.
Our world is changing, but that does not mean that the outlook for all refining is bleak. Nor does it mean that there are no opportunities for margin growth. It does mean, however, that access to margin expansion will be structural and probably expensive. It does also mean that over the next 20 years there will be winners and losers in the refining business.
I am not being a pessimist, just a realist. I will base my arguments in the fundamentals of world energy.
For the next ten to fifteen minutes, I would like to focus on the changing world of hydrocarbons and what the implications are for the fuels business, with a major emphasis on refining.
Our world is changing, but that does not mean that the outlook for all refining is bleak. Nor does it mean that there are no opportunities for margin growth. It does mean, however, that access to margin expansion will be structural and probably expensive. It does also mean that over the next 20 years there will be winners and losers in the refining business.
I am not being a pessimist, just a realist. I will base my arguments in the fundamentals of world energy.
This chart shows BP’s growth forecast for global primary energy consumption out to 2030. From 2010 growth will average 1.6% per annum, adding 39% to global consumption by 2030.
One big difference from the past is that almost all, 96%, of the growth is in non-OECD countries.
The fuel mix changes slowly. Gas and non-fossil fuels gain share at the expense of coal and oil. Oil grows the slowest at 0.7% p.a. while renewables, including biofuels, grow fastest at 8.2% p.a. with biofuels taking share from oil. Biofuels account for 23% of transport energy demand growth globally, and supply will continue to be dominated by first generation sources over the next decade. The development of advanced technologies means growth post 2020 is likely to be through conversion of energy grasses and other waste cellulosic materials.
Although fossil fuels still account for about 80% of primary energy in 2030, the transport sector shows the weakest growth, and is projected to decline in the OECD.
Although total additional demand for hydrocarbon liquids to 2030 will be some 16 Mb/d, the growth in the call on refinery throughput will be constrained by the growth in liquids which do not need refining - biofuels and NGLs. The total call on new refined crude will be 9 Mb/d. Most of this will be met by Chinese capacity, leaving only 2 Mb/d outside China and that will be essentially met by growth in other non-OECD countries.
All of this puts fundamental pressure on existing refining in which we know we already have excess global capacity, with industry utilization rates in the low 80’s percent.
So, having talked about volume, what about price?
One big difference from the past is that almost all, 96%, of the growth is in non-OECD countries.
The fuel mix changes slowly. Gas and non-fossil fuels gain share at the expense of coal and oil. Oil grows the slowest at 0.7% p.a. while renewables, including biofuels, grow fastest at 8.2% p.a. with biofuels taking share from oil. Biofuels account for 23% of transport energy demand growth globally, and supply will continue to be dominated by first generation sources over the next decade. The development of advanced technologies means growth post 2020 is likely to be through conversion of energy grasses and other waste cellulosic materials.
Although fossil fuels still account for about 80% of primary energy in 2030, the transport sector shows the weakest growth, and is projected to decline in the OECD.
Although total additional demand for hydrocarbon liquids to 2030 will be some 16 Mb/d, the growth in the call on refinery throughput will be constrained by the growth in liquids which do not need refining - biofuels and NGLs. The total call on new refined crude will be 9 Mb/d. Most of this will be met by Chinese capacity, leaving only 2 Mb/d outside China and that will be essentially met by growth in other non-OECD countries.
All of this puts fundamental pressure on existing refining in which we know we already have excess global capacity, with industry utilization rates in the low 80’s percent.
So, having talked about volume, what about price?
Energy prices are on the rise, driven by continued energy demand. The increasing prices are also driven by two other critical factors. One is the rising price at which energy producing countries can balance their economies. The other, in the case of oil, is the rising cost of the marginal barrel. OPEC stated recently their wish to stabilize the oil price and keep it at a level of around $100/bbl. This was before the most recent geopolitical tensions and may not be easy given supply disruptions we have seen from political changes in many other countries.
