The downstream oil industry in the UK is at a key juncture. UK refining remains under pressure due to tough market conditions, supply versus demand challenges, a burdensome legislative background and growing competition from the USA and new players in the Middle East and Asia, where oil refiners have become significant players in the global market, thanks to investments in large, modern facilities. Most crucially, refineries are impacted by multiple UK and EU legislation which places on them taxing incremental costs demands in terms of operational and other requirements, whilst severely disadvantaging them against EU and global competitors. Sustaining and maximising domestic production to ensure a reliable and secure source of energy supply, particularly in light of the cumulative burden of existing and planned legislation both from the UK and EU, is a key concern.
The downstream oil industry has undergone significant change in recent years. In particular, between 2009 and 2013, over 30% of EU refining capacity has either changed hands, been converted to storage or closed down. Since 2009, two refineries have closed in the UK. For this reason, UKPIA sponsored an independent report by IHS Purvin and Gertz to inform the Department for Energy & Climate Change (DECC) review into the refining sector in the UK. The report, published in May 2013, highlighted the serious threat to the survival of UK oil refining which has serious implications for the economy nationally and regionally and potential impacts upon energy security of supply.
The key findings of the report are:
- UK refining makes a substantial contribution; 8500 jobs in refining support 54 000 jobs in the extended supply chain industries; expenditure by these employees supports a further 25 500 jobs in the wider economy, making an overall total of 88 100 jobs (Source: IHS Purvin & Gertz 2013). The monetary input of refining to the UK economy in a normal year is estimated at £2.3 billion (Source: IHS Purvin & Gertz 2013) and each large refinery is estimated to inject approximately £60 million+ into the local economy where it is located (UKPIA estimate).
- UK refining plays a vital role in maintaining the country’s fuel supplies but the UK is already at a high risk level for supply of diesel and jet fuel and close to high risk for kerosene heating oil (based on the International Energy Agency’s ‘MOSES’ methodology). Further refinery closures could increase this exposure.
- Although long term net refining margins are projected to average around US$ 2.6 /bbl of oil, this masks the huge potential cash impact of additional required capital and operating expenditure in the period 2013 - 2030 of £11.4 billion just to meet UK and EU legislative measures, most of which would generate no return and would not be recoverable from consumers. In addition there are other legislative impacts such as Fuels Quality Directive and Energy Efficiency Directive as yet not fully defined and thus uncosted.
- To keep pace with changing product demand trends, refineries would also need to invest some £1.5 to £2.3 billion over the same time frame which is unlikely in view of the impact of legislative compliance costs. Given a legislative level playing field with other refineries across the EU and globally, UK refineries would be considered competitive.
- The report concluded that no industry would bear such a mandatory investment burden for no return and a consequence could be the closure of more UK refineries and greater reliance upon imports for key products such as diesel and jet fuel.
A question of balance
The International Energy Agency forecasts global primary energy demand rising by approximately 35% through to 2035, almost comparable to adding another US to the global demand balance. For several decades to come, oil is still likely to be the most important fuel in the energy mix. In Europe, oil is set to account for approximately 80% of total transport fuels in 2030 (IEA World Energy Outlook 2011). In the UK, oil is projected to account for over 32% of total primary energy demand, with transport accounting for 41% of final energy consumption (DECC Updated Energy & Emissions Projections 2012 - Central Scenario). The projected global increase in demand for primary energy creates a tremendous challenge.
We need our refineries both here in the UK and in the rest of Europe but economic pressure means some may close in the coming decades. However, we need a strong refining core because petroleum derived products will remain a vital part of the energy mix, for transport fuels and other products used by industry, to 2030 and beyond. In addition, although imported fuel will form an important part of supply, the UK risks becoming heavily reliant upon imported diesel and jet fuel.
The HIS Purvin & Gertz report points out that with a level playing field with other refiners across the EU and world, UK refineries are considered to be competitive. Indeed, they represent what is termed ‘a core refining capacity, refining capacity expected to survive and needed in order to keep the European market adequately supplied’ (IHS Purvin & Gertz). However circa £11.4 billion is estimated to be required to comply with UK and EU legislation to 2030. The legislative cost impact is likely to increase further once the impacts from legislation which has yet to be fully defined, such as the Fuels Quality Directive (FQD), are factored in. The report concludes that ‘no industry would bear such an investment burden for no return. It would be highly likely that, when faced with such a large mandatory capital expenditure requirement that provides no return on investment, UK refiners could be forced to close more UK refineries’.
This would leave the UK even more exposed to the international refined product market for those products already at high risk, based on IEA measures developed to evaluate national energy security risks and resilience capacities.
For this reason, the right infrastructure, policy and regulatory framework, are key to ensure that oil products can be supplied to consumers at affordable prices, meeting the UK’s current and future energy needs in a way that is consistent with sustainable environmental policy and to facilitate economic growth.
UKPIA looks forward to the forthcoming Government’s review into the UK oil refining industry, which should help inform not only the development of a future policy framework for the industry, but also an urgent analysis of legislative impacts through the ‘Fitness Check’ being undertaken at the EU level, expected in September 2014.
Article written by UKPIA. For more information on the association please click here.
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