Chris Faulkner's Comments on Petroplus

Petroplus – first of many dominoes to fall?

The failure of the Petroplus refining group isn’t simply a local or regional concern. When viewed in the context of other world markets, it may prove to be the first of many dominoes toppled by a perfect storm of economic and market conditions.

Which dominoes fall after Petroplus will depend on the region and other political and economic conditions.

On a broad scale, Petroplus’ fate could appear almost inconsequential for the refining market. According to Morningstar analysts, it is Europe’s largest independent oil refiner by capacity, but its three refineries facing shutdown total only about 2% of total European capacity.

 

Sanctions impact

In fact, the shutdown of Petroplus’ three refineries could actually ease overcapacity in the region. However, the European Union has agreed to ban oil imports from Iran, and the US is under pressure to join the embargo. This embargo could accelerate additional refinery closures throughout Europe, hitting hardest the smaller and older refineries that specialize in the kind of heavy oil Iran provides.

Asian countries, of course, have ensured that their dominoes won’t be tipped, refusing to embargo Iranian oil. China and other Asian countries could end up buying Iranian oil at a discount, cutting European refineries out of the loop and selling their cheaper refined products back to Europe. If China and other Asian countries follow this course, dozens more European refinery dominoes could fall.

Saudi saviour?

While refiners can replace Iranian imports with Saudi Arabian and Russian oil, let’s not forget the age and extraordinary

exploitation of the Saudi oil fields. Saudi Arabia has always come to the rescue with ‘elastic reserves’, opening the valves and increasing daily oil production as needed.

Every time the Saudis do this, they damage the reserves and shorten the life of the fields. In the long term, they’re reducing the amount of producible ‘oil in place’. This is the reason Saudi Arabia is using secondary and tertiary recovery methods like water flooding, carbon dioxide (CO2) flooding and other controversial methods to stimulate production in their ageing fields.

Saudi Arabia doesn’t want to admit it, but the country reached peak oil production a long time ago and has not had any recent new discoveries. In the end, Saudi Arabia may not be able to come to the rescue after all.

Boon for US

The Petroplus situation has different implications across the pond. Indeed, it could prove to be a boon for US refiners. US exports have already been on the rise, up 22% in 2011 with a record 1.07mn barrels of distillates exported last October, according to the US Energy Information Administration (EIA). Europe received 48% of those exports, an increase of 43% from the year before.

Unlike many of their European counterparts, US refiners have been upgrading equipment and are wellsituated to process and export more crude. This is especially true as US refiners have been bitterly disappointed by President Obama’s refusal to approve the Keystone XL pipeline project, which would ultimately pipe tar sand crude from Alberta, Canada, to the US Midwest and Gulf Coast. The possibility of an influx of crude from the EU could help the US refinery dominoes stay upright, even while facing the potential for Canadian crude to be snapped up by the Chinese if the Keystone project doesn’t go through. At the same time, the price advantage from the glut of crude at the Cushing, Oklahoma, storage hub has begun to narrow, leaving American refineries looking for crude with higher profit margins.

In the meantime, oil prices have risen globally by over 30% since the start of the year, and are likely to continue rising as global politics and economies come into play.

It remains to be seen whether shale gas will lower oil prices. Although the production of shale gas is cheaper than any renewable alternative, it has always been a contentious energy product and the debates over shale gas – or, more precisely, the hydraulic fracturing methods used to extract shale gas – rage on. In the US, some vigorously oppose the practice and are seeking to ban it. France has voted to ban the use of hydraulic fracturing.

China, on the other hand, is embracing shale gas. The country’s largest energy company, CNPC, has pledged to increase its production of shale gas by 2015, attracting interest from both Shell and Chevron.

Due to the economic climate and the increasingly pressurised atmosphere of the Iran oil embargo, it’s difficult to predict how many and which refinery ‘dominoes’ will fall. The largest refineries seem best insulated against the potential ripple effect of Petroplus’ woes, while the smaller, older refineries appear vulnerable.