Why are Refineries Closing Down

abarrelfullabarrelfull wrote on 24 Jan 2012 14:32
Tags: refinery refining

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The sudden spate of refinery closures have a number of people wondering why it is happening. A few years back, commentators were blaming high oil prices on the lack of refining capacity, and yet today, refineries are dropping like flies. What happened?

The first thing to understand is that all refineries are not created equally. There are huge differences between

  • The ability to add value, something that depends in large part on Nelson Complexity
  • The cost of operations, including energy efficiency
  • Access to and ability to process low cost raw materials, like extra heavy crudes
  • The market conditions in the local or regional area

If a refinery scores high on all of these factors, it is likely to make money even in the bad times, scores low on all of them, and its probably going to shut down.

A complex refinery has the ability to upgrade low value products into higher value ones, thanks to cracking units. As Residual Fuel Oil sells for less than the price of crude, producing it drags down a refiner's margin. Highly complex refineries such as the Jamnagar Refinery I & Jamnagar Refinery II twins in India, can produce a much more valuable mix of products than could the Port Clarence Teeside Refinery one of the early victims of the current sector downturn.

Fredericia Refinery in Denmark is not a very complex one, but it is one of the worlds most energy efficient. This is extremely important when you consider how much energy a typically refinery needs. In fact, Valero, the owner of the Aruba Refinery, which was mothballed a couple of years back, decided that solving the high cost of energy was a major priority, so they announced an LNG import terminal project to replace expensive oil with cheap gas.

The importance of raw materials is hard to overstate. As an example take a look at the Wood River Refinery Project. The Conocophillips / Cenovus JV refinery has been upgraded at a cost of $3.6 Billion, partly to enable the processing of heavier crude. Crude mix has been one of the key reasons for the closure of Pennsylvania's 3 large refineries.

As an illustration, I analysed the EIA data for crude purchases by the Marcus Hook Refinery for October 2011. Imports came from Ivory Coast, Nigeria & Azerbaijan, all countries with light crude oil. The average API was 37.1. By comparison, the average US refinery was processing 30.6 API crude. Remember the lower the number, the heavier and more difficult to process, but significantly cheaper.

In terms of markets, the world can be split into two, growing markets in the developing world, and stagnant or even shrinking ones in the developed countries.

According to the International Energy Agency, demand for refined products in Europe, fell by 1 million barrels per day between 2008 and 2011. Now the current economic problems may have exacerbated this but when you look at the details, it is heating oil & fuel oil that have fallen, as natural gas steals market share. Using oil products for heating makes no sense when natural gas is so abundant and cheap. This is one reason why refineries are being upgraded to produce far more transportation fuels.

In the USA, it is actually falling gasoline demand that has helped shrink demand for oil products
according to the EIA, as high prices led to reduced mileage and more efficient vehicles.

So if we look at the refineries closing or under threat, they have a number of things in common, expensive crude, a lack of upgrading capabilities and they are located in markets with poor growth prospects. Unfortunately there are still a lot more like them, so this is unlikely to be the last word.

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