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The Outlook for Europe’s Refining Industry- a changing landscape

CIEP Energy Seminar 2012 Rachel Williams, Senior Refining Analyst

Wood MackenzieApril 2012

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Refining margin review

Introductions

1

Refining rationalisation2

External factors affecting European Refining3

4 Summary

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Global Refining MarginsMargins have diverged reflecting local conditions

Source: Wood Mackenzie

In 2011, composite complex margins were being driven by different local factors

Margins on the USGC were supported by good demand for exports to Latin America and Europe, despite weak domestic demand growth

In Europe, production problems for light-sweet crudes made Brent relatively expensive whilst local products demand has been weak

In Singapore, refining margins were supported by wide discounts for Dubai and relatively strong regional demand growth

In 2012, European margins remain weak due to falling domestic demand, USGC margins are supported by strong export demand and Singapore margins are buoyed by growing local demand

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1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012ytd

US

$ p

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bb

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Northwest Europe US Gulf Coast Singapore

NWE margins – 50% Brent cracking, 50% Urals cracking

Singapore margins – 70% Dubai FCC/HCU, 30% Tapis cracking

USGC Margins – 50% LLS cracking, 50% Mars coking

Global Composite Complex Refining Margins

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bl

NWE Brent FCC NWE Urals FCC USGC WTI FCC

USGC LLS FCC USGC Mars Coking Singapore Dubai FCCSource: Wood Mackenzie

Europe refining margins have not recovered and continue to lag other regions…

Regional Gross Refining Margins

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Utilisation in OECD Europe in 2009 was 6% lower than in 2008 due to falling demand. European utilisation fell again in 2011 as refiners struggled with the loss of Libyan crude supplies. We forecast only a slight recovery as some capacity is closed, but that is countered by weak demand growth and lower competitiveness due to carbon costs

The capacity at risk in Europe can be assessed as the amount of capacity required to close to return the utilisation to 2007 – 2008 levels.

• For 2011, the utilisation improvement is hence circa 8 percentage points (from the chart)

• The end 2010 OECD Europe refining capacity is 15.4 million bpd

• This indicative assessment is hence 1.2 million bpd, equivalent to approximately 8 average sized sites (but more if smaller than average sites are closed)

• However, 400kbd has been closed by the loss of Berre L’Etang, Cremona, Reichstett and Arpechim included in our 2010 figure.

• A further 800 kbd of capacity is hence required to be closed for utilisation rates to restore to historic levels

Which is clear to see when looking at refinery utilisation..


70.0%

72.0%

74.0%

76.0%

78.0%

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82.0%

84.0%

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88.0%

90.0%

2005 2006 2007 2008 2009 2010 2011 2012 2013

Utilis

ation

OECD Europe USA Asia 8

Refinery utilisation for Europe, USA and Asia

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Broader issues cloud the market, with margins remaining under pressure and more closures likely

Iran crude sanctions in 2012

• European refiners will face increased competition for crude supplies, Urals will be relatively more expensive, negative for margins

ETS Phase III from 2013

• European refiners will face increased production costs making it more difficult to compete with imports from outside of the EU

Weak demand

• European product demand is forecast to fall in 2012 and 2013, increasing the amount of spare capacity in Europe

• Demand growth for gasoline in the US is minimal and competition from export refiners in Asia and the Middle East will increase

More closures likely

• The outlook for European refining margins remains bleak and further refinery capacity closures are necessary to maintain a sustainable level of margin for the medium term

Monthly gross refining margin for FCC Brent in NWE

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5-yr range 2011 2012 5-yr avg

Source: Wood Mackenzie Product Markets Service - Short-term

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Introductions

1


External factors affecting European refining3

4 Summary

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Source Wood Mackenzie Refinery Evaluation Model

In Europe historical precedent suggests refineries with a NCM of <US$1/bbl are at risk of closure

European company aggregated NCM $/bbl

Refiners most ‘at risk’Refiners most ‘at risk’

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Recent European refineries that are not now operational have a NCM <$0.50/bbl with Petroplus assets placed among them

European refinery closures 2010 NCM $/bbl

Permanent closure and converted to

terminal announced in 2011

Permanent closure and converted to

terminal announced in 2011

Intermittent operation during Q1 2012 due to loss of

credit facility

Intermittent operation during Q1 2012 due to loss of

credit facility

Harburg reported to cease operation Q2

2012

Harburg reported to cease operation Q2

2012

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PP Closed


Historically European refinery sales show that a NCM > $0.50/bbl is typically required for prospective buyers

European refinery sales 2010 NCM $/bbl

Purchased in 2010 by Valero for strategic integration.

Purchased in 2010 by Valero for strategic integration.

