Refining — Surely It’s Simple?

The oil majors’ downstream businesses have delivered value to shareholders over recent years. This  is due to portfolio high grading and the surge in oil demand due to low crude oil prices.

The majors are now making selective refinery investments to upgrading their existing portfolio, but are not building new refineries in growing markets, such as Asia and Latin America. Why? You’d think it would make sense, especially as the big players know how to build and operate a successful refinery.

Actually, it’s quite complicated.

Wood Mackenzie analyses the earnings of over 550 operational refineries with a capacity of more than 50,000 barrels per day. Earnings are typically measured as absolutes (US$million) or on a per unit basis (US$/bbl of crude processed). A review of the 2017 results highlights the following challenges:

Size – refinery capacity is not necessarily a good indicator of overall earnings. Being bigger is better in terms of absolute earnings, but as refineries get bigger, the law of diminishing returns takes hold.

So why are refineries getting bigger? This is technology driven, and is all about making the most efficient capital investment and operating decision. Refinery investment costs do not have a ”straight line” relationship with refinery size and the unit costs  – that is, investment per barrel per day of capacity – fall as the refinery size gets bigger. There is, however, a limit as to how large key equipment items can be. Operationally, a larger crude unit requires the same number of operators as a small one, so again, there are efficiency savings with larger units. New refinery investment decisions therefore the “bigger is better” mentality, as this spreads the investment and operating costs over a larger volume of crude feedstock.

Complexity – this is a measure of the sophistication of the refinery.  It is an indication of the refinery’s capability to convert crude into higher-value products, such as high quality transportation fuels. There is a strong relationship between complexity and refining margins.  However, it is far from perfect, as complexity measures the investment cost of the process units, not the value they deliver.  The challenge is that for some units, their cost to build is sometimes disproportionate to their value.  Another challenge is that petrochemicals, a key driver of future value, are poorly captured in these cost-based metrics.

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