A study about the downstream of the refining sector exposure to the climate risks concludes that its values and earning can be possibly reduced in half by 2035, as a quarter of global refining capacity could become unviable and be forced to close by then.
According to the ‘Margin Call: Refining Capacity in a 2°C World’ report by Carbon Tracker, the new climate regulations and the developments in clean technologies cut oil demand will have a significant impact on global refining capacity by 2035.
In particular, the decarbonisation measures that are being taken lately are decreasing the oil demand, something that can lead to squeeze margins in the refinery industry, as well as in small refineries closing.
Report key findings
- Fewer refineries needed due to less volume: Under a 2D scenario, global oil demand could decline by 23% over a 15 year period. The analysis implies rationalisation equivalent to 25% of 2016 capacity.
- Margins suffer across the board : study estimates that a sustained refinery margin contraction of the order of $3.50/barrel by 2035 would be necessary.
- Earnings fall: EBITDA for the refineries analysed (94% of 2015 global capacity) could fall by over 50% by 2035 from an estimated $147bn in 2015
- Transport fuel most profitable but most at risk: the rate of technological change in road transport may surprise the industry and erode demand for these fuels faster than currently anticipated.
- OECD capacity hit hardest: were this to occur, the eventual reduction in capacity needed to balance the market would be that much greater
- Margins squeezed: prospective investors should be wary of all new refinery investments. Margin assumptions in particular should be questioned and sensitised over a broad range of values, as they are likely to prove optimistic should oil demand follow the 2D pathway.
- History lesson: in a 2D demand scenario, where oil demand falls at a somewhat slower rate but for a longer, sustained period, study suspects the same might happen again.
- New & complex beats old & simple: the study considers the results reasonable in terms of a general exploration of the implications of a 2D demand scenario for the refining sector.
The procession of less oil and at lower margin means that refinery earnings and hence values could halve by 2035.
Andrew Grant, senior analyst at Carbon Tracker who co-authored the report, said:“A 2°C pathway sees oil demand peaking followed by major rationalisation in the global refining industry. Many players will exit the market rather than haemorrhage cash. Investors should beware that the risk of wasting capital extends to all new investments, including expansions or upgrades to existing facilities.
The think-tank analysed 492 refineries representing 94% of global capacity in what is believed to be the first analysis of how the industry would fare in meeting a transition pathway aligned with international objectives to limit climate change to 2°C based on clean and revolutionary technology.
According to the report, the industry expects oil demand to grow steadily up to 2035, in contrast to the 2˚C scenario analysed. Transport fuels account for 70% of refinery profitability, and represent the portion of the barrel most vulnerable to demand destruction.
The 2˚C scenario highlights that refineries are worth tens of billions of dollars, and generate key profits. Furthermore, it provided assessments about companies, saying that Total and Eni are the most exposed, risking a 70%-80% fall in earnings from their refineries by 2035. Shell and Chevron risk a 60%-70% fall and ExxonMobil and BP a 40%-50% fall.
Alan Gelder, Wood Mackenzie Vice President Research, noted:“The consequences of achieving a 2˚C world are far more detrimental to the refining sector than the upstream sector, as it results in structural over-capacity and associated poor refining margin environment, which can only be addressed by sustained capacity rationalisation.”
The Taskforce on Climate-related Financial Disclosures set up by the G20’s Financial Stability Board advised companies to disclose their exposure to climate risk, taking into account 2°C scenarios in line with the Paris Agreement on climate change. Its recommendations have so far been supported by more than 100 companies with $11 trillion of assets under management.
As the study shows, there is already enough capacity to meet future demand in the 2˚C scenario and that no new refinery capacity needs to be added globally.
Additionally, Carbon Tracker estimates that the price of a barrel will be at $3.50 across the industry by 2035, driving a reduction in global capacity equivalent to 25% of the current refining industry. While, global composite margins were estimated to be $5 a barrel in 2016.
Lastly, it notes that 21% of existing refineries are already unprofitable, and warns that loss-making refineries which are kept open for strategic reasons will sharpen margin declines and put pressure on low-margin refineries elsewhere.