Higher prices are also being seen in most fossil energy sources, with the notable exception of US Natural Gas and US domestic oil production which at present cannot clear to the coast and access World markets. Although there is much speculation about this, I personally believe that it is only a matter of time before sufficient infrastructure is developed to allow for significant price normalisation.
The current high prices of oil put pressure on refiners in two ways. Firstly, it further reduces demand and utilization as consumers look to energy efficiency and changed behaviours to make economic savings. Secondly, it increases the value and therefore funding requirements of working capital. For some refiners, this is beginning to mean that the working capital in tank is worth more than the fixed assets themselves. This depresses returns, and the call on funding working capital puts pressure on balance sheets. At a time of tight credit lines, these high prices are beginning to threaten the viability of some refiners and we have seen some high profile examples.
There is another effect which is significant, and which will continue to sustain upward pressure on prices - the competition for access to hydrocarbon supplies.
Higher prices are also being seen in most fossil energy sources, with the notable exception of US Natural Gas and US domestic oil production which at present cannot clear to the coast and access World markets. Although there is much speculation about this, I personally believe that it is only a matter of time before sufficient infrastructure is developed to allow for significant price normalisation.
The current high prices of oil put pressure on refiners in two ways. Firstly, it further reduces demand and utilization as consumers look to energy efficiency and changed behaviours to make economic savings. Secondly, it increases the value and therefore funding requirements of working capital. For some refiners, this is beginning to mean that the working capital in tank is worth more than the fixed assets themselves. This depresses returns, and the call on funding working capital puts pressure on balance sheets. At a time of tight credit lines, these high prices are beginning to threaten the viability of some refiners and we have seen some high profile examples.
There is another effect which is significant, and which will continue to sustain upward pressure on prices - the competition for access to hydrocarbon supplies.
This chart shows the historic, and BP projected, convergence of energy intensity of GDP.
It shows that the World intensity of GDP is falling. It also shows that the energy intensity of GDP for China, a major driver of global energy demand growth, is higher than average.
On average, the World is currently at about 0.15 tonnes of oil equivalent per $1000 of GDP. Now, we all know what 0.15 tonnes of oil equivalent is……it is just over a barrel.
This means that on average it now costs about $130 of energy per $1000 GDP, and for China it is approaching $200. When oil prices were $25/bbl this mattered less. At today’s prices, and with the potential for further rises, it matters a lot. Securing the energy for growth is expensive, and fundamental.
As a result, there is an intense competition for hydrocarbons taking place, including for oil. China is competing for access to oil in places such as the Middle East, North America, Latin America, and Africa, and for natural gas in the Middle East, Caspian, North America and South Asia. It is very understandable why.
What this competition for hydrocarbons results in, apart from further pressure on prices in general, is that while all grades of oil are being sought, the ability to process the most difficult grades, and the most infrastructure constrained grades, becomes important for the OECD refiner. The advantage of feedstock flexibility and capability is becoming increasingly important.
This is why at BP we have been refocusing our refining portfolio significantly and concentrating our investment in order to maximise our ability to take advantage of dimensions of scale, location and flexibility. I will return to this in a moment.
So, what then are the implications for OECD refiners?
It shows that the World intensity of GDP is falling. It also shows that the energy intensity of GDP for China, a major driver of global energy demand growth, is higher than average.
On average, the World is currently at about 0.15 tonnes of oil equivalent per $1000 of GDP. Now, we all know what 0.15 tonnes of oil equivalent is……it is just over a barrel.
This means that on average it now costs about $130 of energy per $1000 GDP, and for China it is approaching $200. When oil prices were $25/bbl this mattered less. At today’s prices, and with the potential for further rises, it matters a lot. Securing the energy for growth is expensive, and fundamental.
As a result, there is an intense competition for hydrocarbons taking place, including for oil. China is competing for access to oil in places such as the Middle East, North America, Latin America, and Africa, and for natural gas in the Middle East, Caspian, North America and South Asia. It is very understandable why.
