Viewpoint: European refineries suffer underinvestment

Falling demand for fuels has been dissuading many European refiners from investing in their plants, with the result that assets are deteriorating and some closing altogether. But extraordinary margins are still achievable in the short term for those that can stay online.

Argus reported 14 separate incidents in which a European refining unit had to close because of a fire, leak, power outage or other accident in 2023 — up from 12 in 2022. Underinvestment has been exacerbated by circumstances. European costs are uncompetitive against those in the Middle East or Asia. European oil demand is declining, but growing in those other regions.

Ageing units have been undermaintained since 2020 because of the Covid-19 pandemic and then a reluctance to miss out on resurgent margins by halting units for upkeep. A prolonged heatwave in summer 2023 added further mechanical stress. The EU's ban on Russian crude has pushed some units to run lighter slates than for which they were designed.

The inevitable conclusion of long-term underinvestment and underperformance is permanent closure. This trend has been seen for decades and resumed in late 2023, after extraordinary margins for most of 2022 and 2023 led to a pause. UK-Chinese joint venture Petroineos announced in November that it is beginning the process of converting the 150,000 b/d Grangemouth refinery in Scotland into an import terminal in 2025.

"Refinery margins are forecast to normalise over the medium term, resulting in a reversion to loss-making for our business," Petroineos told Argus.

Six European refineries have closed since 2020. Grangemouth will increase that to seven and Shell's 147,000 b/d Wesseling refinery in western Germany will make it eight if they both close in 2025. Those eight mean a total loss of 935,000 b/d of capacity.

Italian retreat

Italian refineries look most vulnerable. Eni told workers as long ago as 2021 that its 84,000 b/d Livorno refinery would stop refining crude by 2022, to focus on base oils and biofuels. It has not happened yet, perhaps because conventional refining margins have been so unexpectedly high.

Oil traders said the Eni-KPC 241,000 b/d Milazzo refinery in Sicily is comparatively unprofitable too.

The majors keep edging away from European refining through divestments too. TotalEnergies, Shell and ExxonMobil have exited eight European refining assets between them since 2020. Most recently, ExxonMobil sold its 25pc stake in the southern German Miro refinery in October 2023, and Shell its 37.5pc stake in Germany's Schwedt to UK-based Prax.

In the shorter term, European refiners are likely to keep reaping extraordinary profits by historic standards. Falling regional capacity and frequent outages are helping the margins of those who manage to stay online.

"If we have outages, then, all of a sudden, [refined product] prices start to increase," BP interim chief executive Murray Auchincloss said on the company's third quarter earnings call.

Without political rapprochement with Russia, diesel supply lines will remain long and unreliable, keeping margins high in Europe. The forecast recovery of European gross domestic product (GDP) growth in 2024 could add demand and push margins still higher. TotalEnergies' chief executive Patrick Pouyanne noted its refineries are already "running to make diesel" because the loss of Russian supply has kept diesel margins at historic highs despite weak demand.

If production does not have room to rise to match a demand recovery, margins respond more strongly.

But if new refining capacity opens in other regions as planned, European refiners may face stiffer competition, hurting their margins and vindicating plans to close units. The key examples are Oman's 230,000 b/d Duqm and Nigeria's 650,000 b/d Dangote refinery, which could start up fully in 2024. Kuwait's 615,000 b/d Al-Zour refinery could avoid mishaps and begin shipping diesel west as expected too. But the only thing seemingly reliable about new refinery openings is that they will not happen on schedule.

By Benedict George