As oil prices hit $100 a barrel it is easy to conclude there is not enough petroleum to go round. Producers though have long argued the increase is not just a result of accelerating international demand for crude, particularly in emerging economies, but also due to a chronic world shortage of refining capacity.
This shortfall, they say, has added to oil price volatility and exacerbated the effects of high demand and uncertainty over petroleum supplies and not least the effects of speculation in forward markets.
“Nowhere along the value chain do we see capacities as tight as they are in the refining sector. Crude oil is of little use to the average end user until it is refined into useful products, and at the moment, our industry’s ability to do that is being stretched.” says Saudi Aramco’s Chief Executive Abdullah Jum’ah.
According to Organisation of Petroleum Exporting Countries “the market volatility witnessed in recent months has been to a large extent the result of imbalance between the available refining capacity and the demand for petroleum products. Until the necessary investments are undertaken in the downstream sector of the industry, volatility is likely to remain a feature of the oil market worldwide.”
Refinery capacity globally has not increased in line with demand because until relatively recently, low or negative margins have dissuaded most refiners from investing in new plants, while environmental regulations in the main consumer markets have barred any new refineries being built.
No new refineries, for example, have been built in the United States for 30 years or for about 20 years in Europe.
The resulting decline of spare refining capacity has added to supply bottlenecks.
Total world refined output is some 86 million barrels a day. However, on present trends output will need to rise to 93 million bpd by 2010 and grow to 113 million bpd by 2030 to meet a global demand that is now driven as much by the energy needs of emerging economies as much as demand in traditional industrial countries.
The International Energy Agency (IEA) says a third of the additional investment in capacity will be needed in the Middle East and in China. Any easing of supply constraints will depend on the nearly 70 new refineries planned by oil companies and producers being built.
This involves an overall investment commitment of some $300 billion (Dh1.1trn).
According to Claude Mandil a former executive director of the IEA there is general recognition now that the lack of spare capacity in refining combined with the shortage of spare capacity in crude production comprise the key factors that have to be managed in order to rein in high prices.
The bill is going to be huge. About $160bn needs to be spent on developing downstream capacity over the next decade as well as a further $150bn on maintaining existing plant and replacing out-of-date units.
Saudi Arabia and other Gulf oil producers have accepted the challenge and risks involved with a wave of refinery expansion projects under way or planned. At present, the Middle East and North Africa account for less than 10 per cent of world’s oil refining capacity in spite of controlling about half the world’s petroleum reserves.
They now see a window of opportunity to take advantage of strong margins and take more control over international oil prices as a result, and thereby reducing the effect of speculation by commodity brokers.
It is not going to be an easy task. The Opec wants to see additions of about four million bpd to its members’ refining capacities by 2010. Saudi Arabia holds the bulk of Opec’s spare oil output capacity but most of its unused capacity consists of heavy sour crude that refiners find difficult to easily process into transport fuels. But if the schedules are met, Opec country investments may add 5.9 million bpd to global refining capacity by 2011. Significantly, the new production capacity planned in the GCC will be predominantly for the high-sulphur sour crude, which only a small proportion of the world’s oil refineries are equipped to process.
While the investments required are huge, by developing the refineries themselves, the Gulf countries can set the conversion yields to produce the high demand, light products that world markets increasingly seek.
Kuwait National Petroleum Company is modernising its Al-Ahmadi and Mina Abdullah at a cost of $3bn, which will increase refined products capacity to 1.4 million bpd from 915,000 bpd at present. A major boost to capacity will result from a planned 615,000 bpd refinery to be located at Al-Zour, 100 kilometres south of Kuwait City.
Some 30 companies are bidding including France’s Technip, the US’ KBR, Bechtel, Foster Wheeler and Italy’s Snamprogetti.
At 615,000 bpd the refinery would be the largest ever built and exceed the processing capacity of Saudi Arabia’s Ras Tanura plant, which is currently rated at 550,000 bpd. The growing focus on refining is seen throughout the region. Bahrain is investing $1.1bn to modernise refinery assets to process low-sulphur content diesel and is also considering a new pipeline link with Saudi Arabia, according to the kingdom’s Oil and Gas Affairs Minister Abdul Hussain Mirza.