What this competition for hydrocarbons results in, apart from further pressure on prices in general, is that while all grades of oil are being sought, the ability to process the most difficult grades, and the most infrastructure constrained grades, becomes important for the OECD refiner. The advantage of feedstock flexibility and capability is becoming increasingly important.
This is why at BP we have been refocusing our refining portfolio significantly and concentrating our investment in order to maximise our ability to take advantage of dimensions of scale, location and flexibility. I will return to this in a moment.
So, what then are the implications for OECD refiners?
This chart shows on the x-axis, the cumulative production for light oil products in the Atlantic basin, and on the y-axis an estimate of relative net cash margin under conditions similar to those in 2010.
Firstly, as we all know, the chart is not flat. The net cash margin of the most capable refinery is materially - some $13/bbl - better than the least advantaged.
For the least advantaged, the pressures of higher oil prices and limited credit are already taking their toll. However, the next big threat is the fall in demand in the Atlantic basin.
As you can see from the yellow lines, by 2030 Atlantic basin demand for light oil products is projected to be some 4.5Mb/d below where it was in 2010. That equates to about 6 to 7Mb/d of total refining nameplate capacity depending on configuration. This clearly means that a significant volume of capacity will either have to be viable to export from the region, or will come under significant pressure to shut down.
On the other hand, the very best refiners will still be capable of delivering net cash margins of $8/bbl above the marginal price setter and this is before investments to improve that margin capability further.
The bottom line to my mind, therefore, is that there will be winners and losers in Atlantic basin refining over the next 20 years and this effect is likely to be seen across the OECD.
So, what does it take to win?
Firstly, as we all know, the chart is not flat. The net cash margin of the most capable refinery is materially - some $13/bbl - better than the least advantaged.
For the least advantaged, the pressures of higher oil prices and limited credit are already taking their toll. However, the next big threat is the fall in demand in the Atlantic basin.
As you can see from the yellow lines, by 2030 Atlantic basin demand for light oil products is projected to be some 4.5Mb/d below where it was in 2010. That equates to about 6 to 7Mb/d of total refining nameplate capacity depending on configuration. This clearly means that a significant volume of capacity will either have to be viable to export from the region, or will come under significant pressure to shut down.
On the other hand, the very best refiners will still be capable of delivering net cash margins of $8/bbl above the marginal price setter and this is before investments to improve that margin capability further.
The bottom line to my mind, therefore, is that there will be winners and losers in Atlantic basin refining over the next 20 years and this effect is likely to be seen across the OECD.
So, what does it take to win?
The headline is simple - it is all about quality, not quantity, and about integration across the value chain.
Everything starts with being safe. This obviously includes understanding risks, ensuring appropriate controls are in place, knowing that they are being managed and constantly looking at ways to reduce and manage our key risks through systematic management of operations.
It then is all about being available, and being excellent and efficient in all aspects of operations. However, as I have indicated, that will not be sufficient on its own.
Beyond these operational aspects, there are structural factors which will be the key determinants of success.
As always, scale and location are critical. The underlying complexity of the refinery is clearly also key to ensure base margin capability.
However, in my view feedstock flexibility and advantage will become fundamentally important. In a market of shrinking demand, making more product is not the way to succeed. Rather it is making the same product from the cheapest feedstock. To do that with the most challenging grades, you have to have the right metallurgy. You can see in the chart on the bottom right, that recent oil production growth has increasingly been from extra-heavy oil, syncrudes and condensates. The low growth of conventional oil will add to the pressure on those who are limited to running it because of their configuration and metallurgy.
Product flexibility is also important, as shifts between distillate and gasoline take place. However, in a shrinking market the ability to stay utilized is increasingly key, and integration into marketing and petrochemicals will become much more important. As seen on the top right, BP’s portfolio is now delivering utilization rates at the top of the industry range.
Everything starts with being safe. This obviously includes understanding risks, ensuring appropriate controls are in place, knowing that they are being managed and constantly looking at ways to reduce and manage our key risks through systematic management of operations.
It then is all about being available, and being excellent and efficient in all aspects of operations. However, as I have indicated, that will not be sufficient on its own.
