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Businesses in secular decline can sometimes benefit from an unexpected surge of energy. Alas, it tends to be short lived.
Look no further than the European refining sector. Sanctions on Russian products brought higher margins and a brief moment of respite. But with flows settling down, the sector’s dismal squeeze has resumed.
The latest to feel the pinch is BP, whose stock fell more than 4 per cent on Tuesday after it warned of a $500mn-$700mn hit from weaker refining margins and flagged an impairment of up to $2bn — partially related to the Gelsenkirchen refinery in Germany where it is reducing capacity.
BP is not the first oil major to cut its refining footprint, and it won’t be the last. Refineries tend to be located near demand on the basis that it is cheaper to ship a boatload of crude oil than a slate of refined products, whether diesel or jet fuel. And demand in Europe has fallen from 12.1mn barrels a day in 2003 to 9.6mn b/d last year, according to Alastair Syme at Citigroup, with the pace of decline accelerating in recent years amid slow industrial activity.
Unsurprisingly, Europe has been closing capacity at an annual average rate of 220,000 b/d since 2010, thinks the International Energy Agency. Yet, with cheaper refineries coming on stream in Asia and Africa, margins are under pressure. Plants in north-west Europe will make an average of $3.91 per barrel in the third quarter, says Wood Mackenzie, or less than half what they were making in the first quarter of this year.
The energy transition will dim prospects further. Global demand for refined products will rise by 1.2mn b/d between now and 2030, according to the IEA. Refining capacity, meanwhile, will increase by 3.3mn b/d. That will put close to 1.5mn b/d of European capacity at risk of closure.
European majors thought they had found a way round this logjam — by converting big chunks of capacity to the production of biofuels. Yet that road, too, is proving treacherous. Shell’s $1bn writedown of its biofuels plant in Germany highlights the perils of relying on policy-driven demand amid the wave of backsliding on green pledges.
Refining has become a relatively small part of the European majors’ business, accounting on average for a normalised 8-10 per cent of cash flow, thinks Citi. Even so, the sector is living on the smell of an oily rag. There will be more writedowns to come.