Global oil refining capacity is set to continue to expand despite the demand and price shock caused by Covid-19. Global investment in new downstream oil refining and integrated chemicals capacity will average $55 billion per year to 2025, leading global crude distillation unit (CDU) capacity to increase by 1.7% annually. We see a number of factors driving downstream investment. These are:
- Consolidation and modernization of China’s refining sector
- Strategic expansion by Middle East exporters
- Bets on growth in chemicals demand
China megaprojects lead the downstream expansion
China leads the global refining and petrochemical expansion with a plan to consolidate and modernize its downstream sector. A significant trend shaping China’s downstream expansion is an increase in mega-refineries with capacity of more than 300,000 barrels per day (b/d), which integrate fuels and chemicals production. As the country faces a surplus of fuels and a shortage of petrochemicals, those integrated projects will aim to extract a greater share of petrochemicals from each oil barrel. This growth of mega-refineries will accelerate the phase-out of China’s small independent refiners, which are mostly simple fuel-oriented facilities.
Middle East majors invest heavily in refining and chemicals
Downstream investment by major Middle East national oil companies (NOCs) is driven by strategic ambitions to secure future demand for crude exports and to capture a greater share of oil product margins in key growth markets. Significant capacity additions are planned in the region, and Middle East NOCs are also investing in major growth centers across Asia Pacific. Investment in downstream oil, within the Middle East and in low-cost high-demand growth regions such as India, has become a strategic necessity. It is a natural hedge against oil price volatility and the long-term risks to oil demand amid the energy transition.
In the long term, the majority of capacity additions will have a strong focus on petrochemicals. The rationale being that chemicals demand growth is expected to outstrip growth in demand for fuels over the next five years. This trend is apparent in Asia Pacific, where countries such as India and Indonesia are keen to reduce future reliance on chemical imports. Boosting chemicals yields has been shown to boost margins, which encourages existing refineries to upgrade and increase chemicals output.
Implications for refiners: increased competition and pressure on margins
Global downstream capacity additions are forecast to far exceed oil product demand growth. BNEF expects the cumulative surplus of refining capacity to reach 5.2m b/d, assuming all planned projects reach the commissioning stage.
As the downstream market moves further out of balance, pressure will grow on refining margins, producer profitability and operating rates. The Covid-19 demand shock illustrates this in real-time, with refining margins collapsing as utilization rates have been hit by a sudden decline in demand for road and aviation fuels. Overcapacity will lead to a prolonged drag on downstream profitability. Simple refineries in Asia and Europe are already looking at negative margins out to 2021.
Overcapacity and persistent pressure on margins will lead less efficient, higher-cost refiners to cut runs and potentially be forced to close. European refiners are at particular risk, as oil demand recovery lags behind other regions. The addition of large, efficient, complex and export-facing projects in the Middle East and India will intensify competition in the European market.
These trends are causing a shift in oil majors’ strategies toward their refining assets. BP aims to reduce its refining throughput to 1.2m b/d by 2025, a 30% drop from its 2019 level. Shell has sold its Martinez refinery in the U.S. and is exploring the sale of four more refineries in the U.S. and Europe. Meanwhile, Total is considering re-purposing its Grandpuits refinery in France into a biofuels plants, after selling the Lindsay refinery in the U.K. As downstream competition intensifies, we expect further disruptions across high-cost markets.