NEWS Shakeout gathers momentum in Europe's refining sector

Mobil's 200,000 b/d Coryton refinery in the U.K. Last year's announcement by Mobil that it would close its Woerth refinery in Germany and cut operating costs at its Gravenchon refinery in France and at Coryton is seen as the starting point for a weeding out of Europe's refining sector.

European refiners in recent years have often complained of puny profits because of surplus refining capacity.

It is an industry truism that some refiners continue to operate only because it is cheaper to keep plants running than to shut them down and face the resulting scrapping and cleanup costs.

If a company is lucky enough to find a potential buyer for an unwanted refinery, the price usually is no reflection of the intrinsic value of the plant.

Yet increasing pressure to cut operating costs and concerns about stringent fuel quality rules expected soon from the European Commission appear to have brought Europe's refineries to the meltdown point.

Illustrating that point, British Petroleum Co. plc and Mobil Corp. late last month disclosed a plan to merge their European refining and marketing operations in a bid to reduce costs in an increasingly competitive market.

That was a surprise because Mobil had closed a refinery in Germany less than 12 months previously, and BP had only weeks before announced plans to reduce its world refining capacity.

The BP-Mobil announcement confirmed that a long awaited shakeout of Europe's refining sector is under way in earnest. That kicked off speculation about which companies would be next to make major refining changes.

Expectations

Western Europe's refineries have a combined crude distillation capacity of more than 14 million b/d. There is 12.85 million b/d of capacity in eastern Europe, increasingly viewed as potential competition by the West.

Twenty or so companies hold about 70% of western European refining capacity. The biggest are units of Exxon Corp. and Royal Dutch/Shell. They both have nine refineries with 1.69 million b/d and 1.41 million b/d throughput capacity, respectively.

Other major players in European refining are Agip SpA, Total SA, Elf Aquitaine SA, BP, Repsol SA, Petrofina SA, and Mobil (see table, OGJ, Dec. 18, 1995, p. 44).

European Commission reported that from 1976 until the early 1990s there was a continuous decline in primary distillation capacity among member countries from more than 18 million b/d to about 12 million b/d of late.

Utilization of primary capacity was only 59% in 1981 but has risen since, with utilization rates of about 95% typical today.

Wood Mackenzie Consultants Ltd., Edinburgh, said the 1995 average gross refining margin for a complex unit in Northwest Europe running Brent crude oil was only $1.53/bbl, down from $1.75/bbl in 1994. Margins are not expected to improve soon.

Hydroskimming refinery margins were worse, averaging only 7/bbl last year.

Wood Mackenzie said, "Throughout 1995 the European products markets remained oversupplied, and the weak clean/dirty and cracked spreads both reflected this."

In a review of Europe's refining sector, Merrill Lynch & Co. said persistent weakness in refining and growing competition from hypermarkets in retailing have created considerable urgency among majors to improve their downstream performance.

The New York investment firm said, "Restructuring efforts in recent years have entailed mainly cost reductions and organizational changes aimed at improving efficiency.

"We believe a process is under way toward asset rationalization as well. The trend is likely to be influenced not only by weak refining margins but also by increasingly stringent environmental regulations, dictating both refinery emissions and product quality, which should require large capital expenditures."

In a report published only 2 days before the BP-Mobil asset merger announcement, Merrill Lynch said rationalization measures announced in Europe so far were modest but a step in the right direction after years of inertia.

"More substantive measures are likely to be announced this year," it said. And prophetically, "A joint venture between Mobil and British Petroleum would be a truly major initiative which would have a meaningful impact on the operations of the two companies and the European downstream business generally."

An official at European Petroleum Industry Association (Europia), Brussels, said there had been reports about a potential BP-Mobil merger for years. But this concerned a general merger because of a good fit of overall resources, and not just a downstream combine.

Shakeup begins

Europia said the BP-Mobil merger is not so much the start of a European refining shakeup, but rather a continuation of a move that started last year with Mobil's mothballing of its Woerth refinery in Germany.

In late May 1995, Mobil announced its plan to shut down its 100,000 b/d Woerth plant and at the same time slash operating costs and further integrate operations at its 70,000 b/d Gravenchon refinery in France and at its 200,000 b/d Coryton refinery in the U.K.

Mobil said then it would take a $180 million charge after tax in pursuit of these changes but would save $80 million/year before tax as a result.

The Woerth announcement was followed by Total's disclosure that it planned to pull out of a refining venture with Petrogal EP of Portugal and out of a western group buying into the Litvinov and Kralupy refineries in the Czech Republic (OGJ, July 10, 1995, p. 35).

Last January, BP announced a plan to close or reduce capacity at three refineries worldwide, including sale or closure of the 200,000 b/d Lavera unit in France and a 70,000 b/d capacity reduction at its Nerefco joint operation in Rotterdam (OGJ, Jan. 15, p. 32).

Rolf Stomberg, chief executive of BP Oil, outlined the company's thinking about refining and marketing to a Mar. 13 meeting of analysts in London.

