Nov-2021

Site emissions become a new metric for competitiveness

Sites must be competitively strong and low emissions to be sustainable as these provide cashflow to support both investment and returns to investors.

Alan Gelder
Wood Mackenzie

Article Summary

Global oil demand growth is to stall then demand is to fall. The energy transition is under way, with the global community increasingly focused on reducing greenhouse gas emissions. Recent policies, such as the EU’s Fit for 55 proposal, are increasingly focused on decarbonising key sectors of the economy, reducing the demand for refined products. Compared to Wood Mackenzie’s base case outlook, such proposals are a downside risk in the mid-2030s and beyond.

In the near term, global oil demand is recovering from the pandemic and we are expecting global oil demand to exceed 2019 levels in Q3 2022. Despite 2017 being the peak in global sales of internal combustion engine passenger cars, growing global populations, rising urbanisation, and increasing economic activity continue to drive oil demand higher, with our energy transition scenario projecting oil demand to peak at near 108 million b/d in the mid-2030s.

The outlook for the refining sector is one of muted recovery. Despite recent capacity rationalisation, new sources of supply outpace demand growth. Refinery utilisations and margins will improve, but not repeat recent highs. Once global oil demand has peaked, the refining sector faces sustained capacity rationalisation. The refining outlook is not totally bleak, as the demand for petrochemicals is expected to grow through to 2050, supporting greater integration as a way of capturing volume and value growth.

The refining sector is challenged by the energy transition as demand for its traditional products is set to fall. Growth opportunities lie in petrochemicals and low carbon liquid fuels (either biofuels or synthetic e-fuels), both of which are core competencies of refiners, who safely operate large-scale continuous chemical transformation processes. While evolving their product mix, refiners also need to decarbonise operations.

Emissions reduction is key to achieve our net-zero ambitions
Refining is an energy-intensive sector and its emissions account for around 3% of global energy sector CO2 emissions. Around 80% of these refinery emissions are from fuel combustion to support chemical transformation and treating reactions. Emissions are very site specific, but in general the more sophisticated the refinery (as measured by Nelson Complexity), the higher the carbon emissions, as the greater the chemical transformation of low value products into transport fuels and petrochemical feedstocks.

Wood Mackenzie analysis shows refinery emissions are, however, poorly correlated with site profitability, as complexity is only one of the key drivers of site net cash margin. Location, scale, and crude diet are other key drivers of site profitability.

At present, only Singapore and Europe impose a carbon charge on the emissions from their refiners. European refiners are exposed to a carbon charge of over €50 per tonne as of September 2021. This has a material adverse effect on their profitability as there are no similar charges imposed on imports of refined products from other regions, so they are currently unable to pass on those costs. European refiners do enjoy the benefit of free allowances to reflect the emissions of the most efficient process technologies. Despite this, Wood Mackenzie expects most of the 2021 recovery in gross refining margins has not made its way to the bottom line.

The EU provides free allowances to mitigate the risk of carbon leakage. These are established by best-in-class technologies for the various refinery process units, reflecting the emissions of the top decile of facilities. The net result is that European refiners are exposed to significant additional carbon costs, which we anticipate to largely eradicate the positive margins of third and fourth quartile European sites for the next few years. An analogous situation exists for Asia, by which a carbon price of, say US$100/tonne in 2027, results in the carbon liability taking over 60% of cumulative refinery earnings, as shown in Figure 1.

The EU has considered, but not adopted, a carbon border adjustment mechanism for refining. The concept appears supportive of the European refining sector, as charging a tariff on imported middle distillates based only on the emissions of the export refinery and the transport delivery to Europe would lift the effective import parity price. Wood Mackenzie’s integrated analysis along the entire oil value chain suggests a more holistic perspective might offer no such protection, as shown in Figure 2.

When emissions are evaluated on a refinery gate forwards basis, European emissions for middle distillate production are below those of barrels delivered from Saudi Arabia, so a carbon border adjustment would raise the costs of Middle East volumes imported to Europe. However, if the Scope 1 and 2 emissions associated with the crude production and delivery are included, the low upstream emissions for Russian and Saudi crude results in the emissions being broadly comparable. In such a framework, the carbon border adjustment would offer no protection to European refiners. Given this uncertainty, refiners need to establish a robust, commercially viable conversion platform that can adapt to the energy transition and not rely upon potential regulatory support.

Significant investment is required to achieve site sustainability
Wood Mackenzie believes refining’s role as a conversion business provides a long-term future, as decarbonising the world requires large volumes of low carbon liquid energy carriers as electrification is not a silver bullet across all sectors. Refining also has a key role in supporting the development of a circular economy through the chemical recycling of petrochemicals and conversion of municipal solid waste. The challenge facing the sector is that these technologies are still under development and so are not yet commercial, even at Europe’s current high carbon costs. Refiners need to be prepared to partner with others to pilot new technologies and approaches to deliver low carbon fuels. Government policies are critical to ensuring early-stage projects are nurtured and form the basis for future industry deployment at far larger scales.

For this to be successful, these investments need to be made at a commercially viable conversion sites that are generating cash for both future investment plus providing a return to investors. Our REM-Chemicals research confirms that large integrated refinery/petrochemical sites dominate the first and second quartile competitive positions. These are the sites best placed to adapt to the challenge of the energy transition.

Petrochemical integration has many benefits, including that the additional value from a major petrochemical investment significantly outweighs the additional costs of carbon emissions, given the synergies that are available between refineries and liquids-based steam cracking. Not all sites, however, can support such investments and so refiners need to consider their portfolio of site options.
Portfolio rationalisation will be critical to focus investment on sustainable sites.