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January 10, 2020

Major uptick in store for downstream sector

By MEED   

Sophisticated refinery schemes move ahead amid energy transition and a shift away from heavy fuel oil towards more refined products.

After a year of significant delays in the Middle East downstream sector in 2019, a range of large-scale projects is expected to come online in 2020.

In Kuwait, several downstream megaprojects are due to start producing over the year after long periods of planning and construction. The $12bn Clean Fuels Project (CFP) is expected to be completed in April 2020, and the $16bn Al-Zour refinery is set to become partially operational in June.

In Saudi Arabia, the $16bn Jizan refinery scheme and the $3.7bn Ras Tanura clean fuels project are both expected to be completed in early 2020.

Other important projects due to come online over coming years include the Duqm refinery in Oman and the New Refinery Project in Abu Dhabi. The $6bn Duqm refinery is currently under execution and due to be completed before 2023, and design work is underway for the $15bn New Refinery Project, which is due to come online in 2026.

Growth market

While downstream projects activity has diminished in many regions around the world, the Middle East remains on track to bring significant refining capacity online over the next 15 years. The other region that is likely to bring significant refining capacity online in Asia. In a report released earlier this year, US consultancy McKinsey & Company estimates that global refining capacity will grow by more than 6.8 million barrels a day (b/d) over the next five years. McKinsey predicts the new wave of refining capacity additions, led by greenfield projects in Asia and the Middle East, will put pressure on global refining utilisation as early as the end of 2019.

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Tim Fitzgibbon, a senior expert at McKinsey, says there are three major factors fuelling the global downstream market: the International Maritime Organisation’s 2020 shipping regulations; the energy transition; and unconventional oil exploitation, which is opening up new production fronts.

In the near term, the change in shipping regulations is expected to be the most important factor for downstream markets. Under the new rules, which are due to be implemented on 1 January, ships will have to use low-sulphur fuel instead of heavy fuel oil, or install an exhaust gas cleaning system known as a scrubber.

The legislation will reduce demand and weight on prices for heavy fuel oil with high sulphur content.

“This is a major change in the quality specifications for global bunker fuels that we think has the potential to drive a major uptick in refining conditions, utilisation and margins – at least for a period of time,” says Fitzgibbon.

It will also weigh on the price of heavy crude, which is closely linked to demand for heavy fuel oil. Fitzgibbon says this will likely benefit the larger, more complex refineries that are heavy users of heavy crude oil as a feedstock, adding: “For the industry as a whole, we expect this to result in an overall improvement in profitability – at least for the short term.”

While countries in the Middle East with recently constructed, complex refineries are likely to benefit from a decline in the price of heavy crude oil, nations with more basic refineries are likely to suffer from lower revenues.

Audrey Dubois-Hebert, a consultant at UK-headquartered research company Facts Global Energy, says Iraq’s revenues from refined products will deteriorate due to the country’s lack of sophisticated refineries.

Iraq impact

“Looking ahead to 2020, the price of high-sulphur fuel oil is going to be a big area of weakness,” says Dubois-Hebert.

“Iraq is an important producer of fuel oil. So whatever new primary capacity you bring online, if you don’t have enough secondary units to add to your complexity, you are going to be producing high levels of fuel oil.”

In April, the Paris-based International Energy Agency (IEA) published a report that said Iraq’s refining sector was not well matched to the country’s needs. Only 60% of the country’s nominal one million b/d of refining capacity was utilised in 2018, and the product slate is weighted heavily towards heavy fuel oil.

Iraq’s excess in heavy fuel oil production means this product is exported, while the country remains dependent on imports for many other refined products, at an annual cost of about $2bn-$2.5bn. The IEA report said the full rehabilitation of Iraq’s Baiji refinery would help remedy the most immediate pressures. However, the report added that ‘without an increase in upgrading or hydrotreating facilities, the surfeit of heavy fuel oil may be increasingly problematic for Iraq’.

Over the longer term, the most important factor affecting the global downstream sector is expected to be the transition away from oil.

“Longer term, we think the outlook will be dominated by the effects of energy transition – and by this we mean the adoption of a variety of new technologies that we think will fundamentally reduce structural demand for oil products across the board and lead to a long-term decline in industry size,” says McKinsey’s Fitzgibbon.

The rise of electric and self-driving cars and increased connectivity will also play a leading role, with McKinsey estimating that peak oil demand in global road transport will come in 2026, while peak oil demand across all sectors will come only in 2032.

Refined output

The market for refined products is expected to remain stable through to 2035, according to McKinsey’s estimates, supported by demand growth in emerging markets and continuing global demand for liquefied petroleum gas, naphtha and jet fuel.

South and South-East Asia are expected to see the strongest market growth, at 1%, while the Middle East will see a 0.6% growth. By contrast, the refined products market in North America and Europe will contract by 0.2% and 0.4% respectively.

“One interesting secondary effect of this demand growth focusing on a few countries in a few regions is that it will provide some further negative effect; it will trigger and encourage further investment in refining capacity in those isolated growth areas,” says Fitzgibbon.

“This will contribute to the overall growth in the oversupply of refining capacity – and make the global market even worse. The behaviour behind this is one that is validated by history, where we typically see countries that are short on product and have strong growth continue to add refining capacity to serve their local demand – even if there is spare capacity available in nearby countries or regions. Post-2025, when the global market conditions become quite severe, we believe there will be a slowdown in this tendency.”

In the Middle East, the refining capacity being added is generally in the form of advanced, large-scale refineries that are more complex and efficient than the base capacity they are being added to – allowing more refined products to be made with less crude feedstock.

“This adds another element of oversupply to the overall outlook,” says Fitzgibbon, who notes that the Middle East’s easy access to cheaply produced crude and its close proximity to growing markets for refined products may give it some advantages over other regions in coming years.

Just how the Middle East refining sector will cope with the expected era of oversupply remains to be seen.

This article is published by MEED, the world’s leading source of business intelligence about the Middle East. MEED provides exclusive news, data and analysis on the Middle East every day. For access to MEED’s Middle East business intelligence, subscribe here.

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