Sometimes, but not always, the gains of some are the losses of others. This can be well extrapolated to the world of oil (when OPEC wins, the rest of the world loses) and, on this particular occasion, to the refining sector, which is experiencing a golden age paradoxically caused by the lack of investment in recent years. . (they transform crude oil into fuel and other derivatives) causing the price of gasoline or diesel to reach all-time highs in both Europe and the US, opening a hole in the consumer’s pocket.
“More money than God”, this forceful expression was the one used by the US president, Joe Biden, to refer to the benefits of Exxon Mobil. Much of the political class in the West is facing discontent at home as gasoline prices rise. The rise in fuel prices is exacerbating inflation and eroding the purchasing power of families. On the other hand, it also increases the costs of transport and production in some sectors.
Although it is true that the price of oil has risen sharply since 2021 at this point, fuels have done so much more intensely. The low investment in refineries for years has created a trap (a bottleneck actually): In recent years more than twenty refineries have been closed in Europe alone. Fuel is scarce and therefore much more expensive. To this must be added the need to use gas for the refining process and rising labor costs. A combination of factors that are making fuel the new ‘liquid gold’.
In a document published by the Swiss private bank Syz, it is explained that “although the price of oil shot up by almost 40% in the first half of 2022, the ‘crack spread’ or difference between the price of crude oil and the price of products refined, historically it was around $20. Today, that figure is in the $60 range. The largest refining companies in the US, such as Valero and Marathon Petroleum, are generating their highest profit margins in decades,” they warn from this financial firm.
Refining margins skyrocket
How is this explained? The key lies in the lack of investment in recent years, which has reduced refining capacity. Companies are moved by incentives, money flows to sectors where there is security and benefits. In the case of refining, companies have preferred to paralyze their investments in the face of plans to end the use of fossil fuels. Companies picked up the message and the trend has been to reduce investment and close refineries. Nobody is willing to spend large amounts of money in a sector that supposedly has its days numbered.
everything to green
“The social movement in favor of sustainable mobility and the energy transition make it understandable that oil companies have tended to reduce productive capacities. However, as of 2021, energy demand has recovered much more strongly than expected. After years of very strong pressure from governments to reduce fossil fuels in favor of green alternatives, oil companies are reluctant to increase capacity once again,” the Swiss bank report said.
From the Canadian Institute of Energy Research, they explain in a report that the planning, design, obtaining of permits and the construction of a new medium-sized refinery is a process of 5 to 7 years, with costs ranging between 7,000 and 10,000 million dollars, not including the acquisition of land. The cost varies according to the location, the type of crude to be processed and the size of the plant. This is a very capital and investment intensive industry, so great legal and economic security is needed to undertake this type of investment.
A capacity down
Not only is there no question of building new refineries, the refining capacity of current ones has been steadily declining since 2020, driving utilization rates to levels close to 100% (no more crude can be refined with current capacity ). In the case of the US, for example, the refining capacity today is one million barrels per day less than before the covid pandemic.
“However, this phenomenon is not specific to the US, as global daily capacity drawdowns are approaching three million barrels. There are many reasons for refinery capacity declines. These include extreme weather , demand forecast errors and the withdrawal from the market of refineries located in Russia, due to the war with Ukraine.However, the most important cause of this loss of refinery capacity is the significant decrease in investment in the industry”, warn these experts from the Swiss bank.
This is not a recent phenomenon, as the number of refineries has been declining since the early 1980s. In fact, no major new refineries have been built since the late 1970s, while many are closing down or integrating. in large oil groups. “This trend has created inadequate refining capacity to meet demand. In the event of adverse weather or unforeseen disruptions, the imbalance between supply and demand widens, leading to even higher margins,” these experts say.
According to data from Freemarket in the European Union, 24 refineries have been closed during the last decade. This represents a 10% cut in the continent’s refining capacity. And it is that the profitability of the activity of converting crude oil into fuel has not been attractive to European oil companies (until now) and the directly refined product used to be brought from Russia. “The consequence of the supply shock and the fact that Europe has not done its homework in refining means that world reference prices have increased significantly,” according to Freemarket.
For now, real fuel shortages have only reached low-income countries with internal problems, but the risk remains for almost everyone. Daniel Yergin, vice president of S&P Global, warns in a column in Project Syndicate that this tension in the refining sector generates great risks in any eventuality: “A possible accident, a bad political decision or a hurricane that destroys refineries on the Gulf coast US and the situation could get even worse.”
there is no quick fix
The IEA warned in its latest monthly report on the oil market that “in the current circumstances, the risk is significant. Recovering the suspended refineries implies a serious financial commitment and a long rehabilitation work. With the inventory coverage so reduced after After the sharp declines of the past few months, the most immediate relief for markets could only come from demand-side measures, i.e. the ‘natural’ destruction of demand.”
Charles-Henry Monchau, chief economist at Syz, believes that “there is no immediate solution to pressure refinery margins, although governments do have some tools to mitigate skyrocketing prices at the pump. One of the most popular is the use of taxes: either by imposing single taxes or by reducing the national tax on gasoline”. Crude oil only accounts for 50% of the price of gasoline, with refining costs, state and excise taxes, and distribution costs making up the rest.
“Therefore, removing any tax could have a substantial impact on fuel prices for consumers. It wouldn’t solve the imbalance between supply and demand for petroleum derivatives, but it would at least start to curb price rises in the short term. Another The solution is to put pressure on demand.Rising interest rates in the US should eventually raise unemployment and lower wages, which should then weigh on demand.
This expert recalls that, in the long term, the reduction in pump prices must be resolved by improving the supply situation. This means increasing the refining capacity once more or looking for an alternative solution that is quick, painless and not very expensive, that is, something good, nice and cheap. So far, nothing with these characteristics has been found.
From Syz they call for pragmatism and believe that government policies and messages should be changed to allow oil companies to invest again in the refining industry. “Russia’s invasion of Ukraine has changed the energy security situation in many developed countries. It is imperative that we adopt pragmatic policies that continue to invest in the energy transition while encouraging oil companies to increase their fossil fuel production capacity in the coming years. coming years”, states the report of this bank.
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