Beyond these operational aspects, there are structural factors which will be the key determinants of success.
As always, scale and location are critical. The underlying complexity of the refinery is clearly also key to ensure base margin capability.
However, in my view feedstock flexibility and advantage will become fundamentally important. In a market of shrinking demand, making more product is not the way to succeed. Rather it is making the same product from the cheapest feedstock. To do that with the most challenging grades, you have to have the right metallurgy. You can see in the chart on the bottom right, that recent oil production growth has increasingly been from extra-heavy oil, syncrudes and condensates. The low growth of conventional oil will add to the pressure on those who are limited to running it because of their configuration and metallurgy.
Product flexibility is also important, as shifts between distillate and gasoline take place. However, in a shrinking market the ability to stay utilized is increasingly key, and integration into marketing and petrochemicals will become much more important. As seen on the top right, BP’s portfolio is now delivering utilization rates at the top of the industry range.
Last on the list of structural factors, it is about optimisation capability along the chain, from oil supply and trading, to product optimisation.
I believe that such factors also do apply and will apply to non-OECD markets, despite their market demand growth, and a winning participant would do well to dial these in early because I cannot see any reason why the non-OECD would not follow the same path of evolution, just potentially faster. This means that marginal refiners in Asia will also feel the pressure.
Finally, a winning participant will need to continue to invest into those aspects of our business which also create advantage - into technology, brands and of course relationships.
So in my view these are the key success factors for the refining and fuels business going forward.
I believe that such factors also do apply and will apply to non-OECD markets, despite their market demand growth, and a winning participant would do well to dial these in early because I cannot see any reason why the non-OECD would not follow the same path of evolution, just potentially faster. This means that marginal refiners in Asia will also feel the pressure.
Finally, a winning participant will need to continue to invest into those aspects of our business which also create advantage - into technology, brands and of course relationships.
So in my view these are the key success factors for the refining and fuels business going forward.
So, to conclude.
The World will remain dependent upon hydrocarbons for the foreseeable future.
There is a competition for hydrocarbons today, fuelled by non-OECD GDP growth, the energy intensity of GDP and the higher prices of fossil energy.
The business of refining and supply of fossil fuels is not for the feint-hearted, and the combined pressures I have outlined will mean that there will be a material shake-out over the next 20 years.
There will be winners and losers.
However, that statement contains two words - losers and winners.
The World will remain dependent upon hydrocarbons for the foreseeable future.
There is a competition for hydrocarbons today, fuelled by non-OECD GDP growth, the energy intensity of GDP and the higher prices of fossil energy.
The business of refining and supply of fossil fuels is not for the feint-hearted, and the combined pressures I have outlined will mean that there will be a material shake-out over the next 20 years.
There will be winners and losers.
However, that statement contains two words - losers and winners.
I believe it is fundamentally possible to be a winner in this business even against these trends. It is all about relative quality, and a relentless focus upon it.
BP is pursuing a path of quality not quantity, and focusing our portfolio so that we can afford to invest for margin quality and integration in what we have left. We have been pursuing this for over ten years, selling ten refineries in that time and investing for feedstock advantage here in the U.S.
Faced with the fundamentals I have outlined, it is far too simplistic to say that oil refining and fuels marketing is a bad business. It isn’t and doesn’t have to be. However, bold and decisive actions are required to ensure a position on the right side of the equation.
Thank you.
ICC
CERA, Houston, 6th March 2012
BP is pursuing a path of quality not quantity, and focusing our portfolio so that we can afford to invest for margin quality and integration in what we have left. We have been pursuing this for over ten years, selling ten refineries in that time and investing for feedstock advantage here in the U.S.
Faced with the fundamentals I have outlined, it is far too simplistic to say that oil refining and fuels marketing is a bad business. It isn’t and doesn’t have to be. However, bold and decisive actions are required to ensure a position on the right side of the equation.
Thank you.
ICC
CERA, Houston, 6th March 2012
