Long-term Scenario for the Global Refining Industry: What are the Givens in a World of Uncertainty?

While medium-term refining scenarios (less than 10 years) appear to be reasonably well-defined, long-term scenarios—over a 15, 20 or 25-year horizon—look much less certain.

Therefore, to manage refining investments for value, what assumptions can be considered as givens? They are few in number, but large in potential impact:

Product demand will continue to grow in Asia, notably in the most populated countries, China, India and Indonesia. There is an almost inevitable trend toward higher passenger-car equipment rates in countries where a large middle class is now emerging.

Demand for middle distillates will grow faster than demand for gasoline. This is due to the fact that truck fleets tend to be diesel-driven in most regions of the world, and that diesel private cars are becoming increasingly popular and are showing signs of taking off in regions and countries which have been essentially gasoline-driven so far. In addition, demand for jet kerosene will continue to be strong, essentially following and amplifying the trend in economic activity.

The surge in current construction costs at refineries—associated with construction delays—means that refining projects need higher margins to become viable. This also means that delays will result in fewer capacity additions than anticipated given the current margin levels.

A last given seems to lie in the fact that green initiatives are poised for continuous growth, notably in the United States, where such initiatives have become mainstream and can only benefit from the political change in 2008. Biofuels will continue to grow; however, car makers have indicated that the technically possible limit for biofuel content is around 7%—meaning that biofuels can be only a partial answer to the need for diversifying energy supply. In addition to higher biofuel penetration, it is likely—although not certain—that fuel efficiency will improve gradually in the United States, spurred notably by high retail prices. However, the exact impact is not clear—despite President Bush's commitment—simply because the ability of US consumers to quickly change their lifestyles remains unclear.

One final element is that every investor benefits from the same information and is aware of the givens, just as PFC Energy has described them here. This translates into an investment policy focusing on: a) quick return on investments, and b) regions where growth in demand appears to be inevitable. In turn, this very cautious investment policy will mean less supply capacity 5 or 10 years from now, leading to potentially higher margins, particularly if demand in mature markets hold better than anticipated. Depending on the variables, however, the opposite could hold true.

Key conclusions:

The combination of these factors suggests that there exists a long-term risk on US demand, notably for gasoline.

If the trend toward “greenness” and biofuels holds—especially in the United States— this could have a negative impact on refining margins in the long term, especially when combined with lower demand or less robust demographic trends.

However, a cloudy long-term future for Atlantic Basin demand is currently limiting Atlantic Basin investments, thereby sustaining margins in the medium term; a more optimistic long-term view of Asian demand is leading to more proactive refining investment in the short-medium term, thereby leading to more downward margin risk in Asia over the medium term.

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John Paisie is a Partner and Head of the Downstream practice. For further information on this article contact Enews_jpaisie@pfcenergy.com.