Abu Dhabi has brought two 140,000 bpd condensate units at its Ruwais plant on stream. Qatar has expanded capacity at its Umm Said refinery to 137,000 bpd from 80,000 bpd. Oman is planning to increase the capacity of its 116,000 bpd Sohar refinery by up to 35 per cent.
Iraq’s Government has also announced plans to build a 300,000 bpd oil refinery in the southern city of Nasiriyah, which would end the country’s dependency on refined imports from Kuwait, Iran, Turkey and Jordan.
Saudi Arabia at present has the capacity to refine about three million bpd of which some two million bpd are produced in the Kingdom. Projects under way will double this refining capacity to six million bpd by 2011, says Minister of Petroleum and Mineral Resources Ali Al-Naimi. The programme involves major upgrades to the eight refineries the Kingdom owns in and outside of Saudi Arabia as well as construction of new facilities. These will include two major 400,000 bpd export-oriented refineries.
Saudi Aramco and ConocoPhillips are building one of these at Yanbu costing $6bn with commissioning in 2011.
It will be a full-conversion refinery able to produce high-grade ultra-low sulphur refined products designed to meet current and future US and European product specifications.
A similar $6bn contract was signed with France’s Total for the new Jubail refinery in 2006. Each company will hold a 35 per cent stake in the venture with 30 per cent offered to Saudi investors. The refinery again will be built to refine heavy Arabian crude into high-quality diesel and other related products.
Last August, Saudi Arabia also said it intended to invite bids for an oil refinery at Jizan Economic City on the Red Sea coast with the plant to be built on a build-own-operate basis. The government wants the planned 250,000 to 400,000 bpd capacity refinery to be a private sector initiative.
Malaysia’s Petronas has indicated interest. Meanwhile, a $430 million contract was awarded in December by Saudi Aramco to South Korea’s Samsung Engineering to build a hydro-desulphurisation plant at Ras Tanura. The facility, to be completed by 2010, will be able to process 100,000 bpd of crude. Nabilah Al Tunisi, manager at Aramco’s project support and controls department, says the company’s downstream investments will result in the Kingdom possessing the world’s fifth largest refining capacity, by 2012 will be able to process 3.9 million bpd of crude.
Aramco in concert with joint venture partners expects to invest $50bn over the next five years in increased refining capacity.
The company’s total refining capacity, including overseas refineries, will increase by a third to 6.5 million bpd within the next five years, taking account of new output from modernisation of three refineries in Texas and Louisiana owned jointly with Shell.
However, the Kingdom is seeking a much wider global reach with joint ventures already set up or planned in China, Japan, South Korea and the Philippines.
Gulf Producers brace for pitfalls
Even with the huge budget surpluses available to Gulf oil producers for new projects there are big risks involved.
In the long term, demand trends could change and economic growth could slow down, and, as a result, export-oriented refiners in the Gulf could find themselves with surplus product and capital investment costs not amortised.
The 2011 completion target for many of these projects is also highly ambitious given spiralling construction and engineering costs and shortages of engineering talent. As a result, only 80 per cent of the projects to raise global refining capacity through 2011 are likely to go ahead, according to Fereidun Fesharaki of Facts Global Energy.
Kuwait National Petroleum Corporation is working on the 615,000 bpd Ras Al Zour facility, which will rank as the world’s largest refinery. However, KNPC was forced to increase the budget for the venture to $13.94 billion (Dh51.2bn) from an original estimate of $12bn. Which itself was double the cost first envisaged. Escalating costs are also blamed for the cancellation of plans by Exxon Mobil and Qatar Petroleum to build a large refinery in Qatar.
There are also strategies to spread the risks on investment with a trend in the Gulf to link petrochemicals production with refining. As a result of this new thinking, Saudi Arabia’s Petro-Rabigh petrochemical complex will produce 60,000 barrels of gasoline a day in addition to a wide range of ethane yields.
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