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Currently we see some 1.3 million bpd at risk in today’s low margin environment…

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Closed (BTW) Not Operational High Risk

European refineries ‘At Risk’ 2010 NCM $/bbl

In this environment, developing commercially attractive refining projects will remain challengingIn this environment, developing commercially attractive refining projects will remain challenging

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In Europe / FSU / Africa, margins deteriorated in 2011

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15$/bbl

Europe Africa FSU 2010


1st Quartile 2nd Quartile 3rd Quartile 4th Quartile

Average preliminary 2011 NCM was -$1.20/bbl for the region, a quite significant drop from the 2010 average of just $0.39/bbl and resulted in a number of refinery closures in Europe over the course of the year and into 2012

On an international basis, most of the Russian refiners are located in the 4th quartile, handicapped by simple configurations, disadvantaged locations, and expensive rail transportation. This is not the case when domestic tariffs are included

African refiners are spread fairly evenly across the curve. Some reach the 1st quartile thanks to location or cost of crude acquisition advantages

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Given our outlook, the changing fundamentals do not have uniform impact, so there are, of course, corporate winners and losers

The key attributes for “relative success” (i.e. 2012 is better than 2011) for Europeans are:

• Located in NWE rather than Med (due to threat of EU sanctions on Iran)

• Diesel focussed

• Light/sweet crude (to capture weakening of Brent market as Libyan production returns)

• Suggested companies (for which 2012 should significantly outperform 2011) include:

• Petroplus (if it continues to exist)

• Preem

• GALP

Repsol and Hellenic Petroleum will be impacted by the unfavourable environment in the Med but new upgrading capacity will provide upside to a certain extent. Tough year ahead for Eni, SARAS and ERG

As Russia diversifies crude export routes (BPS 2 expected in 2012) the Druzhba discount is likely to diminish. CEE ‘supersites’ margins might suffer.

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Introductions

1


External factors affecting European refining3

4 Summary

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Other factors detrimental to European refining

European refiners have lost share in the PADD I gasoline market. PADD III and other regions likely to remain more competitive in the future.

The change in the tax regime provided economic incentive for a large number of Russian refinery upgrades. This will reduce the supply of key intermediates feedstocks (VGO, AtRes) for deep conversion refineries in Europe

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Other

Europe

PADD III

European Refinery NCM Ranking

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2010 2011 2012 2013 2014 2015 2016 2017

Pro

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VGO

3.5 wt%S Fuel Oil

Atmospheric Residue

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Atmospheric Residue

Russia Intermediate Product Balance 2010 to 2017PADD I Gasoline Imports

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The US mid-continent and Gulf Coast refineries are advantaged through increased processing of domestic tight oil supplies

US Tight Oil Supply Brent – WTI differential

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/d

Bakken Niobrara Eagle Ford Avalon/Bone Springs

Monterey Anadarko/Woodford Austin Chalk Barnett

Marcellus Tuscaloosa/L.Smack.

Source Wood Mackenzie

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A first pass look at North America reveals that the potential closure candidates list is complicated

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Low ProbabilityNew Lease

NOCShutdownAt Risk?

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FFI

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New RefineriesGlobal capacity additions driven by NOCs in Asia Pacific and theMiddle EastS

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Net capacity additions from 2011 to 2015 (firm proj ects)

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-4.0

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6.0

8.0

10.0

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2008 2009 2010 2011 2012 2013 2014 2015

Cumulative New Refineries Cumulative Capacity Expansions

Cumulative Non Ref Sup growth Cumulative Demand growth

Mb/d

..but globally, the market remains oversupplied through to 2017 as compared to 2007

Excludes capacity creep and utilisation rate changes

4.7 Mb/d imbalance created

in 08/09

3.5 Mb/d “surplus”remains in 2015

Source: Wood Mackenzie Product Markets Service

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Introductions

1


External factors affecting European Refining3

4 Summary

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Conclusions

2011 was “annus horribilis” for the European refining industry. The situation was similar for US East Coast refiners (due to similar feedstock and configuration)

In the short term, we expect margins to recover, due to low stocks and capacity rationalisation

• Global recovery in margins is driven by strong Asian demand outlook

In the longer term, growth prospects in Europe and North America are poor compared to the developing economies such as Latin America and Sub-Saharan Africa

European refining is projected to remain challenged as:

• Increasingly stringent legislation, such as ETS Phase III

• North American export refiners in the USGC will be advantaged by growing volumes of domestic tight oil supplies

There is a long term future for the European refining industry, given the sheer magnitude of oil product demand, however:

• Europe’s export potential is weakening, due to its self-imposed carbon legislation

• It is not in control of its destiny, as it is subject to developments in other regions

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Rachel WilliamsSenior Refining Analyst

T +44 203 060 0425E [email protected]

Rachel joined Wood Mackenzie in 2011 as a Senior Refining Industry Analyst working within the Downstream Oil Research Team.

Prior to joining Wood Mackenzie, Rachel worked for ConocoPhillips for 5 years as the Clean Products Optimisation Lead for Europe, focused on maximising profit through ConocoPhillips’European and US East coast refining and marketing system.

Prior to working with ConocoPhillips, Rachel worked as a Supply Optimisation Analyst with Chevron for 4 years in London and at the Pembroke Refinery.

Rachel graduated from the University of Bath with an Bachelor degree in Chemical Engineering.

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Wood Mackenzie Disclaimer

This presentation has been prepared by Wood Mackenzie Limited for delivery at CIEP, The Hague, April 2012. It has not been prepared for the benefit of any particular attendee and may not be relied upon by any attendee or other third party. If, notwithstanding the foregoing, this presentation is relied upon by any person, Wood Mackenzie Limited does not accept, and disclaims, all liability for loss and damage suffered as a result.

The information contained in these slides may be retained by attendees. However, these slides and the contents of this presentation may not be disclosed to any other person or published by any means without Wood Mackenzie Limited's prior written permission.

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