He said, "The average refining and marketing return for European oil majors in the first half of the 1990s has been a disappointing 8%. BP has been at this average, and we cannot be satisfied with this performance.

"Within this overall result, our marketing performance has improved significantly, and there are further opportunities to broaden and deepen this performance.

"The main drag on total performance has been in refining as margins have weakened considerably due to excess capacity, particularly in upgrading. It would be unrealistic to count on a return to historic margin levels over the next cycle due to continuing increases in capacity.

"Only competitively advantaged refineries will be able to generate adequate returns. The key drivers of performance are the location and quality of the assets. Beyond that it is important to ensure that the plants are run as efficiently as possible with minimum downtime and minimum cost."

Stomberg explained that a mixture of refinery rationalization and investments is expected to increase BP's refining margins by $300 million/year after tax.

Marketing rationalization also is aimed at increasing BP earnings by $100 million/year, while upgrading 1,000 service stations at a cost of $1 billion during 5 years is expected to bring in $150 million/year from increased volumes and convenience store sales.

BP also plans to open 300 new service stations in Eastern Europe.

BP-Mobil asset merger

In a joint press statement announcing the BP-Mobil asset merger, BP Chief Executive John Browne and Mobil Chairman and Chief Executive Officer Lucio A. Noto said, "The European downstream operations of our two companies are uniquely complementary.

"Bringing them together will produce efficiencies through sharing costs, eliminating duplication, and achieving major economies of scale. It will provide us a distinctive asset base that offers a superior range of products and services and will have strong potential for future growth."

The BP-Mobil venture will operate in 43 countries, including the 15 European Union nations, Switzerland, Turkey, Cyprus, all of eastern Europe, and Russia west of the Urals.

BP said the companies will have to pay initial restructuring costs of about $400 million but would then expect to see combined pretax cost savings of $400-500 million/year within 3 years.

BP's contribution to the venture will be interests in eight refineries with a total 760,000 b/d net throughput capacity and 5,600 service stations holding an 8% share in the European fuel and lubricants markets.

Mobil's contribution will be interests in six refineries with a net capacity of 350,000 b/d and 3,300 service stations holding a 4% share of the fuels market and 10% in lubricants.

The venture's businesses will be operated under two partnerships: a refining and fuels unit with BP as operator and 70% partner and Mobil owning 30% and a lubricants unit operated and owned 51% by Mobil with BP holding 49%.

Mobil's refining and marketing staff will transfer to BP, and BP's lubricants staff will move to Mobil. The companies plan to lay off 2,000-3,000 of a total 17,500 nonservice station staff. Other layoffs are to occur as duplications in the venture's assets are removed.

BP said none of its refineries has been earmarked for closure as a result of the merger, but both companies will continue with existing plans to reduce refining capacity.

Michael Wilcox, analyst at Wood Mackenzie, said recent events are the first signs that a refining shakeout is starting. But it is early. Closure of Mobil's Woerth plant is still the only significant evidence.

Merger implications

The BP-Mobil venture will have $5 billion in assets, $3.4 billion from BP and $1.6 billion from Mobil, sales of more than $20 billion/year, and a market share on a par with those of Shell and Exxon.

BP said the venture will hold about 12% of Europe's retail market, and should not fall foul of European Commission antimonopoly rules because of the similar positions of Shell and Exxon.

BP and Mobil hope to secure EC approval for their joint venture this year, with a view to having combined operations up and running early in 1998.

The Europia official said he would be surprised if the EC refused approval of the BP-Mobil venture because the largest market share they would have is 25%, and EC's threshold for monopoly concerns is 40%.

He said, "The BP-Mobil merger goes beyond a simple shakeup because it has long term implications and includes several emerging markets.

"In some ways, the merger can be likened to the Caltex venture in which the partners took a long term viewpoint. Maybe this is where the impact of the BP-Mobil merger is more interesting."

The Europia official said the BP-Mobil venture may be more of a shakeup of marketing than refining and may not be classifiable as part of a true shakeup unless it prompts Shell and Exxon to respond.

"The BP-Mobil refineries merger will still leave them short of product in terms of current marketing operations," the official said. "So no imminent closure of BP or Mobil refineries is expected.

"The deal can be seen as mainly offering improved returns in a marketing sector where there is low profitability and where with the merger they will be able to get better returns against increasing competition-from hypermarkets, for example."

Although lubricants will be handled by Mobil, base oil plants will be operated by BP under the refinery and fuels partnership. The companies have some lubricants blending plants sited close together. Some will be closed, but their fate will be decided case by case.

Wilcox of Wood Mackenzie said the BP-Mobil asset merger doesn't have much relation to what is going on in refining. More relevant to the sector's key problems is BP's earlier refineries closure and sale announcement.

Who's next?

A spokesman for Shell International Petroleum Co. Ltd. said the BP-Mobil venture will have to pass EC scrutiny, and until then Shell won't make public comments on the venture.

