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  • January 6th, 2012

Refinery closures raise fears on oil prices

Growing tension with Iran and a threat to global crude supplies may be dominating oil traders’ attention but a potentially bigger story is breaking on the demand side of the market.

Petroplus, Europe’s largest independent refining company, this week began shutting down three of its five refineries, halting about a quarter of a million barrels of daily production.

The move by the refiner follows plans by other operators to mothball half the refining capacity on the US Atlantic coast. Since the 2008-09 financial crisis, 2.6m barrels a day of capacity has disappeared from advanced economies, according to the International Energy Agency. More closures are coming.

These decisions will have a lasting impact on petroleum markets, say analysts. Refineries are the main customers for the world’s oil producers. Shutting down one plant reduces demand for the types of crude oil it uses if other refineries do not fill the gap.

In the case of Petroplus, half the oil its refineries process is similar to the high-quality, low-sulphur Brent crude traded on the ICE Futures Europe exchange, according to Bank of America Merrill Lynch Global Research. Spot markets for the benchmark North Sea grade, trading at more than $113 a barrel, could weaken as a result.

Cheaper crude prices do not necessarily mean cheaper fuel for drivers, airlines and trucking companies. Fewer refineries hand those that are left greater influence over prices on the forecourt. After Swiss-based Petroplus warned it faced a credit freeze last week indicative refining margins jumped in north-west Europe, according to data from the IEA and Purvin & Gertz, the consultants.

“When refineries close you have: number one, less demand for crude oil; and two, less supply of products,” says Francisco Blanch, head of commodities research at BofA Merrill Lynch. The bank expects refiners to cut 1m b/d of capacity this year.

Just over a decade ago, George W. Bush, then US president, declared: “What this nation needs to do is to build more refining capacity.” Then, in 2001, US refineries ran at 93 per cent of capacity. Now they are running at 86 per cent. The amount of idle crude oil distillation capacity has more than trebled to almost 1m b/d, US Energy Information Administration statistics show.

There are several reasons for this. The US refining industry responded to Mr Bush’s call. The ethanol industry took off, supplementing petrol supplies with fuel from corn. Strict new standards for sulphur and other pollutants were expensive for older refineries to meet.

Oil prices later rose and the financial crisis struck in 2008, sapping petrol demand. Europe’s debt crisis has not only slowed its economy but crimped access to loans for refiners such as Petroplus, which on Thursday announced its access to revolving credit had been suspended. Since mid-2008, nine refineries have closed in Europe, the IEA says.

“We still see more closures to come in Europe,” says Toril Bosoni, IEA refining analyst.

On the US east coast, Sunoco is selling refineries at Marcus Hook and Philadelphia, in Pennsylvania. It idled Marcus Hook last month. ConocoPhillips idled and put a nearby refinery on the auction block in September. Together these three units comprise more than half the refining capacity for a region that includes Boston, New York and Washington.

The closures come as global oil demand is set to break records this year. But the bulk of the consumption growth is in Asia and, to a lesser degree, the Middle East. It is to these regions that refiners have migrated. Many newer refineries are more complex than older plants in the west, and thus able to buy a slate of cheaper crudes to make a wider array of fuels and chemicals.

“You built to meet the expected growth in the region and have more capacity than is currently required,” says David Greely, commodities analyst at Goldman Sachs.

Oil markets are reacting. After Petroplus disclosed the credit freeze on December 27, profit margins for refiners using Brent jumped back into the black. These so-called “crack spreads” have been negative for much of the past year.

The price of Brent crude has meanwhile jumped on jitters over Iran, which has threatened to shut down a main tanker route as the west moves towards an embargo on Iranian oil imports. BofA Merrill Lynch nevertheless says Petroplus shutdowns “should increase the availability of light sweet crude oil in Europe” and thus weaken the premium for spot Brent over that of crude for later delivery dates.

With the US east coast closures, fuel suppliers may be forced to import more petrol from Europe, while Europe may need to buy more diesel from plants on the US Gulf of Mexico coast.

“Greater transportation distance and greater holding of stocks will probably have a cost impact,” says Mindi Farber-DeAnda, EIA oil economist. “We could potentially see higher and more volatile pricing.”

Casualty of crisis

Petroplus is shaping up to be a casualty of expensive crude and the European debt crisis.

Europe’s largest independent refiner on Thursday said all its revolving credit lines were suspended. Petroplus is shutting down its Petit Couronne refinery in France, with 162,000 b/d capacity; Antwerp, Belgium, with 108,000 b/d capacity; and Cressier, Switzerland, with 68,000 b/d capacity. Its UK and German refineries are still open.

The company’s losses mounted after high-quality crude prices soared when Libya’s output stopped last year, while Europe’s fuel demand is sluggish.

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