He said, "We have long said returns downstream are unsatisfactory and all Europe is suffering from overcapacity. In that light, we would welcome any rationalization."

Shell has completed a review of its refining operations in Europe and concluded that its refineries are comparatively well positioned competitively in their areas.

"We don't foresee any need for further major capital expenditures at any of our refineries," the Shell spokesman said. "They are thus able to remain structurally cash positive."

Merrill Lynch said Shell's review had come to the conclusion that Shell Haven refinery in the U.K. and Berre refinery in France are the weakest links in the company's refining network.

"Shell has not indicated what specific actions it intends to take to address the weakness," Merrill Lynch said. "It recently announced, however, that it intends to downsize the Shell Haven refinery and operate it exclusively as a 'sweet crude' refinery. Although the plan is intended to improve the refinery's profitability, it does not preclude a more radical solution in the future."

Texaco Inc. is BP's partner in the Nerefco joint venture, now slated for downsizing.

Merrill Lynch cited a suggestion that downsizing and joint ventures could be a solution to the concentration of too many refineries in South Wales.

It said, "The refineries in the area, which include the Texaco refinery at Pembroke, account for more than 20% of total refining capacity in the U.K.

"Chevron U.K. Ltd. also operates a refinery in Wales, which shares a cracking unit with Texaco. The refinery does not represent a core asset for Chevron. We would not be surprised if Chevron were to exit its relatively small downstream presence in the U.K. under the appropriate circumstances."

The analyst said Chevron recently indicated it was reviewing its options with regard to its European presence downstream. And Elf was said to have indicated a desire to sell its majority interest in a 110,000 b/d refinery in Wales, as well as it retails outlets in the U.K.

Wilcox said he is aware of a number of joint initiatives in which talks between refiners serving local areas are under way with a view to spreading high closure costs of unwanted plants. Economic pressures on refiners are said to be greater now than they were 12 or even 6 months ago.

Wilcox said these initiatives are likely to lead to trimming of capacity at plants within a region rather than closure of entire plants: "Margins would have to be a lot worse than today for plant closures to occur. Closure of a typical refinery would cost $100 million".

As an example of regional debates, Wilcox cited debate among French refineries concerning surplus capacity in France.

Antipollution measures

EC mandates for air pollution reductions are said by the Europia official to be the most likely biggest force behind further shakeouts in Europe's refining industry.

European Union (EU), Europia, and European Motor Vehicles Manufacturers Association last year homed in on nitrogen oxides as the key target in a bid to reduce air pollution in Europe's cities.

Air quality improvements to 2000 are effectively taken care of through sulfur reduction legislation that will go into effect this October, but longer term pollution cuts are the target of a study called the Auto-Oil Program.

The three organizations concluded that nitrogen oxides are the main threat to Europe's air quality, with others such as carbon monoxide and benzene tackled by measures under way (OGJ, Nov. 20, 1995, p. 41).

Wilcox agreed that the Auto-Oil Program is a more likely catalyst of a major shakeout among Europe's refiners than poor operating economics.

He said, "It remains to be seen where the debate on future fuel specifications will end. EC's current proposals are very onerous for refiners and would require substantial investment."

Earlier this year, Europia Sec. Gen. Hubert Knoche told association members, "One should keep in mind the enormous investments that will be needed to achieve the EU's air quality standards.

"These are estimated today at 30-120 billion ECUs ($24-96 billion) over the next 15 years and clearly show the need for the use of cost effectiveness in choosing the optimum package of measures to address air quality."

The Europia official said the Auto-Oil Program is viewed by refiners with great interest because they will need to study how much it will cost to upgrade refineries to keep them competitive.

Wood Mackenzie has calculated that for many of Europe's refineries, some $125-400 million each will need to be spent to make them competitive under expected EC rules.

"If the most cost effective measures for tackling air pollution are chosen by EU, refining companies will be reassured of their future in the industry," the Europia official said. "If more arbitrary measures are chosen by EU, the companies will reappraise their positions."

Eastern Europe

Besides EC rules, the other major threat to western Europe's refiners is seen as eastern European refiners, keen to compete in free markets after the demise of Communist regimes in the early 1990s.

The Europia official pointed out that EU has general association agreements with former Communist states. "These will ultimately lead to eastern European countries joining the EU, after which there will be free transfer of goods.

"Eastern European refining companies will try to get their refineries up to speed so they can compete throughout Europe. Eastern Europe's refiners are becoming more competitive, and their entry into the EU may be only 5 years down the line."

The only move completed so far by western oil companies to buy interests in eastern European refineries has been a 49% stake in the Czech Republic's Litvinov and Kralupy refineries by equal partners Shell, Agip, and Conoco Inc.

Shell said the Litvinov/Kralupy refinery venture is proceeding after completion of agreements with Czech authorities, although plant upgrading has not started.

The western partners are committed to a 5 year program, expected to cost $500 million, to modernize the 100,000 b/d Litvinov and 66,000 b/d Kralupy plants.

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